Feb 2009
On 7 January 2009, the Ministry of Finance ("MOF") and the State Administration of Taxation ("SAT") jointly promulgated Cai Shui [2009] No. 5 ("Circular 5") addressing the China Individual Income Tax ("IIT") treatment on Share Appreciation Rights ("SARs") and Restricted Share Units ("RSUs") granted to employees by listed companies. The Circular extends the so-called "preferential IIT treatment" and share plan registration requirements introduced in the earlier MOF/SAT circular Cai Shui [2005] No. 35 ("Circular 35") beyond share options.
Among other things, Circular 5 now provides that:-
- Income derived from SARs and RSUs is chargeable to China IIT pursuant to Circular 35 and its supplementary SAT notice Guo Shui Han [2006] No. 902 ("Circular 902") (see numerical illustration below);
- Similar to the requirement as currently imposed on share option plans, companies listed in China are required to register their SARs and RSUs plans with the in-charge China local tax bureaus; and
- Companies listed in China are responsible for the China IIT reporting and withholding requirements in respect of the SARs and RSUs income.
Applying the Circulars 35 and 902, the IIT payable on such equity income will be calculated separately from the monthly salary in accordance with the following formula:-:
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(A / B X applicable marginal tax rate - quick deduction) X B - accumulated IIT paid on equity income in the calendar year concerned |
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where: |
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Factor A represents the "accumulated equity income of the calendar year concerned" |
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Factor B is the number of months for which the employee worked in China during the vesting period. In the case of multiple exercises occurred in the same calendar year, the vesting period of each exercise will be weighted average based on the respective amount of equity income. This factor is however capped at 12 (months). |
To illustrate how this works for SARs and RSUs income, assuming an employee received SARs income of RMB100,000 in January 2009 on the exercise of some SARs with a vesting period of 12 months during which he worked in China, his China IIT liability on the SARs income will be calculated as follows:-
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In January 2009 |
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IIT on SARs X = [RMB100,000 / 12 X 20% - 375] X 12 = RMB15,500 |
It is worth-noting that, in the absence of the Circular 35 preferential tax treatment, the SARs income should have been added to the employee's monthly salary for China IIT calculation purpose. Hence, if the employee was chargeable to China IIT on his monthly salary at the top marginal tax rate of 45%, the China IIT on the SARs income would be RMB45,000 (which is almost three times higher as compared to the amount calculated using the preferential IIT treatment).
However, in the case where the employee exercises SARs more than once in the same calendar year concerned, say February 2009, then the China IIT liability will be calculated as follows:-
| Employee exercises |
Taxable SARs income
(RMB) (i) |
Vesting period in China
(months) (ii) |
Total
(i) X (ii) |
| SARs X in Jan 2009 |
100,000 |
12 |
1,200,000 |
| SARs Y in Feb 2009 |
400,000 |
18 |
7,200,000 |
| Total |
500,000 |
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8,400,000 |
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In January 2009 |
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IIT on SARs X = [RMB100,000 / 12 X 20% - 375] X 12 = RMB15,500 |
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In February 2009 |
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IIT on SARs Y = [RMB500,000 / 12 * X 30% - 3,375] X 12 - RMB15,500 = RMB94,000 |
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*Factor B = 8,400,000 / 500,000 = 16.8 (capped at 12 [months]) |
PwC Observations
- Equity based awards are regarded as an effective means to motivate and retain talent. It is believed that there will be an increasing use of similar performance linked long-term equity based awards to replace the traditional cash based incentive compensation to allow the companies stay competitive, especially in the current economic downturn;
- Circular 5 seems to restrict its application to the share-settled RSUs, but it is believed that it should be equally applied to cash-settled RSUs despite the former is more common in China;
- The literal reading of Circular 5 seems to impose the tax registration and IIT withholding requirements only to the companies listed in China. This appears to be inconsistent with the current requirements imposed on share option plans pursuant to Circulars 35 and 902 which instead impose the requirements on listed companies, including those listed overseas, implementing the share option plans in China. We are in the course of clarifying this point with the SAT; and
- There is an increasing trend that the local China tax bureaus are tightening up the enforcement of the tax registration requirements on share option plans. In some locations, the local tax bureaus have refused to accept the Circular 35 preferential IIT treatment on share option income, unless the share plan has been properly registered with them. As the application of the preferential IIT treatment will in most cases give rise to tax savings to the employees, companies shall ensure that their SARs and RSUs plans are complied with the necessary tax registration requirements in order to secure the use of the preferential IIT treatment.
