China Tax Issues Concerning Employee Stock Options

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Sept. 11 – The State Administration of Tax has issued Circular 461 to provide guidance to previous Circulars 5 and 35 concerning the individual income tax treatment for employment-related Stock Appreciation Rights (SARs), and Restricted Stock (RS).

The new circular clarifies the tax position on such stock incentives, the determination of taxable income, the tax-trigger point and documentation requirements. These are as follows:

Applicable tax computation
The circular dictates that income derived from SARs and RS should be taxed as wage/salary according to the calculation method set out in Circular 35.

Determination of taxable income
A) SARs related income
Circular 461 clarifies that SARs related income should be calculated in accordance with the following formula:
Taxable income = (stock price on date of exercise – stock price on date of grant) x number of shares

B) RS related income
The calculation formula is:
Taxable income = {[stock price on registration date + stock price on date stock is free to sell) -:- 2] x number of shares to sell – actual amount paid by RS qualifying person} x number of shares free to sell -:- total number of RS stock shares authorized.

Stock incentive plans (related income)
The circular additionally specifies that employers shall use the applicable formula provided in Circular 35 to calculate IIT to be withheld for the first occurrence of income derived from stock options, SAR or RS in a calendar year. However, should more than one stock incentive plan be exercised in a calendar year, the IIT should be calculated based on the cumulative income derived from all of the plans in accordance with Circular 902.

Tax trigger point
The tax trigger point for SAR related income is the date when a listed companies SAR to an authorized person is cashed. The tax trigger point for RS related income is when the restricted stock is free to sell.

It should be noted that for the purposes of computing IIT payable, income derived from the exercising stock options should not be aggregated with other compensation and should be treated as a standalone employment related income, thus subject to IIT at progressive rates. Employees may spread the gain over a period of 12 months for the purpose of determining the applicable IIT rate.

Those needing assistance with IIT issues can email Sabrina Zhang, national tax partner for Dezan Shira & Associates at