By Matthew J. Zito
SHANGHAI — The China Securities Regulatory Commission (CSRC) announced last week that companies listed on a Chinese stock exchange will soon be able to offer employee stock ownership plans (ESOP) as a type of employee benefit. The pilot ESOP program is poised to introduce greater flexibility to how companies design compensation packages and manage their finances. At present, details of how the system will work and its implications for foreign-invested enterprises remain limited. However, following the roll-out of the “international board” on the Shanghai stock exchange, the ESOP system will likely have interesting repercussions for talent recruitment and retention in China.
Under an ESOP, company shares are typically purchased via a dedicated trust fund and allocated to all full-time employees, who are required to hold on to the shares for a specified minimum period. When employees leave the company, they have the option of retaining the shares, selling them back to the company (who must buy them at a fair market value), or selling them on the market. Unlike stock options, the amount of stock individual employees receive through an ESOP must be pegged to a general formula, such as seniority, rather than offered at the employer’s discretion.
This type of system has been successfully implemented in several mature securities markets—including the U.S., the U.K., Germany and Japan—as a means to increase employees’ stake in their companies and thereby improve efficiency. As a result, ESOP typically acts as a positive indicator of a company’s future prospects, and often raises its market value. Most importantly, however, are the tax benefits an ESOP can provide to companies, providing them with significant opportunity for deductions.
The “Guiding Opinions” issued by the CSRC stipulates that the total stock held by employees in an ESOP shall not exceed 10 percent of the company’s total capital stock (the total stock owned by an individual employee shall not exceed 1 percent). Other regulations govern the lock-up period for stocks (12 months), the minimum period over which stocks may be held by employees (36 months), as well as the company’s responsibility to periodically disclose employee stock ownership.
Companies will be permitted to choose from a number of methods to issue stocks, including repurchasing shares from the market, direct purchasing from the B-share market, issuance of non-public shares, voluntary gifting by existing shareholders, and other legally permitted methods. All parties to such an arrangement are charged with strictly abiding by market exchange regulations.
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Employee ownership of company shares is nothing new in China. CSRC data from 2012 showed that some 74 percent of listed companies had employees owning stock. Last week’s announcement merely serves to formalize and regulate this phenomenon, and followed confirmation from the State Council last month that a pilot ESOP program was in the works. This was described as one means by which China hopes to diversify the ownership of domestic enterprises, including SOEs.
Analysts were quick to point out a lack of implementing details on how ESOPs in China would interact with taxation issues—something the CSRC is said to now be working on in coordination with related government departments. It remains unclear, for example, whether workers will receive tax exemptions on their stock dividends, as is common in other countries that have implemented ESOP.
In the U.S., companies are permitted to take out loans under an ESOP for the purchase of shares, which can provide an injection of quick revenue to purchase new technology or expand operations. Critically, payments on these loans are tax deductible, as are contributions to the ESOP trust through share issuances or cash contributions. This provides companies with a powerful tool for managing their liquidity.
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Unfortunately for foreign investors in China, there are several existing regulatory barriers that will keep foreign-invested enterprises from participating in the ESOP pilot, and benefiting from the related tax and financial advantages. Most basically, only one type of foreign-invested enterprise is permitted to operate in China as a limited public (i.e., “listed”) company, a prerequisite of the ESOP pilot. The specificity and scale of the requirements for setting up this type of company (e.g., RMB 30 million in registered capital) entail that de facto there are very few FIEs that can list their stocks on Chinese exchanges, thus barring them from the ESOP pilot.
This may change in the near future, however, with the anticipated launch of the “international board” at the Shanghai Stock Exchange, which would newly allow foreign firms to list their shares directly on a mainland bourse. While this reform has been said to be “forthcoming” since 2009, the inauguration of the Shanghai Free Trade Zone in late 2013 and the pilot ESOP program will put added pressure on its timely implementation.
Asia Briefing Ltd. is a subsidiary of Dezan Shira & Associates. Dezan Shira is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in China, Hong Kong, India, Vietnam, Singapore and the rest of ASEAN. For further information, please email email@example.com or visit www.dezshira.com.
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