Background – drawbacks with China’s pension system
China’s pension system is currently centred around three primary pillars: state-endorsed public pension, enterprise annuities and personal pension. The first two pillars, state-endorsed public pension and enterprise annuities, currently serve as the bedrock of China’s pension regime;
The main drawback of China’s public pension has always been the lack of national coordination, with funds typically being segregated to local areas. To eliminate this limitation, the National Council for Social Security Fund (NCSSF) was established in 2000 to operate and manage the National Social Security Fund (NSSF). The NCSSF selects fund management companies which are approved and licensed by the China Securities Regulatory Commission (the CSRC) to carry out investment activities for the NSSF across the country, the overall purpose being to accumulate capital to counterbalance potential public pension deficits. The NSSF is, however, limited by its investment scope (eg it is prohibited from making foreign investments).
The enterprise annuity scheme, also known as the Supplementary Endowment Insurance System, was established in 2004, whereby independent legal persons approved by state financial regulatory authorities were authorized to act as investment managers of enterprise annuity funds. Despite its importance to China’s pension system, Enterprise Annuities suffer from low participation rates due to the lack of incentives for Chinese enterprises to adopt an occupational pension scheme (compared to similar arrangements in developed countries) and the high establishment costs.
Notice on income tax deferral on commercial pension contributions
In light of growing discontent with the pension system and a demographic trend towards an older population, the Chinese government recently shifted its focus towards personal pension.On 2 April 2018, the Ministry of Finance, State Administration of Taxation, Ministry of Human Resources and Social Security, CBRC and CSRC jointly issued a notice introducing individual income tax deferral for contributions to eligible commercial pension schemes, encompassing investment gains and retirement distributions (the Notice), in the hopes that a greater proportion of people would be incentivized to participate in their own retirement arrangements.
Key information regarding the deferral scheme:
1) Duration and location of the pilot programme
The pilot programme commenced on 1 May 2018 with a tentative duration of one year (ie expires on 1 May 2019). The programme was simultaneously inaugurated in Shanghai, Fujian Province (including Xiamen) and Suzhou Industrial Park Zone.
2) Eligibility
Individuals and sole proprietors located in any of the pilot areas with taxable individual income derived from enterprises whose actual place of business are also located in pilot areas are eligible to participate.
If an individual derives income from two or more sources, some or all of which are located in pilot areas, he or she must select one source to benefit from income tax deferral.
3) Application of tax benefits
Contributions to qualified commercial pension plans through personal commercial pension fund accounts may be deducted, within a specified cap, from taxable income.
Individual income tax is not levied on any investment gains in commercial pension funds. Tax will only be imposed once funds are withdrawn from the individual’s pension fund account, whereby 25 per cent is completely exempt and the remaining 75 per cent will be subject to a tax rate of 10 per cent.
Looking forward
Individual pension fund accounts are currently restricted to commercial endowment insurance plans. The Notice expressly indicates, however, that the scope of eligible financial institutions and plans will be expanded accordingly after the trial period, subject to the programme’s outcome and impetus towards further developing personal pension initiatives. This includes the possibility for hedge funds to be incorporated into the scope of permitted investments for pension fund accounts. In our opinion, this reflects increasing flexibility from regulatory authorities in relation to an individual’s freedom to decide his or her own retirement arrangements. If and when individual pension accounts are allowed to invest into hedge funds, provided that such investments enjoy similar tax benefits as insurance plans, the hedge fund industry will likely experience a capital surge; fund managers should be poised to embrace this enormous opportunity.
