If you have employees in China, you definitely know how difficult it is to keep them.

From a legal point of view, the question that always comes up for foreign investors is whether it is possible to set up stock option plans for their employees in China?

If you try to find the answer online, you will find dozens of articles, each one more complex than the next, but none of them offering a synthetic and practical answer to your question.

Concretely, if you are a foreign investor in China, wishing to offer stock options to your Chinese employees, there are two main options available to you.

The first option is to grant your employees stock options issued by a company registered outside of China. Example: a UK company wants to grant stock options to the employees of its subsidiary in China. Such scenario is possible but will be difficult to set up: indeed, the holding by a Chinese person of stock options of a company registered outside China or more generally of assets located outside China is subject to registration formalities with the Chinese Administration of Foreign Exchange (SAFE). These registration formalities can be long and complex to carry out, with a sometimes uncertain outcome. A common practice exists and consist in tolerating that Chinese employees eligible for the stock option plan do not need to register with SAFE. This is not recommended, as the employees in question will eventually have problems to legally repatriate to China the profits related to the realization of their stock options.

The second option is to incentive your Chinese employees directly at the level of your subsidiary in China. The usual practice is then to set up a Phantom Share Plan rather than a traditional stock option plan.

In order to understand what a Phantom Share Plan is, we must first recall the basic mechanisms of a stock option plan.

Under a stock option plan, an employee is granted the right, under certain conditions and at a certain time, to acquire shares in a company in order to hold them for a certain period of time before selling them and making a profit.

In comparison, under a Phantom Share Plan, an employee is granted the right to acquire units under certain conditions and at a certain time to hold them for a certain period of time before liquidating them and making a financial gain.

The unit is a fictional shareholding in the company, which is supposed to replicate an equity participation.

Why use a fictitious interest rather than a real one? For 2 reasons:

1. On the one hand because direct participation of a Chinese natural person in the registered capital of a foreign-invested company has long been legally impossible;
2. On the other hand, because Chinese regulations have long reserved a veto right on certain key company decisions to any Chinese shareholder, even if holding only a very minor stake.

The units acquired by the employee are generally liquidated quickly, allowing the employee to realize a financial gain, which is assimilated and taxed as a salary or bonus.

The Phantom Share Plan aims to mimic the mechanics and the effects of a traditional stock option plan, without however granting the employee any right on the capital of the company that sets it up.