Employers that would like their employees to stay with the company for a long time and/or want their employees to achieve certain performance targets, may offer those employees (conditional) shared-based benefits, such as share options and share awards. Employees need to be award of the share option taxation system in the jurisdiction.
One has to be well aware that such share-based benefits are generally regarded by the Hong Kong Tax Department/Inland Revenue Department (“HK-IRD”) as an income emolument from employment and hence this income may potentially be subject to Hong Kong salaries tax unless certain conditions for tax exemptions can be satisfied. This is specially relevant in Hong Kong as is one of the most attractive places in the world to generate investment income by trading securities, such as shares, bonds, funds, futures and options.
Share Option & Award Gains
Pursuant to the Hong Kong tax laws, a gain realised by an employee through the exercise, assignment or release of a share option granted by his/her employer is usually considered as an employment income. Employees are eligible to exercise stock options only after they have been granted/vested (i.e. after the stipulated conditions for entitlement to the share options, if any, have been met). It is more common for an employee to exercise share options instead of to assign or release share options. As such, our discussion below shall focus on exercise of share options.
Under the Hong Kong salaries tax, share option gains are subject to tax in the year when the share options are exercised. The amount of taxable gain is in general calculated as based on the difference between (a) the market price of the shares at the time of exercise of the share options and (b) the amount/value of the considerations given by the employees for the shares and grant of the share options, if any.
As you may be aware, the share option gain on which tax is charged is a notional gain and the tax is payable irrespective of whether or not the shares obtained as a result of exercising the share options are sold by the employees subsequently.
Employees are also generally liable to Hong Kong salaries tax on their share award gains in the year when they are entitled to the legal ownership/economic benefits of the shares. The amount of taxable share award gains is generally calculated at the difference between (a) the market value of the shares at the time of grant/vest (i.e. applied to the situation where granting of the share awards is subject to fulfilment of certain conditions) and (b) the considerations given by employees to employers for the share awards, if any.
Tax Exemption on Stock Option & Award Gains
Under the territorial source system adopted in Hong Kong, employees are potentially eligible to claim partial/full tax exemption on their stock option or share award gains if the gains are not arising in or derived from Hong Kong. The factors/considerations relevant for determining the source/taxability of the share option/share award gains include but are not limited to:
- Whether the share options/share awards are granted to employees subject to fulfilment of certain conditions
- The date of grant of the share options/share awards
- The date of vesting of the share options/share awards (if applicable)
- The source of employment (i.e. Hong Kong sourced or non-Hong Kong sourced) and the eligibility of tax exemption claim (such as claim of no services in Hong Kong, 60-days exemption claim, time apportionment exemption claim) during the period from the date of grant to the date of vesting (if applicable) of the share options/share awards
- The number of days spent in Hong Kong during the relevant period.
In addition, if there are changes of employment (e.g. from non-Hong Kong sourced employment to Hong Kong sourced employment or vice versa), apportionment of the share option/share award gains into the different employment will potentially be required for the purpose of calculating the taxable gains.
Kindly note that both employers and employees have their respective reporting obligations to avoid tax reporting errors in respect of the share-based benefits. In particular, employers are required to report to the HK-IRD, amongst others, the details of the share options granted to their employees as well as the amount of share option gains derived by each employee in the Employer’s Return filing.
As for employees, in case they are qualified for tax exemption claim on their share-based benefits, they are required to:
- Lodge the tax exemption claim in their individual tax returns
- Provide the relevant details of the share-based benefits
- Prepare a calculation showing the amount of taxable/tax exempted share-based benefits in their individual tax return filing.
In addition, if an employee shall depart from Hong Kong ‘for good’, he/she can elect to have his/her share options to be notionally exercised in order to clear his/her Hong Kong tax liabilities before leaving Hong Kong.
Both employers and employees are suggested to have a thorough understanding on:
- how to determine the taxability of the share-based benefits
- how to calculate the share-based benefits under Hong Kong salaries tax
- their reporting obligations to the HK-IRD in respect of the share-based benefits.
In addition, employees have to be well aware of the potential tax exemption claims on the share-based benefits such that their salaries tax will not be over-paid.
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