Managing Tax and SAFE Registration in China

Between SAFE and Circular 35 registrations, China has some of the most burdensome regulations that apply to equity compensation. I recently interviewed Dustin Lewis of Deloitte Tax for the NASPP’s Equity Expert podcast about the challenges of offering equity plans in China and trends in how companies address these concerns. Here is a summary of our conversation.

SAFE Registration

Companies that offer equity arrangements, including ESPPs to Chinese nationals are required to register their plans with China's State Administration of Foreign Exchange or SAFE. To comply with this requirement, companies must register with their regional SAFE office and also must establish a dedicated foreign exchange bank account that ensures that when Chinese nationals who participate in the equity plan sell their plan holdings, the sale proceeds are repatriated back to China.

Dustin highlighted how SAFE registration has evolved since these rules were first implemented, explaining that there used to be two processes: registration with SAFE and establishing the bank account. But now SAFE has delegated the approval process to banks:

So now if you're going to seek SAFE approval, you're not submitting your application directly to [your local] SAFE. You're going to your local bank, say, HSBC China or Citibank, China—a bank that has the ability to offer those dedicated foreign exchange accounts—and they're the ones that are going to help facilitate your application to SAFE.

Excluding respondents who don’t know whether their plans are registered with SAFE (which was over a third of the overall respondents), 100% of the remaining respondents to the NASPP/Deloitte Tax 2022 Equity Administration Survey have registered an RSU plan with SAFE, about half have registered an option plan, which tracks pretty closely with the prevalence of these plans.

It’s a different story for ESPPs. Although about half of public companies in the United States offer an ESPP, only about 30% of survey respondents have registered an ESPP in China. One reason for this discrepancy might be that some companies choose not to extend their ESPP to China. Dustin noted that SAFE compliance can be more onerous for ESPPs because it involves payroll deductions and moving contributed funds from China to the US parent. Some companies just don’t have the bandwidth to comply with SAFE registration for their ESPPs.

Tax Bureau Registration

In addition to SAFE registration, companies also must register their equity plans with local tax bureaus under Circular 35. Dustin explains that this is more burdensome than SAFE registration—which is completed once and then applies throughout China—because the tax registration must be completed in every Chinese jurisdiction where plan participants are located. If a company has plan participants in seven tax bureaus, that’s seven registrations that have to be completed.

And it gets worse. Dustin further explains that the information requested by each tax bureau varies; there isn’t a global standard. Thus, a registration in one bureau can’t simply be ported over to another bureau:

I think that's been the hardest part for my clients: not only to keep up with all the different registrations and the amendments every time they make a change to their plan or agreement, but understanding, on a bureau-to-bureau basis, what the expectations are in terms of reporting around grants or taxable events.

Dustin says there is some hope that we might see more uniformity in the tax registration requirements in the future, but it’s likely to be a long process.

Preferential Tax Treatment

Currently, China allows income from equity awards to be considered separately from payroll income for purposes of determining what tax rate applies to the income. This can result in a lower tax rate applying to the equity income than applies to employees’ other compensation. Dustin describes how this works during the podcast and notes a couple of pitfalls to be wary of.

Ten percent of respondents to the survey report that they don’t apply the tax-advantaged treatment to equity awards in China. Sometimes companies have the impression that if they don’t want to offer this tax advantage to employees, they don’t have to register their equity plans with the local tax bureaus. But this isn’t the case. Per Dustin, “The registration is strictly required, irrespective of whether or not the company plans on or will apply the preferential treatment.”

Dustin further points out that, although failing to register an equity plan with local tax bureaus disqualifies it from the preferential treatment, this treatment is often applied as a matter of course in China. Local payroll personnel in China often assume that this treatment applies to equity awards. Thus, US companies may think that they aren’t offering this treatment to employees in China, but if they were to check in with their Chinese payroll teams, they may find that it is being applied to their equity awards.

Lastly, this treatment may not be around for long. Dustin warns that the Chinese tax authorities have proposed eliminating this treatment (but registration with local tax bureaus would still be required). As noted in this alert from Deloitte, the current tax treatment has been extended through December 31, 2023 but there isn’t any guarantee that it will still be available in 2024.

Mandatory Same-Day Sale Programs

Among companies that grant stock options in China, nearly 60% report that they require Chinese option holders to use cashless exercises (i.e., same-day sales). I asked Dustin why companies establish these policies. He explains that, although cashless exercise isn’t a legal obligation, it can make SAFE compliance a little easier to administer because the sale proceeds can be immediately repatriated back to China. But Dustin also thinks that in some cases, these policies may be a holdover from the early days when SAFE registration first went into effect and it wasn’t always clear what was required. Now that it’s clear that they aren’t necessary, companies could revisit these policies but some may not have done so.

More Information

I had a great conversation with Dustin and there is so much more that we touched on that I’m not able to cover in this blog entry, such as whether US tensions with China might affect equity plans. Check out the full podcast today.