Member Article

The Ministry of Finance and the State Administration of Taxation jointly issued the Notice on the Issue of the Levy of Individual Income Tax on Income Derived by Individuals from Stock Options on 31 March 2005 ("Notice"). The Notice, which entered into effect on 1 July 2005, provides a number of guidelines regarding the taxability of such schemes. Taxable event The Notice applies to stock options granted to employees of listed companies or their holding companies. The stock options give the employees the right to buy in the future a certain number of shares of their company at a certain price. An employee’s receipt of stock options is in itself not a taxable event. Employees only become liable to pay tax when they exercise the stock options. The difference between the exercise price and the closing market price on the day of exercise is considered the taxable benefit derived by the employee. If an employee is permitted to sell the stock options, the net sales proceeds received are deemed to be taxable employment-related income. Spreading the income The Notice permits an employee to spread the benefit derived from the exercise of the stock option over a period of six months provided the employee can prove that taxing the benefit in a single month would significantly increase his or her individual income tax liability. The following formula represents the individual income tax ("IIT") payable on stock option income: IIT Payable = (Taxable Stock Option Income/Fixed No. of Months x Applicable Marginal Tax Rate - Quick Calculation Deduction Factor) x Fixed No. of Months The "Fixed Number of Months" in the formula refers to the number of months during which an employee has worked inside China to earn the stock option income sourced in China. The maximum value for this number is 12.