With the increase of foreign invested enterprises (FIEs) and the growth of professional managers in China, companies listed on foreign stock exchanges have increasingly used stock incentive schemes to attract, retain and motivate key management professionals and to reward them for their contributions to the company. However, the wide adoption of stock incentive programs for employees in China has created foreign exchange and tax issues for FIEs. Because the stocks of foreign-listed companies are denominated and paid in foreign currency (such as the U.S. dollar), the proceeds of stock options cannot be converted into Renminbi (RMB, the official currency of China) due to China's foreign exchange control restrictions.
To address the foreign exchange issue raised by foreign stock incentive plans, the State Administration of Foreign Exchange and the State Administration of Taxation have imposed the following requirements:
- The employee must choose a domestic Chinese institution to handle foreign exchange matters for him/her, such as the FIE of the foreign-listed company, a labor union or a qualified investment trust company (Domestic Agency).
- The Domestic Agency must engage a domestic Chinese financial institution qualified for foreign asset management and foreign securities exchange to purchase and sell the employee's stock under the stock incentive plan.
- The Domestic Agency must engage a qualified foreign bank to act as a custodian for the stock held by the employee under the stock incentive plan.
- The Domestic Agency must submit several documents to the relevant tax authorities, including the stock incentive plan or scheme for implementation, the stock option protocol and a notice prior to an employee exercising an option under the plan.
- The Domestic Agency must register the stock with the China Securities Depository and Clearing Corporation Limited (or an overseas securities depository and custodian institution).
As for tax liability, the Domestic Agency must act as the withholding agent for any taxes owed by the employee exercising his/her options under the stock incentive plan. At the time the employee exercises an option, the Domestic Agency must submit certain information and documents to the appropriate tax authority, such as the options exercised, the subscription price, the market price and the taxable income generated by the transaction. Any failure to properly withhold taxes accruing from an employee's exercise of an option will result in liability for the Domestic Agency.
This new scheme imposes greater administrative and compliance burdens on the FIEs of foreign-listed companies, but it also creates a mechanism for properly incentivizing employees in China without running afoul of Chinese foreign currency exchange and tax laws. Companies desiring to evaluate their current stock incentive plans in China, or those which want to implement such plans to remain competitive, should seek legal counsel in order to remain compliant with Chinese law.