Issues Concerning the Levy of Individual Income Tax on Income from Personal Stock Options Circular

1. Levy of income tax on the stock options of employees

Individual income tax on the income from the stock options granted to the employees of enterprises with stock option schemes shall be levied in accordance with the relevant provisions of the PRC Individual Income Tax Law and its implementing regulations.

The term "stock option of enterprise employees" (Stock Option) means a right granted in accordance with the specified procedure by a listed company to its employees and the employees of enterprises controlled by it. The said right permits authorized employees to purchase at a future date at a certain set price a certain quantity of the company's shares.

The aforementioned `certain set price', known as the `grant price' or `strike price', is the price at which the shares may be bought in accordance with the stock option scheme. In general, it is the market price or a discounted price based on such price on the date the Stock Options are granted or, alternatively, may be the price calculated according to a predetermined method. The "grant date" is the date on which the company granted its employees the aforementioned right. "Exercise" means the process whereby an employee elects to purchase the shares in accordance with the stock option scheme. The date on which an employee exercises the aforementioned right is known as the "exercise date" or "purchase date".

2. Confirmation of the nature of the income from stock options and specific provisions on the levy of tax thereon

(1) Unless otherwise provided, in general, the Stock Options received by an employee from the enterprise under the stock option scheme are not treated as taxable income at the time of receipt.

(2) When the employee exercises his or her option, the difference - if the actual purchase price (strike price) at which he or she obtained the shares from the enterprise is lower than the fair market price on the purchase date (here and hereinafter the closing price of the shares on said date) - is income connected to the employee's service or employment and obtained for his or her performance and results with the enterprise, and individual income tax thereon shall be calculated and paid in accordance with provisions applicable to "wage and salary income".

If, under special circumstances, the employee transfers his or her Stock Options before the exercise date, the net income derived from the transfer of the Stock Options shall be deemed wage and salary income and individual income tax levied thereon accordingly.

The taxable wage and salary income of an employee on wage and salary income earned during the period in which the exercise date falls shall be calculated in accordance with the following formula:

Taxable wage and salary income in the form of Stock Options = (per share market price of each share for which the option was exercised - strike price for each share paid by the employee to obtain the Stock Options) X number of shares.

(3) The difference obtained by the employee at the time of transferring the shares, after exercising his or her options, due to their price being higher than the fair market price on the purchase date, is income earned through transfer by an individual of negotiable securities, such as shares, etc., on a secondary securities market. Individual income tax thereon shall be calculated and paid in accordance with levy and exemption provisions applicable to "income from a property transfer".

(4) Individual income tax on the income obtained by an employee from distribution of the enterprise's after-tax profit as a result of holding equity in the enterprise shall be calculated and paid in accordance with provisions applicable to "interest, dividend and bonus dividend income".

3. Division of domestic and foreign sources of wage and salary income

Pursuant to the relevant provisions of the State Administration of Taxation, Issues Relevant to Determining the Tax Obligations of Individuals with no Domiciles in China Who Obtain Their Wages or Salaries in the Form of Negotiable Securities Circular (ref. Guo Shui Han [2000] No.190), if it is necessary to determine whether the wage and salary income obtained by an employee from participation in an enterprise stock option scheme is from a domestic or foreign source, the division shall be made by calculating the percentage of the employee's working months in China and abroad based on which the aforementioned wage and salary income was obtained.

4. Calculation of tax payable

(1) Calculation of tax on income from subscribed shares (option exercise income): If, in accordance with this Circular, income obtained in China by an employee in connection with his participation in a stock option scheme should be treated as wage and salary income when calculating and paying tax, the wage and salary income in the form of Stock Options may be distinguished from the other wage and salary income in the same month and the tax payable thereon for that month may be calculated separately in accordance with the formula below.

Tax payable = (taxable wage and salary income in the form of Stock Options ¡Â set number of months X applicable tax rate - default deduction) X set number of months;

where, the "set number of months" means the number of months of work in China during which the employee obtained wage and salary income in the form of Stock Options originating in China. If the number is greater than 12 months, it will be calculated as 12 months. The applicable tax rate and default deduction is determined by dividing the taxable wage and salary income in the form of Stock Options by the set number of months and matching the quotient resulting therefrom against the tax rate table attached to the State Administration of Taxation, Issuance of the Circular (ref. Guo Shui Fa [1994] No.089).

(2) Calculation of tax on income from the transfer (sale) of shares: Individual income tax on the income derived by an employee by transferring such negotiable securities as shares, etc. shall be levied/exempted in accordance with current tax laws and policies. Namely, for the time being, no individual income tax will be levied on income derived by an individual on the transfer of shares of a listed company in China obtained by him or her through the exercise of his or her options. For income derived from the transfer by an individual of shares of a company listed abroad, the taxable income and the tax payable thereon shall be calculated in accordance with tax laws and the tax thereon paid in accordance with the law.

(3) Calculation of tax on income from the distribution of after-tax profits: Tax on the dividend and bonus dividend income received by an employee through the distribution of after-tax profit in connection with the equity held by him shall be calculated on the whole amount at the specified tax rate and tax paid thereon, unless he or she is entitled to a tax exemption or reduction in accordance with relevant provisions.

5. Levy and administration

(1) Withholding agents: Enterprises in China with stock option schemes shall be individual income tax withholding agents and shall perform their obligation of withholding individual income tax in accordance with tax laws.

(2) Filing of tax returns and payment of tax oneself: If an employee obtains wage and salary income in the form of Stock Options from two or more sources and does not have a withholding agent, he or she shall themselves file tax returns and pay tax by the filing deadline specified in the individual income tax law.

(3) Submission of relevant information: An enterprise in China that intends to implement a stock option scheme shall submit its stock option scheme or plan for the implementation thereof, Stock Option agreement, grant notice and other such information to the competent tax authority before it implements such scheme. It shall submit the Stock Option exercise notice and exercise adjustment notice, etc. to the competent tax authority before employees exercise their options.

When filing his or her tax return or when withholding tax, an individual who files his tax return themselves or a withholding agent shall submit information on the acceptance or transfer of Stock Options by himself/herself/individuals and the shares subscribed to (including the type, quantity, strike price, exercise price, market price, transfer price, etc.) to the competent tax authority during the tax return filing period specified in tax laws.

(4) Penalties: If an enterprise with a stock option scheme or an employee who files his or her own tax returns and who obtains taxable income from a stock option scheme fails to submit the aforementioned relevant statements and information or fails to perform his or her tax return filing and payment obligations or its withholding obligation, the matter shall be handled in accordance with the relevant provisions of the PRC Administration of the Levy and Collection of Taxes Law and its implementing rules.

6. Implementation date

This Circular shall be implemented as of July 1 2005. In the event of a discrepancy between the provisions of the State Administration of Taxation, Questions Concerning the Levy of Individual Income Tax on Discounts or Subsidies Granted by Employers to Individuals Who Subscribe for Negotiable Securities such as Shares Circular (ref. Guo Shui Fa [1998] No.9) and those of this Circular, those of this Circular shall prevail.