Is deferred taxation applicable?

Pursuant to the Notice of the Ministry of Finance and the State Taxation Administration on Improving Income Tax Policies Relating to Equity Incentives and Technological Equity Contributions (Cai Shui [2016] No. 101, hereinafter referred to as the “No. 101 Notice”), qualified non-listed companies granting equity incentives—such as stock options, restricted shares—to employees may enjoy deferred taxation benefits, namely: 1. Employees may temporarily defer taxation upon receipt of the equity incentive, with tax liability deferred until the equity is transferred; 2. Upon transfer of the equity, the taxable amount is calculated as the difference between the transfer income and the acquisition cost of the equity plus reasonable taxes and fees; this amount is taxed under the category of “income from property transfer” at a flat rate of 20%. The key distinction between deferred taxation (as described herein) and the previously discussed policy of deferred payment for equity incentives granted by listed companies is as follows: 1. Under the deferred payment policy, the tax obligation has already arisen and the tax amount has already been determined; only the timing of payment is postponed. By contrast, under approved deferred taxation, the tax obligation itself is deferred until the time of equity transfer—meaning that, during the deferral period prior to transfer, the exact tax amount remains undetermined. 2. For equity incentives granted by listed companies, individuals pay individual income tax under the “salary and wages” category (and may elect not to include such income in comprehensive income, calculating tax separately); whereas, for qualified equity incentives granted by non-listed companies, individual income tax is levied under the “income from property transfer” category at the time of equity transfer. II. Key Points Regarding Deferred Taxation for Equity Incentives Granted by Non-Listed Companies 1. Eligibility Conditions As noted above, deferred taxation benefits are available only if certain conditions are met. These conditions are as follows: 2. Filing Is Mandatory! Failure to complete the required filing procedures disqualifies the taxpayer from enjoying the deferred taxation preferential policy. The filing requirements include the following: 1) Within 15 days of the month following the company’s decision to implement the equity incentive plan, the enterprise must submit the “Equity Incentive Situation Report Form” to the competent tax authority and provide supporting documents, including but not limited to: the stock option plan and its implementation scheme, the stock option agreement, the notice of grant, the notice of exercise, and details regarding the stock (or equity) options received or transferred by individuals—including type, quantity, grant price, exercise price, market price, and transfer price. 2) Individuals opting for deferred taxation must, within 15 days of the month following the exercise of stock (or equity) options, the lifting of restrictions on restricted shares, or the receipt of equity awards, have the implementing enterprise submit the “Deferred Taxation Filing Form for Individual Income Tax on Equity Incentives of Non-Listed Companies.” Supporting documents required include the equity incentive plan, board or shareholders’ meeting resolutions, statements confirming the incentivized individuals’ employment status or engagement in technical work, and documentation detailing the composition of the enterprise’s main business revenue for the preceding tax year. 3) During the deferred taxation period, the enterprise implementing the equity incentive plan—as the withholding agent—must file the “Annual Report Form on Deferred Taxation for Individual Income Tax” within 30 days after the end of each calendar year. 4) At the time of transfer of the deferred-taxation stock (or equity), the enterprise must also submit documentation concerning the transfer price, the original value of the deferred-taxation stock (or equity), and related reasonable taxes and fees—including the transfer agreement, valuation reports, and relevant receipts. 3. Domestic Resident Enterprise Requirement Carefully reviewing the above conditions, the No. 101 Notice explicitly stipulates: “The underlying equity subject to the incentive must be the equity of a domestic resident enterprise.” Thus, equity incentive plans based on overseas companies do not qualify for the deferred taxation benefit. 4. Direct Shareholding Requirement Combining the statement above—“the underlying equity subject to the incentive must be the equity of a domestic resident enterprise”—with the No. 101 Notice’s requirement that incentive recipients be employees of the enterprise (“(i) Stock options, equity options, restricted shares, and equity awards granted by non-listed companies to their own employees…”), it follows that equity incentive arrangements implemented indirectly via employee shareholding platforms do not fall within the scope described in the No. 101 Notice and therefore do not qualify for the deferred taxation benefit.

Preferential policies for equity incentives

Pursuant to the Notice Cai Shui [2016] No. 101, deferred taxation applies to qualified stock options, equity options, restricted shares, and equity awards granted by non-listed companies. Illustrative Example: Senior executive A of a company received 10,000 stock options in 2019. In 2020, the exercise price was RMB 20 per share, while the market price on the exercise date was RMB 30 per share. In 2022, A transferred the shares at RMB 40 per share. Method I: Not electing deferred taxation (30 − 20) × 10,000 = RMB 100,000 → Individual income tax due = RMB 100,000 × 10% − RMB 2,520 = RMB 7,480. At the time of transfer in 2022: (40 − 30) × 10,000 = RMB 100,000 → Tax = RMB 100,000 × 20% = RMB 20,000. Total tax payable = RMB 20,000 + RMB 7,480 = RMB 27,480. Method II: Electing deferred taxation No individual income tax arises upon exercise. At the time of transfer in 2022: (40 − 20) × 10,000 × 20% = RMB 40,000.

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