On May 4, 2009, the PRC Ministry of Finance (MOC) and State Administration of Taxation (SAT) jointly issued the Circular on Relevant Issues Regarding Payment in Installments of Individual Income Tax for Stock Options Exercised by Executives of Listed Companies. The Circular lays out special guidelines for levying individual income tax on directors, supervisors and other senior management members of listed companies (Executives) who exercise stock options.  

Under current tax rules, stock options exercised by employees are subject to individual income tax. Tax authorities regard the difference between the exercise price and the market price on the date an employee exercises his or her purchased shares as income derived from the employee’s position and performance, thus categorizing income derived from the exercise of stock options as “income of salary and compensation” and levies individual income tax on it.  

However, special issues arise with respect to stock options exercised by Executives, because the Company Law and Securities Law of the PRC contain certain restrictions on Executives’ transfer of shares. For example, Executives who purchase shares in the company for which they work are prohibited from re-selling these shares within six months of the purchase date. If any Executive violates these restrictions, all benefits accrued from such violation will devolve to the company (excluding the guilty Executive). Given this restriction, Executives may only sell shares they obtain through exercising stock options six months after the exercise date, and therefore may not realize an income gain for at least six months after the exercise date. This time lag makes it difficult for some Executives to pay the individual income tax they owe at the time they exercise their stock options.  

To address this issue, the Circular provides that Executives who have difficulty making payment on time can apply for permission to pay their individual income tax on income derived from the exercise of options in installments. The tax authority will review their application and may allow them to pay in installments within a time period of no more than six months from the exercise date.  

In addition, the Circular provides that payment in installments may also apply to situations involving other stock incentive plans. Although the Circular does not define what “other” stock incentive plans encompass, they may include stock option plans for non-public companies, restrictive stock plans, and stock appreciation plans.