China’s economic rebound in 2020 following its containment of Covid-19 continues to abate, and the Financial Times has shared that China’s growth of 6.5 % in the fourth quarter shows faster growth than before the pandemic and keeps beating expectations.

China is expected to grow further in 2021 and continue attracting international business and with it, foreign talent and experts are expected to work and live in China. A key factor in going forward for China’s businesses’ recruitment of high-quality talents worldwide along with the use of equity incentives to attract and maintain foreign talent.

In this article, we outline the key considerations and formulas for calculating the individual income tax (IIT) on equity incentives and the common misunderstandings that expats have when filing their taxes in China.

Difference between residents and non-residents

The IIT law states that individual taxpayers in China are divided into resident and non-resident individuals. Resident individual refers to an individual who has a residence in China or has lived in China for a total of 183 days in a tax year (the China tax year runs from 1 January to 31 December). A non-resident individual refers to an individual who has not lived in China or has not been registered as a resident in China for less than 183 days in a tax year. The tax related to an expatriate’s residence status is different, and the applicable equity incentive tax policy also differs.

According to the Notice of the Ministry of Finance and the State Administration of Taxation on Issues Relating to Transition of Preferential Policies following the Revision of the Individual Income Tax Law (Cai Shui [2018] No.164), equity incentives obtained by an individual resident following the policy conditions shall not be consolidated into the comprehensive income of the current year before 31 December 2021. The comprehensive income tax rate shall be applied in full on a standalone basis against the equity incentive.

The Announcement on Individual Income Tax Policies for Non-resident Individuals and Non-domiciled Resident Individuals (Ministry of Finance and State Administration of Taxation Announcement [2019] No. 35) says that non-resident individuals which obtain equity incentive income within one month, after calculating the monthly income following relevant regulations, shall not be combined with other wages and salaries for the month, and shall be taxed based on six months without deducting the expenses, and shall be calculated applying the monthly tax rate table.

Method for calculating equity with incentives and taxation

Equity incentives generally include stock options, stock appreciation rights, restricted stocks, and equity awards. For the equity incentives obtained by expatriates from listed companies, it is necessary to accurately calculate the equity incentive income and accurately calculate the IIT payable using different calculation methods applicable to individual residents and non-resident individuals.

Case study

John is a foreign employee of a listed company, and he performed well in January-May 2018. The company granted 10,000 shares of stock options in May, the stock price of the grant was RMB 10, and the option price was RMB 8. These can be exercised in May 2019, assuming that John exercised on 28th May 2019, and the market price of the stock on the day of the exercise was RMB 16, then how much IIT does John need to pay?

According to Notice of Ministry of Finance and State Administration of Taxation on Issues relating to the Collection of Individual Income Tax on Personal Income from Shares and Options, the income shall be calculated and paid using the provisions applicable to “wages and salaries”. Taking the difference between the actual purchase price (the exercise price) of the stock obtained from the enterprise and the fair market price on the purchase date (the stock’s closing price on the day of the stock).

The wages and salaries taxable income in the form of equity incentive = (market price per share of exercised stocks – the price per share paid by the stock option) x the number of shares. That is, John obtained the equity incentive income when exercised on 28 May 2019; therefore, the equation is as follows:

(16-8) x 10,000 = 80,000 

If John is a resident individual, according to Cai Shui [2018] No.164, IIT payable = equity incentive income x applicable tax rate – quick deduction. John’s stock option incentives are fully taxed separately, therefore, the IIT payable is:

80,000 × 10% – 2,520 = 5,480 

If John is a non-resident individual, he lived in China for 90 days but less than 183 days, assuming that he worked 85 days during Jan-May 2018, and only obtained this stock option incentive. According to the Ministry of Finance and State Administration of Taxation Announcement [2019] No. 35, his equity incentive income attributable to China = Incentive income x workdays ÷ calendar days in the period, therefore:

80,000 x 85 ÷ 151 = 45,033.11

IIT payable = [(equity incentive income attributable to China ÷ 6) x applicable tax rate – quick deduction] x 6 = tax paid. Therefore the answer is:

[(45,033.11 ÷ 6) x 10% – 210] x 6 = 3,243.31

(Note: The quick deduction is fixed as part of the formula)

Other tax preferential policies

According to Notice of the Ministry of Finance and the State Administration of Taxation on Improving Income Tax Policies Relating to Equity Incentives and Provision of Technology in Exchange for Shareholding (Cai Shui [2016] No. 101), where a listed company grants share options, restrictive shares and equity incentives to individuals, upon the completion of filing formalities with the tax authorities in charge, the individuals may pay IIT within the 12 months from the date of the exercise of share options, or the date of lifting moratorium for restrictive shares, or the date of obtaining equity incentives. Expatriates can pay attention to and enjoy this preferential policy when exercising these rights.

When the employee re-transfers the stock after the exercise, the difference between the fair market price and the reasonable market price obtained on the purchase date shall be calculated and paid according to the applicable provisions of the “income from property transfer”. According to the Notice of the Ministry of Finance and the State Administration of Taxation on the Temporary Exemption of Individual Income Tax on Individual Transfer of Stocks (Cai Shui [1998] No. 61), income from personal transfer of shares of listed companies will continue to be temporarily exempt from IIT. Foreign employees’ stocks obtained through equity incentives can enjoy IIT’s preferential exemption when they conduct free trade on the stock market.

For example, if an option is granted, and the person buys the share as 70 when the market value is 80, and then sells it at 100, 10 is taxed as a gain for IIT, and 20 is exempt.

General tips for submitting tax

In China, the Individual Income Tax Law has made clear provisions on the IIT collection and management requirements.

Expats being serviced by a withholding agent won’t have to submit their tax, as the withholding agent is responsible for prepaying tax every month or upon each payment earned.  In the case the taxpayer receives taxable income but does not have a withholding agent, they can submit their tax returns with the tax authorities within the first 15 days of the following month after obtaining the income and pay tax.

Tax payable on income from wages and salaries derived by a non-resident individual shall be withheld and prepaid by the withholding agent, if any, every month or based on each income item.

However, if there is a need to deliver a final settlement and payment, the taxpayer can do so from 1 March until 30 June of the following year after obtaining the income.

Finally, expats who are registered as residents in China with consolidated income can submit IIT yearly.

How Acclime can help

Acclime has decades of experience in taking care of taxation for businesses and individuals, navigating difficult situations and delivering tailored solutions. To avoid future issues, it is strongly recommended to carry out proper tax planning and ensure that all preferential tax policies are included.

To resolve your specific situation please send your enquiry to infochina@acclime.com