Many listed MNCs choose to extend the grant of equity incentives to PRC based executives. Such incentives include mainly stock options, restricted stock, and stock appreciation rights.
Equity incentives are treated as employment income under Chinese IIT laws and taxed in the same manner as salaries and wages. As such, failure to withhold applicable IIT would result in significant tax risks to MNCs. Especially, if the failure to withhold is discovered after an employee has left the company, the company may have to bear the cost of the applicable tax (as opposed to chasing the former employee for such tax) in order to reach a speedy settlement with the tax authorities.
Pursuant to the PRC IIT laws, equity incentive income received by Chinese executives would be subject to PRC IIT at the progressive rate ranging from 3% to 45% (i.e., taxed as salaries/wages). In addition, Chinese executives would be subject to PRC IIT at the rate of 20% on the capital gains derived from their subsequent sale of the relevant shares. The 20% tax on capital gains is however not subject to the same withholding as applicable to equity incentive income.
As to foreign executives, because the equity incentives are presumably awarded for their PRC employment, such equity incentives would also be viewed as PRC sourced income and be subject to PRC IIT at the progressive rate ranging from 3% to 45%. Whether the capital gains derived from sale of the shares would be subject to the 20% PRC IIT would however be based on the foreign executives’ tax residency status. If the foreign executive is not a tax resident of the PRC, the foreign senior executive would not be subject to PRC IIT on such capital gains.
For foreign executives, there are some additional rules which may provide some tax relief. For example, if equity incentives are granted for not only their PRC employment but also non-PRC employment prior to and/or after the secondment to China, the equity incentives can be split into PRC sourced and non-PRC sourced based on the foreign executive’s working period within and outside China. For example, if the foreign executive has worked for a MNC for five years and of which two years are in China and if the equity incentive granted to the foreign executive covers the entire five years, theoretically only the equity incentive in connection with the foreign executive’s actual working period in China, i.e., 2 years, would be considered sourced from China and subject to PRC IIT.