Individual Income Tax Treatment for Stock Compensation Schemes

Oct.
16 – The Chinese State Administration of Tax has released circular
Guoshuihan [2009] 461, clarifying PRC Individual Income Tax (IIT)
treatment for income generated from share appreciation rights and
restricted share units granted to employees by listed companies, as
well as those from various stock plans.

This circular completes the regulatory requirements for PRC IIT
treatment of stock compensation schemes.The circular lists the “Concept
of Three Inspired Compensation Schemes” as follows:

SOP – A right that is granted to employees pursuant to prescribed
procedures which allow the employee to subscribe to a certain amount of
stock of the company at a specific price within a specified period;

SAR – A right granted by a listed company to its employees to obtain
the proceeds derived from the increase of stock price in the specified
period under agreed conditions. Where an authorized employee exercises
his/her right under agreed conditions, the company should compensate
the employee equivalent to the price difference between the selling
price on the secondary market on the exercised date and the
authorization date.

RSU – A certain number of shares distributed by a listed company to
its employees under agreed terms. The employees are not allowed to
exercise the shares freely unless the restrictions imposed on such
shares are removed (i.e. listed companies issue the stock to the
employees).

The Circular also defines the recognition and trigger points of taxable income as follows:

SOP – The IIT liability of the employees will not be triggered until
the day when the employees exercise the stock options. The taxable
income is calculated by the difference between the closing price on the
exercise date and the price (if any) paid by the employees for each
share. However, if the employees transfer their stock options before
the exercise date, the net income derived should be subject immediately
to IIT.

SAR – The IIT liability will not be triggered until the day when the
proceeds derived from the SARs are paid by the listed company to the
employees. The taxable income is calculated by multiplying the number
of shares by the stock price and the exercise date.

RSU – The IIT liability of the employees will not be triggered until
the listed company issues the prescribed stock to the employees. The
taxable income is calculated by first multiplying the number of the
shares (A) by the average of the closing price on the date when the
restricted shares are registered with the China Securities Depository
Clearing Corporation (CSDCC) or its overseas equivalent for shares of
overseas listed companies (B), and the closing price on the date when
the restriction on the shares is removed (C), and then subtracting the
price paid by the employees for the relevant shares (D). The formula
can be illustrated as follows: Taxable income = (B+C) / 2 x A – D

Note that it is less favorable for the individual if price C is less
than the price B as it will result in a higher taxable amount than the
income derived. However, there may be limited room for planning as
there is no way to defer the IIT reporting point till a later time when
the price C goes higher than price B.

Technically, taxable income generated from the stock compensation
plans discussed above (the equity income) should be included in the
salary income of the employees for IIT purposes, which will increase
their IIT burden. Employers are required to withhold the IIT on the
equity income of their employees.

However, Circular 35 offered a preferential IIT treatment, in that
the IIT liability on the taxable equity income could be calculated as a
month’s income separate from the regular monthly salary. Without
including this into the regular monthly taxable employment income, the
income derived from the compensation scheme may potentially be taxed at
a lower marginal tax rate.

Registration requirements
SOP and SAR Companies listed in China should register their SOP or SAR
scheme with the in-charge Local Tax Bureau and provide necessary
supporting documents. They should also report to the LTB information
related to the exercise of the SOP or SAR, e.g. number of shares
exercised, grant price, closing price on the exercise date, and so on.

RSU Listed companies in China should register the RSU scheme with
the in-charge LTB within 15 days after the shares are registered with
CSDCC and notices are made public. The above registration requirements
are also applicable to overseas listed companies, which should be
fulfilled by their associated Chinese entities. Please note that the
preferential IIT filing treatment will not be allowed to be applied if
the schemes are not duly registered.

For advice on structuring employee benefit packages, and the other
relevant tax issues email Sabrina Zhang, national tax partner for Dezan
Shira & Associates, at tax@dezshira.com.

Related Reading

China Tax Issues Concerning Employee Stock Options

Clarification on Director’s Fees and 13-Month Salaries

orig posting:  http://www.china-briefing.com/news/2009/10/16/individual-income-tax-treatment-for-stock-compensation-schemes.html