05 April 2014

New Individual Income Tax Deferral Treatment for Enterprise Annuity

On December 6, 2013, the Ministry of Finance, the Ministry of Human Resources and Social Security and the State Administration of Taxation jointly issued the Notice on Issues concerning Individual Income Tax (IIT) on Enterprise Annuities (CAI SHUI [2013] No.103) ("Circular 103"). For the first time, the IIT deferral mechanism, which has been commonly applied in other countries, is introduced to enterprise annuities in China. The new tax treatment for enterprise annuities became effective on January 1, 2014.

This article will comment on the operation of enterprise annuities, the key points of Circular 103, as well as comparing the old and new policies.

I.Enterprise annuity and its operations

The pension insurance system in China mainly consists of basic pension insurance, supplementary pension insurance and individual saving pension insurance. Enterprise annuities are classified within the category of supplementary pension insurance. Specifically, an enterprise annuity is, in addition to the basic pension insurance, a supplementary pension voluntarily established by the enterprise and its employees in accordance with the Trial Measures for Enterprise Annuities (Order of the Ministry of Labor and Social Security No. 20) and other relevant policies and regulations.

The enterprise annuity fund is allocated to and held by the personal accounts on the individual-by-individual basis. The fund consists of the employer's contribution, the employee's contribution and any gain from investment of the annuities. The contributions made by employers and employees based on an annuity plan, and the gain from investment of enterprise annuities are credited to each personal account. An individual employee may withdraw funds from his/her personal account :1) upon reaching statutory age of retirement (generally age 60 for men, and age 50 or 55 for women),either in a lump sum or in periodic installments; 2) in the case of permanent emigration, in a lump sum; 3) upon the death of an employee or a retiree, the balance of his/her personal annuity account may be withdrawn in a lump sum by the designated beneficiary or the legal heir of the individual. Other than the above-mentioned scenarios, withdrawal of funds from the personal accounts of enterprise annuities is prohibited.

Enterprises establishing a pension plan are required to adopt a trust management structure centered on either an enterprise annuity council or a corporate trustee ("Trustee"). Initially an enterprise will appoint a Trustee to manage the enterprise annuity. The Trustee may either be an enterprise annuity council formed by the enterprise or it may be a legal-person trust institution established in accordance with the relevant requirements of the State. Subsequently, the Trustee may 1) engage a qualified enterprise annuity account management institution ("Account Manager"), to be responsible for the management of the enterprise annuity; 2) engage an enterprise annuity fund custodial institution ("Custodian") to take custody of the enterprise annuity fund; 3) appoint a qualified investment operation institution to be the investment manager ("Investment Manager"), to administer and operate the enterprise annuity fund. The management of enterprise annuity fund is supervised by the Ministry of Human Resources and Social Security.

The relationship of the parties involved is summarized in the following diagram relating to the new IIT deferral treatment:

IT deferral treatment diagram

II.New IIT rules on enterprise annuities

Under Circular 103, the IIT treatment for the contribution, investment and withdrawal of enterprise annuities is prescribed as follows:

A. Contribution

  • An enterprise or vocational annuity contributed by an enterprise for its employees based on statutory regulations[1] is provisionally not subject to IIT when credited to the personal accounts of employees
  • Employee annuity contributions, based on statutory regulations, not exceeding 4% of taxable base salary are provisionally deductible from the employee's taxable income
  •  Enterprise and employee contributions exceeding the two limits will be consolidated in the taxable base salary of the employees and are subject to IIT as per the relevant rules
  • The individual taxable base salary for enterprise annuity contributions is to be the average monthly salary of an individual for the previous year. The average monthly wage is calculated using the statistics prescribed by the National Bureau of Statistics. That part of the average monthly salary[2] exceeding 300% of the previous year's average monthly salary of the district-established city where the individual works, shall not be included in the taxable base salary.

B. Investment

When the gain derived from investment of an annuity fund is allocated to an individual's personal account, the individual shall provisionally not be subject to IIT.

C. Withdrawal

Funds withdrawn by an individual from enterprise annuities shall be subject to IIT under the category of "wage and salary income". The specific tax assessment mechanism shall differ depending on when and how the annuity is withdrawn (e.g., by month, quarter, annum or in a lump sum).

III.Comparison of old and new policies

The new tax deferral treatment for enterprise annuities became effective on 1 January 2014, contributions and withdrawals of enterprise annuities made after 1 January 2014 are entitled to the new treatment under circular 103.Before 2014, there were rules pertaining to the IIT treatment on enterprise annuities.However, it should be noted that in comparison with the old rules, the new policy not only defers taxation on enterprise annuities to withdrawal, but also provides preferential treatment to employees' contributions, i.e. the contribution made by an employee within 4% of his/her average monthly salary in the preceding year will be deductible before IIT. Furthermore, the new tax deferral policy also encourages the withdrawal of annuity in installments.The old and the new tax policies on enterprise annuities are compared as follows:

China Bulletin

IV.Issues to be noted

As Circular 103 is a relatively new regulation, during its implementation, the transition from the old rules and some technical issues may require special attention by enterprises during establishment and execution of annuity plans.We have summarized below a few such practical issues:

A. In the event that an enterprise and its employees have failed to fully settle the IIT on the annuities contributed before 1 January 2014, it is not clear whether such contributions will enjoy the tax deferral treatment by application of Circular 103.

For contributions made by an enterprise and its employees before 1 January 2014, where IIT has not been duly settled,it is not clear whether such contributions will be eligible for the IIT deferral treatment under Circular 103; if not, then how the overdue IIT should be calculated and settled needs to be clarified.

B. Under circular 103, individuals shall be subject to IIT on annuities contributed beyond the prescribed limits.The potential double taxation on the withdrawal of such excessive contributions needs to be addressed.

As mentioned above, under the new rules, the portion of annuities contributed by an enterprise and its employees beyond the prescribed standards (i.e. employer's contribution exceeding 1/12 of its employees' total salary during the preceding year, and an employee's contribution exceeding 4% of his/her taxable base salary) is to be consolidated into the taxable income of the employees and will be subject to IIT. In this context, in order to avoid the potential double taxation on the excessive contributions, it is necessary to address whether such IIT paid should be considered when calculating the IIT levied on the withdrawals of annuities.

C. Tax registration requirement

Within 15 days of the month following the setting up of an annuity plan, an enterprise must submit the annuity plan, the filing document issued by the human resources and social security authority, the plan confirmation letter and other required materials to the tax authority. Where the annuity plan, Trustee, or Custodian has changed, the aforesaid materials must be re-submitted to the tax authority within 15 days of the following month after the change occurred. It is worth noting that Circular 103 does not specify the legal consequences for failure to submit an annuity plan to the tax authority on time. As such, in practice, there may be cases where the local tax authority would not allow an annuity plan to enjoy the deferred tax treatment under Circular 103, if it is not filed in time with the tax authority.Therefore, taxpayers should be mindful of the tax registration requirement under Circular 103.

D. IIT withholding obligations for enterprise annuities

At the time of contribution, an enterprise is obligated to withhold the IIT on taxable contributions, and to declare and settle such IIT with the tax authority in charge of the enterprise. At the time of withdrawal, the Custodian is obligated to withhold the IIT, and declare and settle the IIT with the tax authority in charge of the Custodian.

Under the relevant tax regulations, if a withholding agent fails to comply with applicable rules for the withholding of taxes, the tax authority is empowered to impose on the withholding agent a fine ranging from 50% to 300% of the taxes not withheld. As such, when implementing an enterprise annuity plan, the enterprise and the Custodian should strictly fulfill the relevant tax withholding obligations.

V. Conclusion

We believe that the IIT deferral treatment as provided under Circular 103 will encourage more enterprises to set up enterprise annuity plans, which will render support to the establishment of a multiple-level pension system in China. We will closely monitor the enforcement of Circular 103 going forward and keep you updated on new developments.

(This article was originally written in Chinese, the English version is a translation.)

Notes:

1. According to the Provisional Measures for Enterprise Annuities, annuities contributed by an enterprise per annum should not exceed 1/12 of the total salaries of the employees for the previous year; total annuities contributed by an enterprise and its employees per annum generally should not exceed 1/6 of the total salaries of the employees for the previous year

2. According to statistical data released by local Human Resources and Social Security Bureaus in 2012 (the data for 2013 has not been publicly released), the average monthly salary in Beijing is CNY5,223; in Shanghai, the average monthly salary is CNY4,692; in Shenzhen, the average monthly salary is CNY4,918

3. Old policy refers to Circular of the State Administration of Taxation on Issues Concerning the Imposition and Administration of Individual Income Tax on Enterprise Annuities (Guo Shui Han [2009] No. 694) and Announcement of the State Administration of Taxation on Supplementary Provisions on Relevant Issues Concerning Individual Income Tax on Enterprise Annuities (Announcement of the State Administration of Taxation [2011] No. 9)

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