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For years, many factories in China treated social insurance as something to negotiate. Workers who wanted more take-home pay agreed to skip contributions or have them calculated on the city's minimum base, and employers saved money. Enforcement was patchy, so the risk felt manageable.
That changed with two developments. Social insurance collection moved to the tax authorities, which now cross-check payroll, tax, and contribution data. Then, from 1 September 2025, the Supreme People's Court's Interpretation II made any agreement to waive social insurance invalid. Together, they turned a long-tolerated grey area into a clear liability.
This case study follows one fictional manufacturer through a labor inspection, from the first sign of trouble to the corrective plan, and ends with a checklist you can use for your own self-audit.
The Company
"Precision Components Co." is a foreign-invested enterprise (FIE) making electronic parts in the Pearl River Delta.
| Profile | Detail |
|---|---|
| Ownership | Wholly foreign-owned subsidiary of a European group |
| Headcount | 600 direct employees and 130 dispatched workers from an agency |
| Workforce | Mostly production line workers, plus engineers and office staff |
| Payroll | Run in-house by a three-person team, with headquarters reviewing it once a quarter |
On paper, the plant was compliant. All direct employees had written contracts, social insurance was registered, and overtime was recorded. Underneath, four problems had built up over several years.
Step 1: How the Company Got Flagged
Two separate triggers came together.
- An employee complaint. A line supervisor resigned and filed for labor arbitration. She claimed severance on the grounds that her social insurance had been calculated on the city's minimum base for three years, not on her actual salary.
- A data mismatch. Her complaint led the local social insurance authority to compare the company's contribution records with the wages reported to the tax authorities. For about 400 production employees, the wages reported for tax were well above the base used for social insurance.
The labor inspection authority then issued a notice of inspection, asking for two years of payroll records, attendance data, labor contracts, and the company's agreements with its dispatch agency.
Lesson: Most inspections start with an employee complaint or a data mismatch, not a random visit. Both are far more likely now that Interpretation II gives employees a clear legal route to claim.
Step 2: What the Inspection Found
| Finding | What Was Happening | Why It's a Violation |
|---|---|---|
| 1. Underpaid social insurance | Production workers' social insurance was calculated on the city's minimum base, not their actual average wages. Some had signed "voluntary" statements agreeing to this in return for a monthly cash allowance | Contributions must be based on actual wages, within the city's floor and ceiling. Under Interpretation II, waivers and cash-in-lieu agreements are invalid |
| 2. No social insurance during probation | New hires weren't enrolled until they passed their three-month probation | Social insurance is required from the start of employment, including probation |
| 3. Overtime underpaid | Overtime was calculated on the local minimum wage instead of each worker's actual base wage. Monthly overtime regularly went over 36 hours in peak season | Overtime must be paid at 150%, 200%, or 300% of the actual wage. Overtime is capped at 36 hours a month unless an approved alternative working hours system is in place |
| 4. Too many dispatched workers | Dispatched workers made up about 18% of the total workforce (130 of 730), and most worked on core production lines all year round | Dispatched workers are capped at 10% of total headcount and limited to temporary, auxiliary, or substitute roles |
A fifth issue came up in the document review. Several long-serving employees had been on serial one-year contracts. After two consecutive fixed-term contracts, an employee can generally require the employer to offer an open-ended contract. Refusing exposes the employer to claims for double wages.
Step 3: Measuring the Exposure
The company's lawyers estimated the cost before responding. These figures are illustrative.
| Exposure | How It's Calculated | Rough Estimate |
|---|---|---|
| Social insurance back payments | About RMB 2,500 a month underreported per worker × around 30% employer rate × 400 workers × 24 months | About RMB 7.2 million |
| Late payment surcharge | 0.05% a day on overdue contributions | Grows every day until paid |
| Overtime back pay | The gap between pay calculated on the minimum wage and on actual wages, for two years | Several million RMB, depending on hours |
| Severance claims | One month's wage per year of service for any employee who resigns over unpaid social insurance | Potentially the largest item if many employees claim |
| Dispatch penalties | If not corrected within the deadline, RMB 5,000 to 10,000 for each worker over the limit | Up to about RMB 0.6 million for around 57 excess workers |
| Fines for not paying after an order | One to three times the unpaid amount | Avoided only by paying on time |
The biggest risk wasn't the fines. It was the possibility of large numbers of employees resigning and claiming severance once they learned they could. That's the effect of Interpretation II.
Step 4: The Response
The company took five steps over about four months.
- Brought in outside counsel and stopped further damage. It froze all new "voluntary" social insurance statements and began enrolling every employee from day one, including on probation.
- Cooperated fully with the inspector. It submitted the requested records on time and agreed a correction plan instead of disputing findings it couldn't defend.
- Paid back contributions. It recalculated two years of contributions on actual wages, paid the arrears and surcharges, and corrected the base going forward. Under Interpretation II, an employer that pays the arrears can ask employees to repay any cash allowances they received in place of social insurance. The company decided not to pursue this, to protect employee relations.
- Fixed overtime. It recalculated overtime on actual wages, paid the difference, and introduced attendance controls to keep overtime within the legal limits. For seasonal peaks, it applied for an approved comprehensive working hours system.
- Restructured the dispatched workforce. It moved 70 long-term dispatched workers in core production roles onto direct employment contracts, bringing dispatched workers below 10% of total headcount. It also limited the remaining dispatched workers to genuinely temporary or auxiliary roles.
Outcome: The inspection closed with a correction order and no additional fines, because the company corrected everything by the deadline. The arbitration claim was settled. Labor costs went up by about 8% a year, but the company's exposure to mass severance claims was removed.
Why "Cash Instead of Social Insurance" No Longer Works
Article 19 of Interpretation II states that:
- Any agreement between employer and employee not to pay social insurance, or any written waiver by the employee, is invalid.
- If the employer doesn't pay social insurance, the employee can resign and claim severance, even if they agreed to the arrangement.
- If the employer later pays the arrears, it can ask the employee to return any cash compensation paid in place of social insurance.
In practice, any "voluntary" waiver still in your files gives you no protection and gives employees grounds for a claim. Even employers who paid generous cash allowances are exposed.
Self-Audit Checklist for HR and Finance Teams
| Area | Check |
|---|---|
| Social insurance | ☐ All employees, including those on probation, enrolled from their first day |
| ☐ Contribution base matches each employee's actual average wage from the previous year, within the city's floor and ceiling | |
| ☐ No waiver statements or cash-in-lieu arrangements | |
| ☐ Contribution base updated at the city's annual reset, usually in July | |
| ☐ Housing provident fund contributions also paid on the correct base | |
| Contracts | ☐ Written contract signed within one month of each start date |
| ☐ Open-ended contracts offered where required after two consecutive fixed-term contracts | |
| ☐ Probation periods within legal limits for the contract length | |
| Working time and overtime | ☐ Overtime calculated on actual wages, at 150%, 200%, or 300% |
| ☐ Monthly overtime within 36 hours, or an approved alternative working hours system in place | |
| ☐ Attendance records match payroll | |
| Labor dispatch | ☐ Dispatched workers are 10% or less of total headcount |
| ☐ Dispatched workers only in temporary (up to six months), auxiliary, or substitute roles | |
| ☐ The agency holds a valid labor dispatch license | |
| ☐ No "outsourcing" contracts that are really dispatch arrangements | |
| Older workers | ☐ Written agreements, at least the minimum wage, and work injury insurance for employees past retirement age, under the rules in force since 1 July 2026 |
| Data consistency | ☐ Wages reported for individual income tax match the social insurance base |
Where an EOR Fits, and Where It Doesn't
An Employer of Record is the legal employer of the staff it hires for you. It registers them for social insurance and the housing fund, calculates contributions on actual wages, issues compliant contracts, and runs payroll. For companies without an entity in China, or with small teams outside their main entity, this removes most of the employer-side risks described above.
There are limits. If your own China entity uses workers provided by a third party, that can be treated as labor dispatch, which means the 10% cap and role restrictions still apply at your entity. An EOR doesn't solve a dispatch quota problem in a factory you run yourself. For large manufacturing workforces, the long-term fix is usually direct employment, with compliant payroll and social insurance processes behind it.
How Slasify Helps
Slasify helps foreign companies hire in China and run payroll there compliantly:
- Employer of Record: Hire employees in China without your own entity. Slasify acts as the legal employer and handles contracts, social insurance, the housing fund, and individual income tax.
- China payroll compliance: For companies with their own entity, calculate contribution bases on actual wages, apply city-specific rates and the annual resets, and keep tax and social insurance data consistent.
- Regional coverage: Run payroll in China, across APAC, and in more than 150 countries from one platform.
Preparing for a Labor Inspection in China?
Talk to Slasify about checking your China payroll and social insurance setup, or about hiring compliantly through our Employer of Record. Book a free consultation.
FAQs
1. What is Judicial Interpretation II? The Supreme People's Court's second interpretation on labor dispute cases, in force since 1 September 2025. Among other things, it makes agreements to waive social insurance invalid and lets employees resign and claim severance if their employer doesn't pay social insurance.
2. Can employees in China agree to receive cash instead of social insurance? No. Since 1 September 2025, such agreements are invalid even if the employee asks for them. The employer still has to pay the contributions, and the employee can resign and claim severance.
3. What is the labor dispatch limit in China? Dispatched workers may make up no more than 10% of an employer's total workforce. They may only fill temporary roles (up to six months), auxiliary roles, or substitute roles.
4. What triggers a labor inspection in China? Most often an employee complaint or arbitration claim, or a mismatch between payroll, tax, and social insurance data. Industry-wide inspection campaigns and site visits also happen.
5. How is overtime pay calculated in China? At 150% of the employee's actual wage on working days, 200% on rest days without time off in lieu, and 300% on public holidays. Overtime is generally capped at 36 hours a month.
6. Does an Employer of Record remove all China labor risk? An EOR takes on most employer obligations for the staff it employs, such as contracts, social insurance, and payroll. It doesn't change the labor dispatch rules that apply to your own entity if you use agency workers there.