Employee Stock Ownership Plans (ESOPs) are programmes offered by companies that allow employees to purchase a specific number or percentage of shares in the company.

It’s a valuable way for both the company and the employee, as it promotes long-term investment and growth.

In this article, we’ll explore how ESOPs work in Hong Kong, the tax implications of ESOPs, and how to set up an ESOP for your business.

What is an ESOP?

An Employee Stock Ownership Plan (ESOP) is a programme offered by companies, whether private or listed, that allows employees to purchase a specific number or percentage of shares in the company at a predetermined price, known as the exercise price.

The option to purchase shares is valid for a specific period, usually within a number of years from the grant date, and the employee has the choice to exercise the option or not. This is an option given to the employee, not an obligation.

Why use an ESOP?

From an employee’s perspective, ESOPs offer the opportunity to make a profit equivalent to the difference between the future valuation of the company and the exercise price of the stock. This can be a powerful motivator for employees to work harder and contribute to the success of the company.

From the company’s perspective, ESOPs are a useful way to reward and retain key employees by granting them equity interest in the company.

This can be especially valuable for start-ups or early-stage companies with limited financial resources, as ESOPs can be used as an alternative way to incentivise key performers and talent rather than through salaries or other forms of monetary remuneration.

By offering ESOPs, companies can create a sense of ownership and loyalty among their employees, which can lead to increased productivity and a stronger, more successful business.

How does ESOP work in Hong Kong?

Companies can offer ESOPs to employees based on length of service or performance, providing an additional incentive to top performers beyond their existing contract benefits. This can be particularly valuable in industries where good talent is in high demand.

It’s worth noting that ESOPs are not limited to employees only and can also be granted to:

• Directors
• Officers
• Consultants

An ESOP is comparable with dealing with the sale of securities, an activity normally regulated under the Companies (Winding Up and Miscellaneous) Ordinance (Cap. 32).

However, ESOPs fall under an exemption and there is no specific regulatory requirement or restriction provided that the offer of securities is made to the four categories of beneficiaries mentioned (employees, directors, officers and/or consultants).

ESOP tax in Hong Kong

One of the greatest financial advantages of ESOPs in Hong Kong is that there is no tax charged on the grant of a stock option plan.

However, if an employee exercises the option, both the company and the employee are obligated to report the amount to the Inland Revenue Department (IRD) for tax purposes.

In general, the taxable amount will be the open market value of the shares at the date of exercise of the option less the amount/value of the consideration given for the shares (e.g. option exercise costs) and the grant of the options. Such deemed income shall be taxed in the year of exercising the share options.

In case the employment is a non-Hong Kong sourced employment or the employment changes from Hong Kong to non-Hong Kong sourced employment or vice versa during the vesting period, it may not be straightforward to calculate the taxable income.

Salaries tax applies when an employee exercises the option, and it’s worth noting that employees based overseas who exercise their ESOP option may also be subject to salaries tax in their country of residence (one will then need to ascertain whether any tax relief will be available by applying the relevant double taxation treaty).

Fortunately, the ESOP is not considered a source of taxable income for Mandatory Provident Fund (MPF) purposes.

How to set up an ESOP

Setting up an ESOP in Hong Kong is a straightforward and cost-effective process.

The ESOP should be adopted at the shareholder level during the annual general meeting, and the company is required to issue an ‘Option Certificate’ upon adoption of the plan. This certificate establishes the rules and regulations for the ESOP, including vesting schedules, number of shares granted, strike price (buy price), and other related information.

Additionally, the company may issue an explanatory note to provide more details regarding the exercise of the option by the employee.

When an employee exercises the option, the company increases its share capital and allots the newly issued shares to the new participant. It’s important to keep proper records of these transactions and comply with statutory filings with the Companies Registry.

ESOPs can be divided into several vesting option periods, with a common practice being a 1-year cliff during which the option cannot be exercised. This is designed to give both the company and the employee-owners enough time to determine if they wish to commit to each other for a longer period.

For example, an ESOP can be planned where the option cannot be exercised in the first year, and the employee is entitled to 50% of the shares in the second year, and can exercise the option for the remaining 50% in the third year.

The exercise option may also be subject to specific conditions, performances, and/or targets. ESOPs are often formed during the first or second investment round, where investors expect the executive team to be fully and properly resourced.

There is no general rule for the size of the option pool, but it usually stands between 8% to 20%.

How HKWJ Tax Law can help

An ESOP can be a powerful tool for companies looking to incentivise and retain key employees while employees have the opportunity to share in the company’s success.

Though setting up an ESOP in Hong Kong is a straightforward and cost-effective process, it is important to comply with the proper procedures and regulations to ensure legal compliance.

If you’re interested in learning more about ESOPs or have tax-related questions, our team of tax experts is here to help you.

Contact us today via the form below to schedule a consultation.