China's social insurance system has been undergoing numerous changes since 1997 when the central government began its campaign to establish a unified social security system that will provide basic social benefits coverage to its vast population of workers and retirees. Although foreign investment enterprises (FIEs) in China now have a better under-standing of social security regulations and an increasing number of them are complying with social security contribution requirements, confusion still remains.
Besides the regional differences in social security requirements and practices, some FIEs are puzzled by the tax treatments on certain benefits-related items.
Corporate income tax
Before the issuance of Circular 709 by the State Administration of Taxation on October 27, 1999, the tax treatment for various welfare benefit funds mandated by the Ministry of Finance and labour bureaux was not clear. Local tax authorities had different interpretations on what types of employment and social security benefits provided by FIEs could be accrued and how much could be deducted for corporate income tax purposes.
Since the introduction of this circular, FIEs can accrue employer contribution to the medical insurance fund, housing fund and pension fund based on state and local government regulations. FIEs can also accrue the education fund and labour union fund according to relevant finance regulations.
In Beijing, for example, FIEs are required to pay the following five funds as a percent-age of their total wage bill: 7.5 percent to the medical insurance fund, 10 percent to the housing fund, 20 percent to the pension fund, 1.5 percent to the education fund and 2 percent to the labour union fund. For the first four funds, the term `total wage bill' refers to all wages of local employees, while the labour union fund also includes the pay-roll of any expatriate employees.
Besides accrual of employer contributions to these five funds, FIEs are required to accrue 14 percent of their total salary to subsidise general welfare expenses, covering items such as employee living expenses, medical services, nursery education and transportation. However, Beijing Tax Bureau in 1995 issued a document that requires FIEs in the capital to accrue 20 percent of the total payroll as general welfare, 6 percent higher than the 14 percent required by the national financial regulations.
For corporate income tax purposes, Circular 709 stipulates that accrued general welfare expenses can be deductible only if they have actually been used. In addition, the total maximum annual deductible general welfare expenses claimed by a company may not exceed 14 percent of its total local employee payroll cost for the year. Furthermore, any general welfare expenses accrued but not used – the non-tax deductible amount – cannot be carried forward to future years. In cases where an FIE has accrued more than 14 percent of its total payroll for general welfare expenses prior to the issuance of Circular 709, the portion in excess of 14 percent should be adjusted as a permanent difference regardless of how much the FIE has actually spent on general welfare for its employees.
The impact of the regulations issued by various authorities can be significant on FIEs that carry a large balance of provision for the five funds and general welfare. For tax purposes, any accrued amount as of the end of 1999 should be reversed and charged to the 1999 profit and loss statement.
On the other hand, FIEs must continue accruing the expenses according to the various finance regulations. Companies therefore would have to account for a timing difference between statutory and tax accounts and make the tax adjustments in their annual corporate income tax returns.
Individual income tax
For local Chinese employees, their contributions to the statutory medical insurance fund, housing fund and pension fund within the stipulated limits are deductible for individual income tax purposes.
Expatriate employees working in China are presently not required to make any contributions to statutory social security funds. Any foreign social security contributions and overseas insurance premiums made by expatriate employees are not deductible in deter-mining their taxable income in China. More-over, any contributions to overseas benefits plans made by an employer for its expatriate employees working in China should be included as part of their China-sourced tax-able income unless those contributions are statutory in nature and no China corporate income tax deduction has been claimed.
In future, the Chinese authorities may introduce changes to the social security system in order to boost state funds. Any future changes may also have an impact on the corporate and individual income tax treatments.
This article was written by May Huang, tax partner, and Edmund Yang, tax manager, PricewaterhouseCoopers in Beijing. This information is not intended to be either comprehensive or final. Professional advice is recommended before making any planning arrangements.