February 2019: China – New Income tax changes!

New tax law risks are putting a strain on employer and employee relations in China where the employer chooses to operate a cash incentive scheme over equity incentives. Historically,  many companies have not offered shares in China due to the strict foreign exchange rules, which require a registration with the State Administration of Foreign Exchange (“SAFE”). Changes to tax rules may challenge this decision making. The Individual Income Tax Law of China and new regulatory changes (“New IIT Law”) became effective on 1 January 2019 and provides employees with a reduced tax rate on equity incentives.

Registering a share incentive plan with the relevant local tax bureaus will allow an employee’s income from equity to be recognised as a separate category, and consequently subject to lower rates of tax. If the income is from a share plan it will not form part of comprehensive income (which includes wages and salaries, labour service remunerations, rewards of writers and royalties) and therefore won’t be subject to the potentially higher progressive tax rates. This is a change from the previous effect of the tax filing, which only allowed employees to spread the income over, or up to, 12 months (which could have also reduced the effective tax rate).

This will first take effect over a transitional period (1 January 2019 to 31 December 2021), during which income from an equity incentive plan registered with the tax authority will not be included in the comprehensive income and therefore will enjoy a reduced tax rate.
 
Tapestry comment
Employees in China now have more incentive to want shares over cash because of the potentially reduced tax liability, and we are seeing more companies applying for SAFE registration because of this. Companies should balance  the increased demand from employees for share incentives against the onerous and costly SAFE registration and ongoing reporting required for equity based incentive schemes.

If you want further advice as to how Tapestry can help you manage this risk, how to complete the tax registration or how to navigate a SAFE application, please get in touch.

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