Issues Concerning the Collection and Administration of Income Tax on Stock Incentives and Technology Shares(Mainland China)

James Cheng
To put in action the Circular on Improving the Income Tax Policy for Stock Incentives and Technology Shares (Cai Sui [2016] No. 101, the “Circular”) promulgated by the Ministry of Finance and the State Administration of Taxation on September 20, the State Administration of Taxation promulgated the Announcement on Issues Concerning the Collection and Administration of Income Tax on Stock Incentives and Technology Shares (the “Announcement”) on September 28, 2016 to further provide for tax collection and management issues under the equity incentive policy. The effective date of the Announcement was the same as that of the Circular on September 1.
I. Issues concerning the collection of personal income taxes
The Announcement provides that a private company who has completed recordation may be eligible for the tax deferral policy for its stock options, equity options, restricted stocks and stock incentives. To wit, employees will temporarily not need to pay taxes for stock incentives received until the shares are transferred; upon the transfer, the employee shall pay income tax at 20% per the “property transfer income” category.
1. For determining the average number of current employees for the last six months:
Pursuant to the Circular, the number of individuals receiving the incentive may not cumulatively exceed 30% of the average number of current employees in the last six months. The Announcement further clarifies the calculation standard as the average number of individuals subject to full withholding present under the “wage and salary income” category in the submitted withholding statements over a six-month period ending one month before the day of the exercise of a stock (equity) option, the removal of restrictions on a restricted stock, or the acquisition of stock incentives.
2. Handling of conditions not meeting the requirements for a stock incentive plan or changes to conditions during the deferral period:
The Circular requires that for incentives that do not qualify for tax deferral, or if the qualification conditions change during the deferral period so that the they are no longer compliant with the Circular, the personal income taxes shall be collected per the “wage and salary income” category based on the difference between the actual cost of acquisition from the fair market value “Fair market value” is defined in the Announcement that for a public company, the fair market value is based on the closing price of the stock on the day of acquisition; if the acquisition did not take place on a trading day, the fair market value would be the closing price of the stock on the previous trading date. For a private company, the fair market value shall be determined based on the net asset method, analogy method and other reasonable methods. The net asset method will be employed to make the determination based on the net asset of the obtained stock (equity) at the end of the previous year.
3. Handling of incentives received by employees which only partially meet the requirements for tax deferral:
With respect to stock incentives obtained by employees, the Announcement stipulates a differentiation scheme in that between incentives that meet the tax deferral requirements and those that do not, separate tax policies are applied. In particular, if in a single tax year an employee obtains stock incentives that do not meet tax deferral requirements at below fair market price, Article 7 of the Supplemental Circular of the State Administration for Taxation on Issues Concerning Payment of Personal Income Taxes on Income from Personal Stock Options (Guo Shui Han [2006] No. 902) shall be followed.
4. Recordation filing by enterprises:
The Announcement specifies different rules regarding the timing of recordation and the relevant materials to be submitted for tax deferral qualified incentives from a private company, implementation of incentives from a public company, and shares obtained by technology investment. At the same time, the Announcement also contains specific requirements for the annual submissions to be made by withholding agents during the tax deferral period.
5. Materials to be provided at the time of share transfer:
Under the Circular, an enterprise that implements equity incentives or grants technology shares to individuals shall be the withholding agent for the individual income tax levied on such incentives or shares. Therefore, at the time of tax filing for the transfer of tax-deferred stocks (equity), the Announcement provides that the withholding agent and the individual shall submit to the tax agency materials which can substantiate the transfer price of the stock (equity), the original value of the tax-deferred stock (equity), and the reasonable tax amount, including specifically the transfer agreement, appraisal report and relevant notes.
II. Issues concerning the collection of enterprise income taxes
1. The tax deferral policy applies to resident enterprises engaged in audit collections
In consideration that enterprises engaged in the verification of collections generally cannot accurately assess the status of their income or expenditure, the Announcement specifically requires that only resident enterprises engaging in audit collections are eligible for the tax deferral policy.
2. Collection and management requirements under the policy:
Pursuant to the recordation provision under Article 3, Paragraph 1 of the Circular, the Announcement provides that the State Administration of Taxation shall prepare a “Table of Recordation Filing for Tax Deferral by Enterprises Granting Technology Shares” and stipulates that such table shall be submitted to the competent tax authority by an enterprise upon its first prepayment declaration after the completion of its investment. The purpose is to confirm the amount of deferred taxable income from the enterprise’s technology shares so as to lay a foundation for enhanced subsequent supervision by the tax authorities. In addition, to prevent enterprises from intentionally overvaluing its technology shares to lower its income tax basis, the Announcement stresses that the competent tax authorities shall have the right to make adjustments if the assessment of technology shares is clearly unreasonable.