The State Administration of Taxation in China recently issued Tax Bulletin No. 27, which became effective on May 1, 2011 ("Bulletin 27"). Bulletin 27 repealed part of Notice No. 461 ("Notice 461"), which was issued in August 2009 and generally provided for special formulas to compute individual income tax on stock options, SARs, and restricted stock awards. Since individual income tax returns are filed monthly rather than annually in China, the special formulas were introduced in order to give the beneficial effect of spreading the income earned from such awards (which is subject to taxation at progressive rates) over a calendar year. For stock options, in particular, Notice 461 provided that when an employee receives income from a stock option exercise for the first time during a calendar year, the employee calculates the amount of income tax owed on the applicable monthly tax return by using the following formula:
Individual Income Tax = the product of (i) the number of months the employee has worked in China over the vesting period (up to 12 months), multiplied by (ii) the product of (a) the quotient of (I) the closing price of the underlying shares less the exercise price multiplied by the number of shares exercised, divided by (II) the number of months the employee has worked in China over the vesting period (up to 12 months), multiplied by (b) the applicable tax rate.
If the employee receives additional income from equity awards in the same calendar year, then the amount of tax previously paid with respect to stock option exercises is subtracted from the product determined in accordance with the formula set forth above.
Notice 461, however, limited the types of employees who were allowed to use this special formula when calculating their tax liability. For instance, with respect to multinational companies listed on a foreign stock exchange, employees of third and lower tier Chinese subsidiaries of such companies were not eligible for such favorable tax treatment under Notice 461. This particular limitation, however, has now been lifted as a result of the issuance of Bulletin 27.
Bulletin 27 now provides that starting on May 1, 2011, employees of third or lower tier subsidiaries of a listed company can use the special tax formulas set forth in Notice 461 and, as a result, are eligible to receive the favorable tax treatment discussed above as long as the listed company granting the equity awards directly or indirectly owns 30% or more of the subsidiary and the subsidiaries have complied with local tax filing requirements.