Employee Equity Incentive Plans in China: Preferential Tax Policies (Part 2)

Preferential policies for equity incentives in China include deferred tax payment for eligible non-listed companies, extended tax payment periods for domestically listed companies, and instalment payment options for employees of qualifying high-tech companies. The article outlines eligibility requirements, compliance obligations, and key considerations for designing tax-efficient equity incentive plans. 

Equity incentive plans can be an effective tool to attract and retain high-calibre employees, providing an additional financial benefit where direct monetary incentives may be limited. In some cases, equity incentives can also offer preferential tax treatment and greater flexibility in when employees pay tax, helping to make these arrangements more attractive and financially manageable. 

This is the second article in our two-part series on the tax implications of equity incentive plans in China. In part one, we covered how equity incentive plans are taxed. In part two, we examine the preferential tax policies available to eligible employees and their employers and discuss how companies can design tax-efficient incentive plans while managing employee cash flow and meeting China’s regulatory and compliance requirements. 

See part one here: Tax Implications of Employee Equity Incentive Plans – A Guide for Businesses in China

Preferential taxation policies for equity incentives 

Deferred taxation for non-listed companies 

Under Cai Shui [2016] No.101, tax on income from stock options, equity options, restricted shares, or equity awards issued by non-listed companies can be deferred if both the company and the employee meet certain requirements. This means employees are not required to pay tax at the time of acquiring the equity incentives, and tax payment is deferred until the shares are transferred.

When the shares are transferred, IIT is calculated and paid at a rate of 20 percent under the category of “income from property transfer”. The taxable income is based on the difference between the income derived from share transfer and the costs, reasonable taxes, and fees incurred for obtaining the equity.

The private company equity incentives must meet all of the following conditions to be eligible for the deferred tax policy:

1. The equity incentive plan must belong to a domestic resident enterprise.
2. The equity incentive plan must be reviewed and approved by the company’s board of directors and the general meeting of shareholders. The equity incentive plan must specify the purpose of the incentive, the participants, the underlying equity, the validity period, the methods for determining various prices, and the conditions and procedures for participants to acquire the equity interests.
3. The underlying equity for the incentive must be the equity of the domestic resident enterprise itself. The underlying assets for equity awards may consist of equity obtained through the investment of technical achievements into other domestic resident enterprises. The underlying shares or equity for the incentive scheme include those granted to employees through new share issuance, direct transfer by major shareholders, or other reasonable means permitted by laws and regulations.
4. Participant employees must be key technical personnel and senior management staff designated by the company’s board of directors or the general meeting of shareholders. The cumulative number of the participant employees must not exceed 30 percent of the average number of employees of the company in the past six months.
5. The equity incentives must meet certain holding period requirements depending on the incentive type, which must be specified in the equity incentive plan. The holding periods are:
   1. Stock or equity options: held for at least three years from the date of grant and for at least one year from the date of exercise;  
   2. Restricted shares: held for at least three years from the date of grant and for at least one year after unlocking; and 
   3. Equity awards: held for at least three years from the date of receipt.  
   4. The period from the date of grant to the date of exercise for stock or equity options must not exceed 10 years. 
6. Neither the company implementing the equity award nor the company whose equity serves as the award’s underlying asset may belong to an industry listed in the Catalogue of Industries Restricted from Equity Award Tax Incentive Policies, a list of 22 sectors attached to the Cai Shui [2016] No.101 document. The company’s industry is determined by the industry from which it derives the highest percentage of income from its principal activities. 

Extended taxation for domestically listed companies 

From 1 January 2024 to 31 December 2027, equity incentives granted to employees by domestically listed companies can be subject to IIT on the taxable income from the equity incentive over a period of 36 months from the date of the tax event. If an employee pays IIT according to this extension scheme, it must be filed with the competent tax authority. All outstanding taxes must be paid in full if the employee leaves the company during this period. 

Domestically listed companies refer only to joint-stock companies whose shares are listed and traded on the Shanghai Stock Exchange, the Shenzhen Stock Exchange, or the Beijing Stock Exchange. This means the equity incentive plans of overseas-listed companies are not eligible for the extension scheme and must pay IIT according to the statutory payment schedule. 

Deferred tax payment plan for employees of high-tech companies 

The Cai Shui [2015] No. 116 document grants flexibility to employees of high-tech companies in paying IIT on equity incentives if they face difficulties in paying the tax in a lump sum.

Specifically, high-tech companies that grant equity awards to relevant technical personnel in recognition of the application of scientific and technological achievements, eligible employees can make payments in instalments over a period of up to and including five calendar years. The relevant documentation must be filed with the competent tax authority.

If the employees transfer the awarded equity and receive cash income, this income must be used primarily to pay for any outstanding tax liabilities. 

“Relevant technical personnel” refers to technical personnel who have made outstanding contributions to the research, development, and industrialisation of the company’s scientific and technological achievements, and management personnel who have made outstanding contributions to the company’s development that meet certain requirements. 

Considerations for companies designing equity incentive plans 

As equity incentives can produce additional short-term tax burdens for employees, companies should carefully design equity incentive plans to ensure that tax is due at a time and in a manner that employees can reasonably manage. This involves carefully setting vesting and exercise schedules and planning how employees will fund the tax, as well as ensuring eligibility for deferral schemes, where possible. 

Timing tax events 

Companies can design plans so that tax events do not burden the employee unnecessarily, for example by aligning vesting or exercise dates with periods when employees are likely to have more liquidity, or by splitting an award into several tranches. As multiple tax events in the same year are aggregated and taxed at progressive rates, it may be beneficial for employees who are cash-tight to avoid multiple tax events in the same tax year. 

Supporting employee cash flow 

Companies can also design plans so that tax burdens do not fall on employees in a lump sum, for example through sell-to-cover or net settlement arrangements, or through instalment payments where available. However, these may not always be possible, as required holding periods, such as those for tax deferral at non-listed companies, prevent shares being sold early to cover tax. 

Ensuring compliance with requirements for deferred taxation 

For companies that may be eligible for the preferential tax policies, care should be taken to ensure compliance with each policy’s conditions from the outset and throughout the deferral period. For instance, non-listed companies should consider whether to incorporate the required holding periods into their plans, as well as weighing the other requirements, such as the 30 percent headcount cap, internal approvals, and the plan’s filing. 

Ensuring filing and registration 

Companies must ensure they have complied with all of the required filing and registration requirements to ensure equity incentive plans are compliant and eligible for any potential preferential treatment.

For instance, overseas-listed companies are required to assign a domestic Chinese agency to register equity incentive plans with the local SAFE branch and handle the dedicated foreign exchange account and fund transfers. For overseas and domestic listed companies, equity incentive plans must generally satisfy relevant tax registration, reporting, and filing requirements where applicable. 

For non-listed companies, plans must be filed with the tax authority to qualify for deferred taxation. There are further requirements beyond these examples, so companies should confirm the full requirements before structuring equity incentive plans. 

How Dezan Shira & Associates can help 

Dezan Shira & Associates supports companies in understanding the preferential tax policies available for equity incentive plans in China, including tax deferral for eligible non-listed companies, extended payment periods for domestically listed companies, and instalment payment options for qualifying high-tech companies. Our team can help assess eligibility requirements, filing obligations, and key tax and compliance considerations when designing equity incentive plans. Contact us to discuss your company’s needs.