Foreign Direct Investment
How Employees in China Would Benefit from an Overseas ESOP
By Hao Wang
wh@rayyinlawyer.com
The employee stock ownership plan [ESOP] is a widely-accepted practice for giving incentives to employees. With more Chinese companies listed or to be listed on overseas stock markets, their employees in China would expect to enjoy the benefits of a well-designed ESOP. Since the holding company that is actually listed in the overseas stock market is incorporated under the laws of a country other than the PRC due to current legal obstacles in China, the ESOP adopted in such a situation is a plan governed by foreign laws. A foreign company listed on an overseas stock market may also have this concern if it wishes to award its employees in its subsidiaries in China through the ESOP applied in its headquarters. In light of foreign exchange controls and the taxation system in China, certain legal issues need to be resolved before employees in China could benefit from such an ESOP.
Issues Related to Foreign Exchange Control
China has a sophisticated foreign exchange control system to ensure economic stability which indeed proved its effectiveness during the Asian Financial Crisis. All inbound and outbound foreign exchange remittances are administered under either capital accounts or current accounts by the State Administration of Foreign Exchange (SAFE). An employee in China as a beneficiary under an ESOP needs to either remit money out of China to pay the consideration of options or shares and/or receive his entitlements after exercising his right to sell those options or shares. Thus, inevitably, the company needs to understand how to comply with all rules and regulations issued by SAFE.
In accordance with Rules on the Implementation of the Measures for the Administration of Individual Foreign Exchange issued by SAFE on January 5 2007, domestic individuals are allowed to be beneficiaries of an overseas ESOP in terms of foreign exchange administration.
The Operational Guideline on Foreign Exchange Administration for Domestic individual to Participate in Employee Shareholding Plans and Share Option Plans Of Overseas Public Companies (Operational Guidelines) issued by SAFE on April 6 2007 sets out operational details. This Operational Guidelines not only indicate operational procedures, but set requirements as to the ESOP itself. For instance, it requires that an ESOP shall contain the following institutions in its structure, i.e., a domestic agency, an asset administrator, a custodian bank and an entrusted institution for administration. Also, the company needs to clearly indicate the purchasing and payment quotas of foreign exchange that it is applying for.
Taxation Issues Related to ESOP
Individual income taxpayers are classified into two types: resident taxpayer and non-resident taxpayer. Resident taxpayers are individuals who have domicile in China, or who have no domicile but have resided in China for one year. Non-resident taxpayers are individuals who are neither domiciled nor resident in China, or who do not have domicile and have resided for less than one year in China. In China, resident taxpayers are subject to unlimited tax obligations and pay individual income tax on income derived from both inside and outside China. As a comparasion, non-resident taxpayers undertake limited tax obligations, and they only need to pay tax on income sourced within China. Thus, if your employees in China under an ESOP are resident tax payers, they will have the obligation to pay their individual income tax for the income as beneficiaries of such an overseas ESOP.
The PRC Ministry of Finance and State Administration of Taxation addresses this issue in the Circular on Individual Income Tax Policy for ESOP Gains and Supplementary Circular of the State Administration of Taxation on Individual Income Tax Policy for ESOP Gains.
A good understanding of all related laws and regulations would greatly help a company to keep talented people by means of offering a feasible ESOP.
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