Most wages and salaries received by an individual working in China are subject to individual income tax (IIT). According to the regulations, ‘wages and salaries' includes wages, salaries, bonuses, yearend awards, dividends, allowances, subsidies and other employment-related remuneration.
It is common for foreign investment enterprises (lEs) in China to contribute to overseas insurance funds for the benefit of their expatriate staff. Contributions may be made to social insurance funds such as pensions, medical insurance, accident insurance or provident funds. Technically, such overseas insurance premiums or contributions made by the employer should be included as `wages and salaries' and subject to HT.
However, many enterprises in China have not reported in ITT returns the overseas insurance premiums paid for their employees. This might have been due to a general under-standing that overseas premiums would not be subject to IIT if no corporate tax deduction had been claimed by the enterprise in China. This understanding was based on Circular 170 issued by the State Administration of Taxation (SAT) in 1988.
Notwithstanding this circular, many enterprises in China did not report their contributions made to various overseas social insurance for their employees in calculating their employees' IIT liabilities. Moreover, most local tax authorities did not specifically request these contributions to be included in an employee's HT returns.
For the purposes of clarifying the taxation issue of overseas premium payments, the SAT issued Circular 101 on June 26, 1998. The circular, effective from this date, states that:
-enterprises are not allowed to deduct contributions made directly to overseas insurance in respect of employees working in China for the purposes of enterprise income tax. However, such a deduction can be claimed if an enterprise includes contributions as part of the wages and salaries paid to its employees
-if the enterprise has claimed a deduction for enterprise income tax purposes in respect of its contribution, such a contribution should be included as the taxable income of the respective employee when calculating ITT liabilities. If the enterprise has not claimed a deduction, such a contribution may not be included as the taxable income of the respective employee provided that the contribution is made in accordance with the laws of the employee's home country, that it should be paid or borne by the employer and approved by the local tax authority as not taxable
-employees working in China are not allowed to deduct the contributions made by themselves to overseas social insurance for the purposes of ITT.
In other words, the overseas insurance premium paid or borne by the employer is primarily subject to IIT regardless of whether it has claimed the corporate tax deduction for such an amount. In order that the payments or contributions made by the employer to overseas social insurance would not be subject to ITT, the following criteria must be satisfied:
-the enterprise does not claim a tax deduction when calculating its enterprise income tax liability
-the payments or contributions were made pursuant to the laws of the employees' home country, and
-the payments or contributions have been reported to, and approved by, the local tax authority as non-taxable.
Circular 101 states that where contributions made by an employer are not in accordance with the laws of the employee's home country (i.e. where it is not mandatory to make the contributions), such contributions would be taxable regardless of whether the enterprise would claim the tax deduction. Contributions made by an employer to a retirement fund registered under. Hong Kong's ‘occupational retirement scheme ordinance' are not considered as mandatory. The ordinance does not require all employers to make contributions but rather to make the contributions or join the scheme on a voluntary basis. However, when the mandatory provident fund ordinance actually becomes effective, the contributions made by the employer under this ordinance would satisfy the second criteria noted above.
After the issuance of Circular 101, the Guangzhou Local Tax Bureau issued Circular 45 in February 1999, reinforcing the collection of IIT on overseas insurance payments or contributions made by an employer for all employees. According to this circular, the HT treatment should follow the principles laid down in Circular 101 with effect from June 1, 1998. Circular 45 further states that the ITT treatment of the contributions made prior to June 1998 would be by reference to the old Circular 170.
It is not clear whether the local tax authorities of other cities will strictly follow this circular.
Late payment surcharge
It seems that Circular 101 and the recent circular issued by the Guangzhou tax bureau mainly affect expatriate employees. For local employees, the employer's statutory contributions to some social insurance funds in China may be non-taxable. According to another circular, both the employer's and employee's contributions to the housing provident fund, medical insurance or pension fund, which are made in accordance with Chinese law or local government regulations and actually paid to the designated financial institutions, are not taxable. However, any contributions made to these funds over the statutory limits will be taxable. Also taxable are contributions made to other insurance or funds that are not specifically required under the laws or regulations.
In conclusion, the employer's contributions to the overseas insurance funds are generally taxable in China unless certain criteria are met. Statutory contributions made by the employer to some social insurance funds in China for the benefit of local employees are exempt. Nevertheless, these circulars would have significant tax impact on both the enterprises and their employees. In addition, as Circular 45 has a retrospective effect, late payment surcharge and penalty may also be imposed on the underpaid tax due to the under-reported amount of insurance payments.
In view of the above, it is suggested that all enterprises likely to be affected by these circulars should immediately review their current position to evaluate the potential tax issue and design appropriate measures.
Prepared by Charles Leung, tax partner, and Peggy Lue, senior tax manager, of Price water house Coopers.