On September 20, 2016, the Ministry of Finance (“MOF”) and the SAT jointly released Circular Cai Shui [2016] No. 101, on Improvement of Income Tax Policies on Equity Incentive Plans and on the Transfer of Rights in Technology as Capital Contribution (“Circular 101”), retroactive to September 1, 2016. 

Equity incentive plans generally refer to share/equity options, share appreciation rights, restricted shares and equity rewards that companies grant their employees or the employees of other companies in the same group. 

Equity incentive plans first emerged in China in the 1990s. The main regulation governing individual income tax (“IIT”) then was Circular Guo Shui Fa [1998] No. 9 (“Circular 9”), which provided the following: 

  • When individuals purchase their employer’s equity at a discounted price or with a subsidy due to their performance as employees, this discount or subsidy is considered salary income and taxed accordingly
  • When individuals transfer the purchased equity, the capital gain is considered property transfer income and taxed accordingly.
  • When calculating IIT on the salary income at the time of purchase, income can be evenly divided and consolidated into the monthly salary over a maximum six-month period. 

However, it was not until China’s reform on non-tradable shares of listed companies in 2005 that equity incentive plans really took off. To keep up with the reform, the MOF and the SAT issued a series of regulations1 on IIT policies on the equity incentive plans granted by listed companies or companies in which they have a minimum direct or indirect shareholding of 30%. These regulations, particularly Circular Cai Shui [2005] No. 35 (“Circular 35”), established the following tax treatments based on the nature of the income: 

  • When employees are granted equity incentive plans, unless otherwise provided, no tax applies. 
  • When employees purchase the equity, the difference between the average market value of the granted shares and the purchase value is considered salary and taxed accordingly. IIT on this income is calculated separately and a preferential tax calculation method is applied to reduce the tax burden. 
  • When employees sell those shares, the difference between the sale value and the average market value when purchased is considered property transfer income and taxed accordingly. If the transferred shares are listed in China, IIT exemption applies. 
  • When employees receive profit distribution attributable to the shares, this income is considered dividend income and taxed accordingly. If the shares are listed in China, IIT exemption or a reduced tax rate applies, depending on the holding periods. 

This tax treatment was a great advantage for listed companies for attracting talent, as employees of unlisted companies continued to be governed by Circular 9. However, since then, several tax preferential treatments have been introduced for employees in the hightechnology field obtaining equity rewards from unlisted companies, e.g.: 

  • When technological staff working for science and technology institutions or colleges and universities obtain equity rewards, no tax applies as long as they complete a filing procedure. When the equity is sold, or if profit is distributed while holding the equity, IIT will apply accordingly. 2 
  • When technological staff working for high-and-new-technology enterprises nationwide obtain equity rewards, IIT on salary can be calculated using the preferential tax calculation method under Circular 35 and paid in installments within five years. 3

Circular 101 now widens the scope of these kinds of preferential treatments to include employees of other unlisted companies.

Highlights of Circular 101:

1. Deferred tax policy for equity incentive plans granted by unlisted companies

To help unlisted companies attract talent, Circular 101 introduces preferential tax treatments relating to the equity incentive plans of unlisted companies, subject to meeting certain conditions: 

a) By using a filing procedure, share options, equity options, restricted shares and equity rewards that unlisted companies grant their employees are not taxed at the time they are purchased; tax is deferred until the employee transfers them. When the employee transfers the equity, the tax base is the transfer price minus the original purchase cost (which depends on the type of incentive plan: for a share/equity option, the purchase cost; for restricted shares, the contribution made; for an equity reward, zero) and the relevant transaction taxes and charges. The tax rate is 20% as applied to property transfer income, applicable even if the transfer takes place after the unlisted companies becomes listed in domestic stock markets. 

Compared with Circular 35, the above rules consolidate the two-stage tax collection (i.e., at the time of purchasing the equity and at the time of selling it) into a onestage tax collection to solve cash flow insufficiency issues. Additionally, the uniform 20% tax rate greatly reduces the tax burden at the time of the equity transfer. 

b) To apply the tax deferral policy, all of the following requirements must be met: 

  • Equity incentive plans must (i) be initiated by domestic resident enterprises that have sound and complete accounts, (ii) be approved by the board of directors or shareholders meeting, and (iii) only involve the relevant domestic resident enterprises’ own equity.
  • Equity incentive plans can only be granted to core technical staff and senior management approved by the board of directors or shareholders meeting, and the total number of employees accessing these plans must not exceed 30% of the enterprise’s average workforce in the preceding six months.
  • The employees must hold the share/equity options for at least three years from the granting date and for at least one year from the vesting date. The holding period for restricted shares must be at least three years from the granting date and at least one year from the removal of the restriction. The holding period for equity rewards must be at least three years from the granting date. 
  • The time period between the granting date of the share/equity option and the vesting date must not exceed 10 years. 
  • Companies granting equity rewards and rewarded equity must not be covered by the Catalogue of Sectors Restricted to Apply the Tax Preferential Policy for Equity Rewards. These sectors include wholesale and retail, transportation, warehousing and postal, accommodation and catering, monetary financial services and insurance, real estate, leasing and commercial services, residents’ general consumer services, and sports and entertainment. 

If the above conditions are not met, the tax deferral policy under Circular 101 cannot be applied. In that case, the preferential tax calculation method provided under Circular 35 can be applied. 

2. Extended tax payment period for listed companies' equity incentive plans

Listed companies’ equity incentive plans continue to apply the tax treatments provided under Circular 35. However, to ease the cash flow burden, Circular 101 extends the tax payment period from the previous six-month installment period to a twelve-month installment period through a filing procedure.

3. Tax deferral policy for transferring rights in technology as capital contribution

The transfer of rights in technology as capital contribution from enterprises or individuals to resident enterprises is divided into two events: (i) taxable property transfer, and (ii) investment. To date, through a filing procedure, tax on income from the transfer of the non-monetary assets, calculated at the fair value through appraisal minus the sum of their original cost and the relevant transaction taxes and charges, can be paid through installments for up to five years. 4 

Circular 101 provides an alternative tax deferral policy for the transfer of rights in technology as capital contribution, allowing the tax payment to be deferred until the enterprise or the individual shareholders transfer the equity. 

Regardless of the tax treatment chosen, invested companies are allowed to recognize the contributed technology as an asset based on the appraisal value at the time of contribution and deduct amortized expenses when calculating enterprise income tax.