On 20 February 2012, the PRC State Administration of Foreign Exchange (“SAFE”) issued Circular Huifa  No.7 – ‘Notice regarding certain issues related to foreign exchange administration for individuals employed by domestic companies participating in share-based incentive plans of overseas listed companies’ (“Circular  7”). This notice clarified the procedural requirements on SAFE registration of share-based incentive plans previously stipulated by Circular Huizongfa (2007) No.78 (“Circular  78”). This article sets out the key points of Circular  7, as well as certain accounting and tax issues still faced by companies in China offering share-based incentive plans to Chinese employees.
Exchange control is one of the major barriers of international trade and investment; it hinders free flow of capital and increases the cost of doing business. In China, exchange control measures are complicated and ineffective because banks are required to monitor and report clients’ transactions involving foreign currencies, and the exchange control system is linked to the tax reporting system.
Circular  78 is one of the first guidelines issued by SAFE to monitor the administrative matters related to local employees of the People’s Republic of China (“PRC”) who participate in share-based incentive plans granted by overseas listed companies. To facilitate proper inbound and outbound foreign exchange funds flows, registration requirements as stipulated below must be followed throughout the implementation and execution of the overseas incentive schemes.
On 20 February 2012, SAFE took further steps to tighten the share-based incentive plans registration requirements by issuing Circular  7. Circular  7 took effect upon its promulgation and supersedes Circular  78 and Circular Huizongfa  No.2 (regarding the delegation of approval authority for the quota of initial foreign exchange purchase and opening foreign exchange accounts).
Major Differences between Circular  78 and Circular  7
The key differences between Circular  78 (now superseded) and Circular  7 are summarised in the table opposite.
Registration Requirements Under Circular  7
First Time Registration
Local agents are required to submit the following information/documents to the local branch of SAFE for the registration of the share-based incentive plan(s) granted by an overseas listed company:
- Application letter
- Application form
- Authorisation letter appointing the main applicant/local agent in the PRC for the registration procedures
- Public notice issued by the overseas listed company that proves the authenticity of the share-based incentive plan(s)
- Commitment letter stipulating the employment relationship between the participating entities in the PRC and the individuals (the letter should cover the personal details of the individuals and the type of share-based incentive awards given)
- Other documents as required by the authorities
A quota for foreign currency to be remitted out of China and/or to be remitted into China shall also be applied for when performing the above application.
Status Report Filing
Quarterly status on-record filing of the incentive plan (e.g. changes to the main applicant or their designated agent, as well as changes to the operation of the plan) should be performed by the local agents within three working days after each quarter ends.
Local agents should perform amended SAFE registration within three months of the major changes being made to the original share incentive plans, e.g. change of key terms, merger and acquisition, etc..
Local agents are required to perform de-registration of the incentive plans within 20 days after the expiration or termination of incentive plans, e.g. the plan expires, termination of the plan due to de-listing of the foreign listed company, or restructuring/merger of the PRC entities.
Local agents are required to open a special foreign exchange bank account in the PRC for the execution of share-based incentive plans.
The designated bank should report each month’s foreign exchange transactions, as well as track and report the opening and closure of these foreign currency accounts, within three working days following the end of each month.
For local participants who use their own foreign currency reserves to participate in the share-based incentive plans, registration with the relevant SAFE branch office is required.
Points to Note
Circular  7 provides flexibility in allowing local participants using their own foreign currency reserves to participate in share-based incentive plans and simplifies the application procedures for the quota of foreign exchange purchases.
Nevertheless, the SAFE is tightening up the foreign exchange administration related to overseas share incentive plans under Circular  :
- by expanding the types of plans e.g. phantom share incentive plans
- expanding the persons covered e.g. foreigners and residents of Hong Kong, Macau and Taiwan who have employment or working relationship with PRC entities
- making/amending provisions on the subsequent reporting requirements.
In addition, the circular remains unclear as to whether the registration requirements apply to international assignees of the PRC in the same way that it applies to locally-hired foreigners. Multi-national companies should review the current SAFE registration status of their share-based incentive plans to make sure they are properly registered according to Circular  7.
Accounting and Tax Issues
Registration requirements of employee share option plans with the PRC tax authorities have been set out in Circular  No.35, issued by the Ministry of Finance. In general, the plans and the implementation procedures will be provided to the local tax authorities in charge of the PRC individual income tax (“IIT”) filings of the PRC employees concerned. PRC employers will also be required to act as the IIT withholding agents.
Upon issuance of Circular  7, we anticipate the State of Administrative of Taxation (“SAT”) will issue another tax circular to cover the other types of share-based incentive plans and the persons involved so that it is consistent with the provisions of Circular  7.
The PRC IIT treatments in respect of gains from deriving benefits from share-based incentive plans, and capital gains from the disposal of the underlying shares, are in line with international practice.
The PRC Enterprise Accounting Standards No.11 is generally in line with the International Financial Reporting Standards No. 2, in respect of share-based payment. Fair value of the share-based payment shall be recognised by enterprises as its cost of services received from its employees or other personnel.
The SAT has recently issued Circular  18 on 23 May 2012, granting corporate tax deduction on share-based payment costs. However, it is still uncertain if costs charged by a foreign listed company to its affiliates in China regarding share-based payments granted to employees of the PRC affiliates, can be tax deductible in China.
Share-based incentive plans would be more popular in China. Various PRC authorities including the Ministry of Finance SAT, SAFE and the Securities Regulatory Commission shall work together to produce an updated set of regulations and measures.