Issue 26 - January 2009
Tax notes    

The Hong Kong Inland Revenue Ordinance (IRO) charges Salaries Tax on an individual in respect of income arising in or derived from Hong Kong from an office or employment and also from services rendered in Hong Kong.

Income from employment includes Share (or Stock) Options if they are provided as a reward for services.

Salaries Tax treatment of Share Options
Under Section 9(1)(d) IRO, income subject to Salaries Tax includes, "any gain realised by the exercise of, or by the assignment or release of, a right to acquire shares or stock in a corporation obtained by a person as the holder of an office in or an employee of that or any other corporation."

Taxable event
The taxable event for Salaries Tax therefore occurs at the time an option to acquire shares is exercised, assigned or released.

Most share option plans involve a vesting period before the options can be exercised. However, neither the grant of the options nor the vesting of the options is a taxable event for Salaries Tax purposes, even though a benefit may arise in favour of the employee at that time of grant if the amount paid for the option is less than the share value on that date. 

Market value 
When the option is exercised, the assessable amount is the difference between "the amount which a person might reasonably expect to obtain from a sale in the open market" at the time of taking up the shares and the cost of the option and the shares.

The gain to be assessed is therefore a notional one; chargeability occurs whether or not the employee sells the shares acquired as a result of exercising the option. Even if no sale takes place and the employee retains the shares as an investment, the employee is still chargeable to Salaries Tax on the 
notional gain at the date of the exercise of the option.

The market value for quoted shares is readily ascertainable. However if the company issuing the shares is a private company, the company can negotiate with the Inland Revenue Department with a view to agreeing the valuation of its shares on the exercise date.

Share options are sometimes granted on the condition that restrictions will apply in relation to the disposal of any shares acquired under the share option plan – for example restrictions on when or to whom the shares can be sold. Such restrictions can have an impact in determining the market value i.e. the amount "which a person might reasonably expect to obtain from a sale in the open market". Where there are such restrictions a valuation should be undertaken based on the facts of each particular case but, in the Board of Review case D120/02, a 25% discount was allowed to reflect the five year restriction period on the sale of the shares.

Consideration
If a stock option is assigned or released rather than exercised, the assessable amount is the consideration for the assignment or release of the option less the cost of option.

Charge to Salaries Tax
The charging provisions apply regardless of whether the individual is still employed by the employer which granted the options when the employee exercises, assigns or releases the options. The employee will therefore be subject to Salaries Tax on the gain in the Year of Assessment in which the option is exercised and not in the year in which the employment ceases.

This can have important implications for employees who change employment and, in particular, for employees who are granted options before they arrive in Hong Kong to take up employment and exercise them whilst in Hong Kong as well as employees who are granted options whilst in employment in Hong Kong but exercise those options after the employee leaves Hong Kong. Such individuals should seek detailed advice based on their particular circumstances.

Hong Kong and non Hong Kong source employment
A further factor to be considered is whether the employee has a Hong Kong or non Hong Kong employment during the vesting period of the options. (See our Tax notes Issue 3).

If an individual has a Hong Kong source employment he is subject to Salaries Tax under Section 8(1) IRO on all of his assessable income even if he spends significant periods of time outside Hong Kong.

If an individual has a non Hong Kong source employment, he will be able to apportion his income on the basis of days spent in Hong Kong and days spent outside Hong Kong. Only the income relating to the services in respect of days spent in Hong Kong will be subject to Salaries Tax.

This can impact the Salaries Tax treatment of stock options.

The following examples illustrate some of the matters to be considered.

(a) Hong Kong Employment – throughout vesting period
	An employee who has a Hong Kong employment is granted share options. During the vesting period his services are rendered totally in Hong Kong:
	The whole share option gain will be subject to Hong Kong Salaries Tax in the year of exercise.
	If the employee exercises the share options after he has left Hong Kong, he will still be subject to Salaries Tax if he provided services in Hong Kong in the vesting period.

(b) Non Hong Kong Employment – throughout vesting period
	An employee who has a non Hong Kong employment is granted share options.
	(i)	During the vesting period all services are rendered outside Hong Kong:
		The whole share option gain will be exempt from Hong Kong salaries tax.
	(ii)	During the vesting period his services are rendered both in and outside Hong Kong:
		A time basis apportionment is adopted in calculating the taxable share options gain.

Sale of shares
Hong Kong does not have a Capital Gains Tax and any gains realised on the subsequent sale of the shares obtained as a result of exercising stock options are not taxable in Hong Kong.

Summary
Detailed advice should be sought regarding the Salaries Tax implications of share option schemes, particularly where employees have a non Hong Kong source employment or are granted share options before coming to Hong Kong, or where they exercise options granted whilst in Hong Kong after they leave Hong Kong.



Contact Information

Paul Chow
T  +852 2218 3188
E  paul.chow@gthk.com.hk

Gary James
T  +852 2218 3137
E  gary.james@gthk.com.hk

David Southwood
T  +852 2218 3103
E  david.southwood@gthk.com.hk

Brenda Cheung
T  +852 2218 3136
E  brenda.cheung@gthk.com.hk

Mary Ho
T  +852 2218 3040
E  mary.ho@gthk.com.hk

Daisy Ip
T  +852 2218 3168
E  daisy.ip@gthk.com.hk

Winnie Tsui
T  +852 2218 3280
E  winnie.wy.tsui@gthk.com.hk

About Tax notes
Tax notes are issued in summary form exclusively for the information of clients and staff of Grant Thornton and should not be used or relied upon as a substitute for detailed advice. Accordingly Grant Thornton accepts no responsibility for any loss that occurs to any party who acts on the information contained herein without further consultation with ourselves.

Published by Grant Thornton

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