[Q&A] New Company Law: What to Do with "Employee Reward Fund"

2024. 11. 22

Question: Our company is a foreign-invested enterprise. We have always set aside an "Employee Reward and Welfare Fund" as stipulated in our company’s articles of association. With the five-year transition period of the Foreign Investment Law coming to an end, does this mean we no longer need to set aside this fund?

Answer: There is a misconception here that needs to be clarified. The five-year transition period of the Foreign Investment Law applies to foreign-invested enterprises established under the "Three-Foreign Enterprise Laws" (i.e., the Sino-Foreign Equity Joint Venture Law, the Sino-Foreign Cooperative Joint Venture Law, and the Wholly Foreign-Owned Enterprise Law). These enterprises need to adjust their organizational form and structure to comply with the Company Law within this transition period if they are inconsistent. For example, if the board of directors was the highest authority in the past, it must now be changed to the shareholders (if there is only one shareholder) or the general meeting of shareholders (if there are two or more shareholders). The transition period does not mandate changes to the existing three funds or their continued extraction. In fact, the Implementation Regulations of the Foreign Investment Law state that "existing foreign-invested enterprises, after adjusting their organizational form and structure according to the law, may continue to handle matters such as equity transfer, profit distribution, and remaining property distribution as agreed in the original joint venture contracts," meaning that if the Chinese and foreign shareholders still agree to set aside the Employee Reward and Welfare Fund, it is not against the law. Similarly, there are no mandatory provisions stating that wholly foreign-owned enterprises cannot continue setting aside this fund after the implementation of the Foreign Investment Law.

Of course, if the company decides not to set aside this fund in the future, it is also legal. However, from a practical standpoint, we do not recommend continuing to set aside this fund for the following reasons:

• The use of this fund is quite specific, mainly for "non-recurring employee rewards, subsidies for purchasing, building, and repairing employee housing, and other collective welfare." In practice, the feasibility of using it for purchasing or repairing employee housing is no longer practical, and non-recurring rewards overlap with regular employee benefits (such as team-building costs). Hence, the actual use of this fund has significantly diminished.
• Although the fund is extracted from post-tax profits, it is neither the property of the company nor the shareholders but is considered the common welfare property of all employees. This creates a complication in the liquidation of foreign-invested enterprises as the fund cannot be distributed to shareholders or used to offset economic compensations. According to strict regulations, it must be left to the unit that receives these employees (though such units often do not exist), adding unnecessary financial issues to the company's liquidation.

Question: What should be considered if we no longer want to set aside this fund?

Answer: Generally, two main aspects need attention:

1.Articles of Association: In the past, setting aside this fund was usually specified in the company’s articles of association. Therefore, to cease setting aside the fund, the procedure for amending the articles of association must be followed, including obtaining a resolution approval from the shareholders' meeting and filing the amendments for record.

2.Fund Usage: According to the Ministry of Finance's regulations on the implementation of the "Enterprise Accounting Standards" by foreign-invested enterprises, the "Employee Reward and Welfare Fund" should only account for the amounts transferred from the "Payable Wages" account and should be used for non-recurring employee rewards and collective welfare. Since the fund is extracted from post-tax profits, its nature remains collective employee welfare. Thus, in accordance with Article 4 of the Labor Contract Law and Article 17 of the revised Company Law, the abolition of this fund and related systems involves significant issues affecting employee interests and must follow the democratic process of "discussion by all employees or the employee representative congress" and "equal consultation with the trade union or employee representatives."

Question: If the fund is no longer set aside, can it still be used, and what should be noted?

Answer: If there is a balance in the fund after it is no longer set aside, it can certainly continue to be used. Generally, attention should be paid to the following two points:

1.Although the fund is extracted from post-tax profits, its usage is limited (as referenced above). Future usage of the balance must still be within the scope of employee welfare and cannot be converted into the company's capital reserves, distributed to shareholders, or used to offset the company's losses.

2.If the company has both an Employee Reward and Welfare Fund and extracts a "welfare fee" based on the total employee wages, it is important to note that the reward fund, as a post-tax profit extraction, does not affect tax adjustments even if annual expenditures exceed 14% of the total wages. However, the welfare fee extracted from the total employee wages must not exceed 14%, and the excess cannot be deducted from pre-tax costs for corporate income tax purposes. This involves specific financial and tax processing, so please confirm with your company’s financial personnel or accountants.