Companies often use share incentive programs to motivate employees by tying compensation to their service. Though no foreign person can own stock in a private Chinese company, it is possible for a PRC employee of a foreign company’s Chinese subsidiary to participate in the foreign company’s employee share incentive plan (“SIP”). However, due to China’s currency controls, whether such an employee can actually “cash out” on the benefits of such a program depends on whether the foreign company is or becomes listed on a foreign stock exchange at the time of exercise.
The primary rules on PRC citizen employees participating in a foreign company’s SIP come from the Circular on Foreign Exchange Administration of Domestic Individuals Participating in Share Incentive Plans of Foreign Listed Companies [2012] No.7 (“Circular 7”, issued by the State Administration of Foreign Exchange (“SAFE”).
- Registration and Designated Account
Under Circular 7, a foreign listed company can offer SIPs to its PRC subsidiary’s employees in China via an incentive plan. The incentive plan must be registered with the local SAFE office where the foreign company’s domestic agent is located. This domestic agent can be the PRC subsidiary of the foreign listed company participating in the SIP (if multiple places, then the location of the headquarter) or a third party domestic entity that is qualified to provide asset custodian services.
Once the registration is complete, the domestic agent must open and maintain a domestic foreign exchange account designated for handling foreign payments and collecting money for all domestic individuals participating in the SIP of the overseas listed company. Any payments under the incentive plan must go through this special account before they go to an individual participant’s bank account.
Again, just like China employment contracts, we cannot emphasize enough how SAFE registration is highly local. It is critical to consult with the local SAFE office about specific requirements for registration before submitting an application. And just as is true of pretty much anything and everything in China, you do not want to get halfway through the process before you realize you are doing it wrong because this will make doing it right more difficult or perhaps even impossible.
- Type of Awards Covered
Under Circular 7, share incentive plans mean any incentive plan where the shares of the foreign listed company are offered to directors, supervisors (officers who supervise directors and senior management of a company, a position created under the PRC Company Law), senior management employees, other employees of the domestic company or individuals who have a labor relationship with the domestic company. This includes employee stock option plans, share ownership plans, and any incentive plans permitted by law.
Though Circular 7 does not enumerate the specific types of awards to which it applies, the relevant registration form provides checkboxes for the following types of awards: stock ownership plans, stock options, stock appreciation rights, phantom stock, restricted stock (units), performance shares (units), and stock purchase plans.
- Nationality of Participants
Circular 7 defines “domestic individuals” as directors, supervisors, senior management and other employees within the scope of article 52 of the Regulation on Foreign Exchange Administration who are PRC, Hong Kong, Taiwan, and Macao nationals, and other foreign nationals who have resided within China for one year on a continuous basis, except foreign diplomats in China and the representatives of any international organizations in China.
- PRC Employees and Foreign Private Company Incentive Plans
Certain special rules apply to special purpose vehicles (foreign companies established or controlled by PRC residents or organizations) and PRC law and Circular 7 are silent on domestic individuals participating in purely foreign private companies’ SIPs. This does not mean Chinese individuals are not allowed to participate in a foreign private company’s SIP, but the lack of clear legal authorization makes it practically impossible for PRC individuals to receive benefits or awards under those plans if the foreign company is not yet public by the time of exercise.
And again, because SAFE registration is so highly localized, even though the law does not require registration of a private foreign company’s SIP, it is advisable to consult with the local SAFE office and attempt registration anyway. It doesn’t hurt to ask.
A foreign company with a concrete plan to become publicly listed in the near future can enter into an agreement with its employees in China to offer stock option or other awards. If the company does go public as planned, such awards can then be registered with SAFE and special accounts can be created to process payments in compliance with PRC laws. However, when entering into such agreements, the company should also make sure its employees in China understand that if the company does not go public, the employees may never receive SIP related proceeds due to China’s foreign exchange control rules.