In February 2012, China’s State Administration of Foreign Exchange (SAFE) issued the SAFE Notice on Administration of Foreign Exchange Used for Domestic Individuals’ Participation in Equity Incentive Plans of Companies Listed Overseas (known as Circular 7), which replaces the previous Circular 78.

Key Changes

The main change is the scope of eligibility for initial SAFE registration has been extended. The extensions apply to the individuals who can register and the types of incentives that qualify.


In addition to employees of the company listed abroad and the employees of its affiliated subsidiaries, individuals such as directors, supervisors and those having a “labour service relationship” with the company can register. This last category includes retired people acting as consultants to the company. In addition, expatriates who have been in China for “one year continuously” may now register.

Types of Incentives

In addition to stock option plans, other incentive plans such as stock appreciation rights, performance shares, phantom shares and restricted shares may apply for the SAFE registration. As yet, no clear guidance exists for such plans, but local SAFE authorities may give further clarification upon registration.

Administration of Ongoing SAFE Reporting

Circular 7 has simplified the procedures for applying for foreign exchange purchase and payment quotas. A certificate of foreign exchange registration for equity incentive plans is required when a domestic agent (normally a subsidiary of the company listed abroad) applies for a payment quota or opens a domestic special foreign exchange account. Circular 7 requires that domestic agents provide quarterly reports on the status of the equity plan and their banks also must provide monthly status reports on the relevant foreign exchange banks.

Areas of Potential Confusion

Despite streamlining the procedures for applying for SAFE registration for equity incentive plans by adding guidelines in the appendices of Circular 7, several points need further clarification. For example, there is no clear interpretation of what “equity incentive plans” may refer to and therefore can be registered. The only reference to stock appreciation rights and phantom share plans, for example, is in a form attached to Circular 7 that has “Plan Category” as one of its checkboxes.

Another example relates to the category of expatriates who have stayed in China for one year continuously. Circular 7 does not define “continuously” and an informal consultation with several local SAFE officials revealed several different interpretations. It is therefore advisable to consult with local SAFE officials when determining whether certain individuals or equity incentive plans qualify under Circular 7.

Tax Implications

It is worth noting the tax implications of equity incentive plans, especially those that are cross-border.

Tax Registration

According to China tax laws, the income obtained by an employee from the equity incentive plan must be categorised as “wages and salaries” for the purposes of tax. All income—including salary, periodic bonuses and even the income from equity incentive plans (equity incentive income, or EII)— is subject to tax in the month in which it is received.

In principle, EII is often high, whereas the monthly salary is relatively low. The tax rate for wage and salary income ranges progressively from 3 per cent to 45 per cent, which means an employee’s monthly salary is subject to a relatively low tax rate in comparison with the equity incentive plan. Once the EII is added to the monthly salary, the total monthly taxable amount may be high, leading to a higher tax rate and tax burden.

In order to offset the tax impact of an equity incentive plan, relevant tax regulations provide that the EII may be taxable separately from the monthly salary if the equity incentive plan is registered with the relevant tax authorities in advance. This ensures the tax rate applicable to the monthly salary in the month the EII is received is the same as the tax rate in the months that don’t see this income.

Based on experience, the materials necessary for registration include the equity incentive plan, the list of Chinese employees entitled to the plan and the shareholding structure of the company issuing the equity incentive plan. Further, in order to make it possible to file tax returns at a later date, making the relevant tax authorities aware of, for example, the equity incentive plan and its timing in relation to tax periods is advisable.

Withholding Obligation

In addition to categorising the EII under wages and salaries for tax purposes, according to China tax laws, the employer must withhold the employment-related income tax for employees on a monthly basis. If the employer does not fulfil this obligation, as a withholding agent, it is subject to a fine ranging variously from 50 per cent to 300 per cent of the withholding tax. At the same time, the tax authorities will seek the underpayment from the employee.

The employer should closely monitor the implementation of the equity incentive plan and, ideally, it should be administered by a third party.