Preface
Nowadays，share incentive payment is commonly applied by listed and unlisted enterprises to motivate and retain employees. Regarding the tax treatment for this kind of payment, including individual income tax (“IIT”) for employees and corporate income tax (“CIT”) for the employers, we will have a brief review on tax regulation stipulation in this article.
What is share-based payment?
Share-based payment refers to a transaction in which an enterprise grants equity instruments or assumes liabilities determined on the basis of equity instruments to employees or other parties in exchange of their services provision. By way of settlement, share-based payment is classified into equity share settlement payment and cash settlement payment.
Accounting treatment
Before talking about tax treatment, we have a quick look at the accounting treatment to see how this transaction affects the balance sheet and income statement.
| Time point | Cash settled payment (e.g. Cash stock appreciation option ) | Equity share settled payment (e.g. stock option) |
| On the grant date | If incentive plan is that the right can be exercised immediately after being granted, the entry can be made to recognize cost of incentives with the fair value of liability the enterprise shall undertake at the grant date.
Dr. Expense Cr. Payroll payable |
If incentive plan is that the right can be exercised immediately after being granted, the entry can be made to recognize cost of incentives with the fair value of shares at the grant date and quantity of shares granted.
Dr. Expense Cr. Capital surplus-other capital surplus |
| For other types of plan, no accounting entry is required. | For other types of plan, no accounting entry is required. | |
| At each balance sheet day during the vesting period | Entry shall be made to recognize the fair value of liability relating to service provided by employees for the current period based on best estimate of feasibility of the plan.
Dr. Expense Cr. Payroll payable-share-based payment |
Entry shall be made to recognize current period service cost based on best estimate of quantity of vesting shares and fair value of shares at grant date.
Dr. Expense Cr. Capital surplus-other capital surplus |
| At each balance sheet day and exercising day, the fair value of the liability shall be re-measured and the difference between the re-measurement and the estimation made in prior period shall be adjusted
Dr. Gain or loss on changes of fair value Cr. Payroll payable-share-based payment |
After the vesting period is finished, no adjustment on the expense and cost and total amount of owner’s equity is necessary. | |
| On the exercising day | Dr. Payroll payable-share-based payment
Cr. Bank |
Entry is made to increase paid in capital or shares based on quantity of shares actually exercised.
Dr. Bank Dr. Capital surplus-other capital surplus Cr. Paid in capital Cr. Capital surplus-capital premium |
From the above accounting treatment, we can see that, for both cash settled payment and equity share settled payment, accounting principle requires recognize cost of the share incentives in income statement.
Tax treatment
For the enterprise
According to tax regulation, which is applicable to both unlisted and listed enterprise, the expense recognized in accounting during the vesting period cannot be deducted before CIT in the current year, but can be treated as temporary deductible differences, since the expense of incentives can be deducted when the right is actually exercised, although amount calculated according to tax regulation for deduction is different from that recognized according to accounting principle.
According to tax regulation, on the vesting date, the enterprise can determine CIT deductible salary expense with the difference between the fair value of the shares at exercising date and the actual exercise price paid by the incentive employee in the current year.
For the employee
When exercising the right, the employee shall levy IIT according to the applicable provisions of “wage and salary income” on net balance of fair value of the shares on vesting date minus the actual purchase price. Under special circumstances, if the employee transfers the stock option before the exercise date, the net income from the transfer of the stock option shall levy IIT also under tax item of wages and salaries.
With respect of stock options, restricted stocks and equity awards granted to employees by listed company and unlisted company, employees can apply for deferral of tax payment with tax authority. For employees from listed company, upon filing with the tax authorities, employees can pay IIT within a period of no more than 12 months starting from the date of exercising. For unlisted company, employees who meet certain conditions, upon filing with tax authority, can defer tax payment till the transfer of shares.
With respect of transfer of shares obtained from incentive plan, for shares of listed company, IIT is exempted. For shares of unlisted company, employees shall levy IIT under tax item of property transfer at 20% on net income of transfer income minus the purchase cost of shares.
List of applicable regulations
- Enterprise Accounting Principle No. 11-share-based payment
- Announcement of the State Tax Bureau on the Treatment of Corporate Income Tax on the Implementation of Equity Incentive Plan by Resident Enterprises in China (Announcement of State Tax Bureau (2012)18《国家税务总局关于我国居民企业实行股权激励计划有关企业所得税处理问题的公告》（国家税务总局公告2012年第18号）
- An Interpretation of the Announcement on the Corporate Income Tax Treatment of China’s Resident Enterprises Implementing Equity Incentive Plan 国家税务总局办公厅《关于<我国居民企业实行股权激励计划有关企业所得税处理问题公告>的解读》
- Notice of the Ministry of Finance and the State Tax Bureau on the Collection of Individual Income Tax on Income from Individual Stock Options (Caishui (2005)35《财政部、国家税务总局关于个人股票期权所得征收个人所得税问题的通知》（财税[2005]35号）
- Notice of the State Administration of Taxation on Improving the Income Tax Policies on Equity Incentive and Technology Shareholding (Caishui (2016)101《国家税务总局关于完善股权激励和技术入股有关所得税政策的通知》（财税[2016]101号）
- Notice of Ministry of Finance and the State Tax Bureau on the Continued Temporary Exemption of Individual Income Tax for Individual Transfer of Stock （Caishuizi(1998)61）财政部 国家税务总局关于个人转让股票所得继续暂免征收个人所得税的通知财税字[1998]61号
Please note that the article only represents the opinion of the writer. Regarding the implementation of the tax treatment, the consultation with the local in-charge tax authority is required.
And if you have any related tax questions, welcome to contact us at info@lla.cc any time!
