On 10 December 2009, the State Administration of Taxation ("SAT") issued Guoshuihan [2009] No. 694 ("Circular 694") to clarify the China's individual income tax ("IIT") treatment of contributions made to enterprise annuity plans established by Chinese employers.
This position was previously unclear as another circular, Caishui [2009] No.27 ("Circular 27"), jointly released by the SAT and the Ministry of Finance in June 2009 only address the corporate income tax ("CIT") treatment of employers' contributions made to enterprise annuity plans without addressing the respective IIT position. Hence, this had created practical uncertainty for both Chinese local-level tax bureaus as well as employees and employers. Circular 694 now removes this uncertainty and provides guidelines for ongoing IIT treatment and rectification measures in dealing with contributions made prior to this circular.
In this issue of News Flash, we will provide the salient points of Circular 694, and share our insights and observations.
Salient points of Circular 694 
Enterprise annuity plans are considered as long-term reward schemes and have been implemented by many companies in China, including domestic enterprises and foreign investment enterprises. It is also common for employers to prescribe certain vesting conditions (such as, the number of service years) on the employer's contributions to an enterprise annuity plan for long-term employee retention purpose.
What is good Previously, the IIT treatment of contributions to an enterprise annuity plan was not clear. We noted that there were different IIT treatments on the contributions which were mainly based on discussions with the relevant local-level tax bureaus on a case by case basis. Circular 694 now removes this uncertainty and provides guidelines on ongoing IIT treatment and rectification measures and introduces a concessionary treatment for calculating the IIT on the employer's contributions.
It is clear from Circular 694 that the taxing point of employer's contributions is at the time of the contributions and the tax authorities will no longer allow an employer to defer the taxing point of unvested employer's contributions until a later time when the contributions are fully vested. The introduction of the IIT refund mechanism in respect of the forfeited employer's contributions provides a relief for the employees who are being taxed upfront on the benefits they are not otherwise entitled.
Companies may be encouraged to establish an enterprise annuity plan in China due to the concessionary IIT treatment on employer's contributions allowed by Circular 694. Companies which have implemented an enterprise annuity plan should revisit their plans to ensure that it qualifies for the concessionary IIT treatment.
What is challenging Circular 694 imposes an extra burden on employers. It makes clear that employers have the responsibility to withhold and report the IIT on the employer's contributions made to an enterprise annuity plan. In addition, although IIT refunds on forfeited employer's contributions can be claimed by an employee, employers will still have to provide documentation, such as IIT withholding reports and receipts and annuity contributions details, etc, to support the employee's application. This will increase the administrative burden to HR and finance departments, especially in those industries which have relatively high staff turnover rate.
Further, employees may no longer find enterprise annuity plans to be attractive as they have to pay IIT upfront even on the unvested employer's contributions (bearing in mind that no cash is received by the employees and they have to dig into their own pockets to pay the IIT) despite they can have some IIT savings due to the concessionary IIT treatment under Circular 694. Companies which have implemented an enterprise annuity plan may have to revisit their plans to ensure that it can continuously meet their reward target.
From the employer's perspective, it is still harsh to see that Circular 27 only allows deduction of employers' contributions to enterprise annuity plans to be capped at 5% of total salary cost for CIT purposes. In other words, the employer would be unable to claim the CIT deduction in respect of the excess contributions and, at the same time, the employee would need to pay IIT in respect of the employer's contributions - this would result in a lose-lose situation.
What is uncertain
Pension plans are generally classified into "defined benefit plans" and "defined contribution plans". The former plan normally guarantees a certain payout at retirement, according to a fixed formula which usually depends on the member's salary and the number of years' membership in the plan. The latter plan provides a payout at retirement that is dependent upon the amount of money contributed and the investment performance of the fund in the plan. It appears that Circular 20, Circular 27 and Circular 694 have only covered the regulatory and tax issues of defined contribution plans. It is uncertain how the accrued benefits under defined benefit plans should be accounted for both IIT and CIT purposes. It leaves a vacuum to be filled up.
According to Circular 694, an employee can claim IIT refunds on forfeited employer's contributions with supporting documents provided by the employer. However, it remains to be seen how simple and fast the IIT refund process would be.
Circular 694 is silent on the tax treatment of the investment income and gains of an enterprise annuity plan. There are a few fundamental issues that have to be addressed. For example, do the investment income and gains belong to the employers or employees and consequently what type of tax (i.e. CIT or IIT) should be triggered, if any? If such income belongs to the employees, is it taxable (bearing in mind that gains derived by Chinese individuals from the buying and selling of shares listed in the Chinese stock exchanges and unit of funds are currently exempt from IIT)? If it is taxable, what is the timing of taxation (at the time the income is earned or at the time of withdrawal upon retirement?). It is likely that the SAT needs more time to analyse these issues before clarifying the relevant treatments.
Employers which have implemented an enterprise annuity plan but have not reported any IIT on employer's contributions should take immediate action to settle the underpayment of IIT in order to minimize potential late filing interests and penalties.
