Part One - Legal references
The PRC legal authority regarding the taxation of stock compensation is set out below:
- Double Tax Agreement concluded between China and other countries (regions)
- The PRC Individual Income Tax Law, promulgated by the National People’s Congress and effective as from January 1, 2006
- Implementation Regulations of the PRC Individual Income Tax Law, promulgated by the State Council and effective as from March 1, 2008
- Administrative rules Guo Shui Fa (GSF) made by State Administration of Taxation (SAT), setting out details of the tax laws and regulations: 国税发GSF (1998) 009, 国税发GSF (1999) 241, 国税发GSF (2005) 009, 国税发GSF (2005) 205
- Administrative notices Guo Shui Han (GSH) given by State Administration of Taxation (SAT) in reply to the specific cases put forward by a lower level of the tax administration: 国税函GSH (1990) 345, 国税函GSH (2000) 190, 国税函GSH (2005) 130, 国税函GSH (2005) 482, 国税函GSH (2006) 866, 国税函GSH (2006) 902, 国税函GSH (2007) 1030, 国税函GSH (2009) 285, 国税函GSH (2009) 461
- Administrative rules Cai Shui (CS) jointly made by the Ministry of Finance (MOF) and the State Administration of Taxation (SAT): 财税Cai Shui (2005) 035, 财税Cai Shui (2005) 102, 财税Cai Shui (2005) 107, 财税Cai Shui (2009) 005, 财税Cai Shui (2009) 040
Part Two – Taxation on stock options
The point of time for the income tax obligation to arise
The PRC individual income tax rules provide that if the stock option is granted unconditionally and is vested immediately, then the income tax obligation will arise in the month on which the grant day falls. Where the stock option is granted subject to a vesting period, then the income tax obligation will arise in the month on which the exercise day falls.
Questions and answers
Q(1)：The stock option is granted prior to the assignment in China, vested and exercised while the employee is working in China under the assignment contract. How is the employee’s tax position?
A(1): Since the employee cannot exercise the stock option right at the grant day until after the vesting period is over, the obligation for individual income tax arises from the exercise day. The tax liability is computed with reference to two relevant periods. The first period is from the day of the commencement of the PRC assignment to the day the employee exercises the option (from point a to point e). The second period is from the day of the grant to the day the stock is vested to the employee (from point g to point v). The amount of taxable income is ascertained by reference to the gain from the stock option as adjusted as per the ratio between the number of days in the 1st period and the total number of days in 2nd period (from the grant day to the vest day). That is, taxable income = [gain from stock option x number of days worked in China / total number of day in the period from the grant day to the vest day].
Note that the obligation for individual income tax arises from the exercise day. That is a tax on an unrealized gain. Therefore, to ease the employee’s liquidation problem, the PRC IIT law provides that subject to the approval by the in-charge tax bureau, the employee can pay the tax by installments over a period not exceeding 6 months commencing from the exercise day. See article 2 in the document Cai Shui (2009) 040 jointly issued by the PRC SAT and the Ministry of Finance.
Q(2): The stock option is granted prior to the assignment in China, and is vested while the employee is working in China, but is not exercised until after the employee leaves China;
A(2): If the employee exercises the option until after the PRC assignment, then the answer to this question depends on whether the employee’s salary is paid or borne by an entity in China. If it is paid or borne by an entity in China, the gain from the stock option has a PRC source and is taxable in proportion to ratio the number of days the employee works in China (from a to b) to the total number of days of the vesting period (from g to v). If not, then the gain from stock option is exempted from individual income tax in China.
Q(3)：The stock option is granted, vested, and is exercised while the employee is working in China under the PRC assignment contract. How is the employee’s tax position?
A(3): If the stock option is granted, vested and is exercised while the employee is working in China, then the gain is wholly taxable in China. The income tax obligation arises in the month on which the exercise day falls.
The Human Capital stream falls under BDO’s tax umbrella. We provide taxation services to both individuals and companies and are have teams focused on Expatriate Tax, Employee Reward and Employment Tax.
The stream is becoming more technologically aware and have several ongoing projects where we are aiming to improve our visibility in the market through the technology that we use; such as online tax return questionnaires, online share reporting apps (yes we have apps too!), and global travel tracking.
The stream has 3 distinct teams, namely Expatriate Tax Team, Employment Tax Team, and Reward Team. Whilst all 3 teams have their separate clients, it is not uncommon for liaison between them on mutual matters which may require more specialist advice; all 3 teams sit within a stone’s throw of each other – if not closer! It is always encouraged that knowledge is shared where possible, and what better way than having your colleagues close by?
The Expatriate Tax Team is the larger team of the three, and work mainly consists of working with clients on their tax and social security issues in relation to movements both into and out of the UK. A common example is where a company sends several employees on an assignment to a branch in another country. The Expatriate Tax Team will assist the company with reporting requirements in the UK, and liaise with our colleagues in overseas BDO offices to assist with reporting requirements in the assignment country.
There is more to consider for the company, such as ensuring that they comply with local labour laws (laws in France may be substantially different to laws in Israel for example), tracking the travel patterns of their employees to assess whether a permanent establishment has been created in the country the employees are assigned to. This may result in corporate tax implications for the company in the overseas country.
There is also the other side of the coin to consider; the view point of the individual employees. Employees may be concerned about the level of tax and social security which they may be subject to as a result of their assignment. The Expatriate Tax Team hold tax briefings with assignees who are moving to or from the UK to discuss such concerns, and also provide potential planning for possible tax reliefs. The team usually also assist with the preparation of UK tax returns to reconcile any taxes over(under)paid during the tax year. In between these two services, it is also common that the team provides an ongoing service where assignees regularly contact via email or telephone to raise any queries which they have.
A very important aspect of the work that the Expatriate Tax Team considers on almost a daily basis is the residency position of assignees. There are different tax treatments available to taxpayers dependent on their residency position which is based on physical presence in a particular country. There is also the concept of domicile which needs to be considered; domicile is different to residency and looks at where an individual sees their permanent home to be.
The work above includes technical reading of Double Taxation Treaties, Social Security Reciprocal Agreements, and liaison with overseas office, as well as the clients themselves!
The Employment Tax Team differs from the Expatriate Tax Team in that the majority of work is solely on UK based clients. This does not mean, however, that the work is any less challenging!
The Employment Tax Team works more with companies rather than individuals, although work with individuals still occurs. The team assist companies with their reporting requirements to HMRC with matters such as taxable non cash benefits and the structuring of termination payments to ensure tax efficient methods are used to benefit both the company and the employee whose employment is being terminated.
It is not uncommon for the team to be involved in the preparation or review of correspondence with HMRC; in fact a good number of the team have had some sort of experience in working in HMRC offices before joining BDO. The team has regular correspondence with HMRC via postal correspondence and telephone calls to discuss employment related matters that either HMRC have raised an enquiry into or that a client has requested to obtain prior approval from HMRC before implementing a certain scheme.
The Reward Team is another interesting team available to join. The team specialise in assisting companies with incentivising their staff via well structured remuneration packages.
The team is well experienced in reporting and compliance of both share and share option awards and rewards. Shares and share options each have a life-cycle of sort which requires careful analysis at each stage.
A share option, for example may be granted to an individual on a certain date. It may not vest until a future date, and the time in between grant and vest is known as the vesting period. Once vested, the individual has the ability to exercise the option to convert it into shares. Just imagine a caterpillar’s transformation into a butterfly… but in a financial sense!