A Study Into The Taxation Policy For ESO In China

Executive (Employee) Stock option (ESO) is a new way of compensation to solve the so called Agent Problem. In many developed countries, ESO has already had a long history of application which proved to be very effective. In recent years, Chinese enterprises have begun to use ESO as a compensation method. However, many problems occured in China's ESO practices. In the past several years, China accelerated the reform of state owned enterprises. And in this process, more and more ESOs have been applied but remarkable potential risks have emerged. In the US Internal Revenue Code (IRC), there are several sections to regulate the application of ESOs. The IRC classifies ESOs into ISOs and NSOs and implements different taxation policies respectively. China has issued two taxation notices to levy tax on the income of ESOs. However, those two notices haven't formed a integrate taxation policy. And thus no effective regulatory power is imposed on ESO practices. China should form its own ESO taxation policy as soon as possible. According to the status quo of ESO practices in China, we suggest that China should classify ESOs and impose a relatively tight taxation policy. An incentive ESO should be established in taxation laws and thus ESOs are classified into Incentive and Non-incentive ones. Different taxation treatments are imposed on the two types of ESOs, and the aim to regulate the application of ESOs is realized.