On March 19, 2009, the Ministry of Finance (MOF) and the State Administration for Taxation (SAT) jointly issued the Circular on the Pre-Tax Deduction Policies for Enterprises’ Handling Fees and Commissions, which came into effect on its date of issuance and applies retroactively from January 1, 2008. The Circular sets ceilings for the deduction of enterprises’ handling fees and commissions (Commissions) for enterprise income tax (EIT) purposes. Under the Circular, only the Commissions below the prescribed ceilings are deductible for EIT purposes.
According to the Circular, the Commissions that a property insurance company may deduct for EIT purposes is up to 15 percent of the quantity equal to the total premium income less the total cash surrender value (the Quantity). A life insurance company, on the other hand, may only deduct up to 10 percent of the Quantity. Technically, the Circular defines the Quantity as the total premium income less the total cash surrender value et cetera, which implies that the total cash surrender value might not be the only item subtracted from the total premium income. Though the Circular is silent on how to deal with Commissions related to the cash surrender value (i.e. Commissions paid to the commission agents before the surrender), tax experts’ prevailing opinion is that such Commissions will not be considered in the calculation of the Quantity.
For a non-insurance company enterprise, the Circular sets the deduction ceiling at 5 percent of the revenue generated under the commission agreement executed by the enterprise and a qualified commission agent (regardless of whether that agent is an enterprise or a natural person, or whether the signatory is a contract party’s employee, agent or representative). Unless paid to natural person agents, any Commissions paid in cash or other non-account transfer methods will not be deductible for EIT purposes. In addition, Commissions paid by an enterprise to a security underwriter for the issuance of equity securities are nondeductible for EIT purposes. The rationale behind this restriction is that such expenses should be subtracted from the premium price of the issued securities. The Circular does not extend this restriction to debt securities, however. When an enterprise pays Commissions to an underwriter for the issuance of debt securities, such Commissions will be still deductible for EIT purposes.
The Circular also provides that Commissions may not be included in any kickback, percentage deduction, rebate, slotting fee, or the like. Similarly, no kickbacks, percentage deductions, rebates, slotting fees, or the like will be treated as Commissions under this Circular. In addition, enterprises may not directly offset Commissions against service contract prices. Rather, they must keep faithful accounts of such expenses.
The Circular further clarifies the capitalization of Commissions. When Commissions are incurred by an enterprise for its fixed or intangible assets, these Commissions should be deducted through depreciation or amortization, instead of a one-time deduction in the current period. This is consistent with prevailing accounting rules – since fixed and intangible assets are capitalized, the relevant Commissions should be also capitalizable.
All in all, the Circular will serve as clear guidance for EIT taxpayers and their taxation authorities in deducting handling fees and commissions.