Equity incentive plans have witnessed a notable surge in popularity across China, particularly in industries where talents and innovation are highly sought after. Fully-fledged companies and startups in the sectors such as internet, e-commerce, biotech, pharmaceuticals, manufacturing, and financial services often leverage equity incentive plans to maintain a competitive edge in attracting top-notch talents. By offering equity incentives such stock options, restricted stock, and restricted stock units (RSUs), companies can effectively motivate and retain their employees. As the adoption of these plans increases, there is a growing demand for legal guidance to make sure these plans are implemented and managed in accordance with China’s tax laws and regulations. 

This article explores essential considerations and requirements for foreign-listed companies offering equity incentives to their employees in China while attempting to strike a balance between global corporate goals and compliance with local laws and regulations. 

Foreign Exchange Controls

Chinese employees participating in equity incentive plans offered by overseas publicly listed companies are required to register with the State Administration of Foreign Exchange (“SAFE”) or its local branches and complete certain other procedures. The Administrative Regulations on Foreign Exchange (《外汇管理条例》) requires that any Chinese resident who intends to make direct investment overseas or engage in the issuance or trading of negotiable securities or derivatives overseas shall complete the appropriate registrations with the SAFE. The registration is generally initiated within three months of implementing a equity incentive plan.

Furthermore, a Chinese employee participating in equity incentive plans shall appoint a qualified Chinese agent (“Qualified Agent”), which can be a Chinese subsidiary of an overseas publicly listed company or another qualified institution designated by the Chinese subsidiary, to handle the SAFE registration and related procedures, including opening accounts and repatriating funds at the local branch of the SAFE where the Qualified Agent is registered, in accordance with the Circular on Issues Concerning the Administration of Foreign Exchange for Domestic Individuals’ Participation in Equity Incentive Plans of Overseas Listed Companies (《关于境内个人参与境外上市公司股权激励计划外汇管理有关问题的通知》) (“Circular 7”). 

It typically takes around 20 business days for a decision to be rendered by the competent authority with regard to an incentive plan. In some instances, however, if communication with the local branch of SAFE takes time, the process could be protracted. In light of this possible protraction, the SAFE recommends that the applicants provide all application documents for a preliminary review before the formal filing. The applicants can take this as an opportunity to facilitate communication with the SAFE, thereby enhancing the likelihood of a successful application.

Once a Qualified Agent obtains the registration certificate from the SAFE, it should open a dedicated bank account in China (“Special Account”). Employees participating in equity incentive plans should deposit the consideration for exercising the overseas equity incentive plans into the Special Account. The Qualified Agent will then transfer the corresponding funds overseas (and convert such funds to foreign currency if necessary), subject to the foreign currency conversion quota previously approved by SAFE during the earlier registration process.

In addition, the Qualified Agent is also required to update the SAFE registration if there are any material changes to the equity incentive plan. 

Tax

Income from an equity incentive plan is subject to individual income tax (“IIT”) as a result of (i) the exercise of the awards (stock options, RSUs, etc.) and (ii) the sale of the shares in the market. 

Under scenario (i), the employee’s award exercise will be regarded as income from salaries and wages, thus IIT will be levied based on the value of the exercised awards at the time of the transaction. In the context of scenario (ii), the income generated from the employee’s sale of shares will be regarded as income from disposal of assets, thus IIT will be levied based on the difference (if any) between the proceeds from the sale and the initial exercised value. 

Chinese citizens are mandated to declare IIT in China, but if IIT has already been paid outside China, the amount paid can be deducted from the tax payable in China. The Chinese employers are required to withhold the benefits derived from the exercised awards for their employees, remit the tax due, and comply with filing requirements. 

Taxes on income from exercised awards can be calculated separately from the employee’s monthly salary income and therefore, a lower marginal tax may apply to the income from exercised awards. If a Chinese employer fails to comply with relevant filing requirements with the SAFE and the tax authority, taxes will be levied on any income generated from exercised awards in consolidation with the salary for that month, meaning that a higher marginal tax rate may apply to the combined income. 

Labor

Social security contributions in China are based on the employees’ regular salaries. As the incomes derived from equity incentives are usually not included as part of the regular salaries, such incomes generally bear no implications for social security contributions.   

However, benefits received from an equity incentive plan may be considered as part of the employment relationship and included in a severance payment if there is no explicit statement that the equity award is not employment compensation. To mitigate the risk of entitlement claims, the award agreement signed by an employee should stipulate that the stock award is not considered as employment compensation, that vesting of the equity incentive plan ceases upon termination of employment, and that the plan and any awards granted are discretionary.

For employees intending to end employment with their employers, the SAFE has not provided a definitive timeframe for the sale of registered awards upon termination of employment. However, it is understood that the SAFE expects departing employees to sell these awards as soon as possible, with a period of around six months as a generally acceptable timeframe. 

Conclusion Remarks

Implementing equity incentive plans for employees in China requires meticulous attention to regulatory details. The subsidiaries of foreign-listed companies must ensure compliance with the SAFE registration for proper filing and execution of equity awards.

IIT on equity incentives must be withheld by the employers at the time they are exercised. Non-compliance can result in higher marginal tax rates and additional filing requirements.

While equity incentives generally do not affect social security contributions, they may influence severance payments unless explicitly stipulated in award agreements otherwise. Additionally, departing employees are expected to liquidate registered awards within a reasonable period of typically around six months.

By thoroughly addressing these considerations, overseas listed companies can effectively navigate the complexities of equity incentives for their Chinese workforce.