Not So Fast: Tax Deduction For Share-Based Awards in Canada

After discussing the issues for a tax deduction for share-based awards in Israel in my last blog, I wanted to revisit another tax deduction conundrum, this time in Canada.

In the past, the Canada Revenue Agency (CRA) generally has not allowed a local tax deduction for the cost of share-settled awards (other than under very narrow circumstances).  However, based on a technical interpretation released on April 12, 2017, the CRA updated its position such that a company should be entitled to a tax deduction for the cost of awards if:

  • it retains the discretion to determine whether the award will be settled in cash or shares;
  • it does not commit to delivering the shares at any time before settlement;
  • it actually delivers shares upon settlement; and
  • where the award is granted by a non-Canadian parent company, the Canadian entity reimburses the parent for the cost of the award.

Based on this interpretation, most companies should be able to obtain a tax deduction in Canada for (time-based or performance-based) RSUs granted under the above conditions.  By contrast, it would be more difficult to structure an option or purchase rights granted under an ESPP as being able to be settled in cash or shares.¹

But even for RSUs, companies will need to consider two issues before restructuring their awards to be settled in cash or shares to obtain the tax deduction.

First, companies will need to confirm with their accountants whether retaining the discretion to settle the award in cash or shares will subject the award to liability accounting, i.e., mark-to-market accounting (rather than (fixed) equity accounting).  Liability accounting can introduce greater volatility for the balance sheet, but depending on the number of awards granted in Canada, this may not be material for most companies.

Second (and probably more importantly), if the award can be settled in cash or shares, it will be subject to the salary deferral rules, which is Canada’s version of Section 409A (sort of).   If an award runs afoul of the salary deferral rules, it is taxed at grant, and not only when the shares are issued, which is obviously a very undesirable outcome.

An exemption to the salary deferral rules exists, but is often described incorrectly as applying if an award is fully vested at least by the third anniversary of the grant date.  Therefore, it is assumed that awards that vest pro-rata over a three-year period from the grant date or awards that cliff-vest on the third anniversary of the grant date are fine.

However, the three-year vesting exemption from the salary deferral rules is a bit more nuanced.  In particular, it applies only if the award is fully vested within three years after the end of the year in which the services were rendered for which the award is granted.  For example, if a company grants an award in February 2017 (at least partially) for services rendered in 2016, the award would have to be fully vested by December 31, 2019 to avoid taxation at grant (i.e., less than three years from the grant date).

The question then becomes if or when awards are granted in consideration for services rendered before the grant date.  For new hire awards, it should be relatively easy to argue that the awards are not granted to reward past performance, in which case it will be sufficient if the awards are vested by the third anniversary of the grant date.  However, for refresh grants, this argument is more difficult to make, and there is an inherent assumption that awards made to existing employees are made to, at least in part, reward past performance.  This becomes even more clear if a company determines the size of the refresh grant (again, at least in part) based on prior year performance.

Consequently, granting awards that can be settled in cash or shares to obtain a tax deduction in Canada may require additional changes to the award terms to avoid running afoul of the salary deferral rules, i.e., shortening the vesting schedule (in some cases, quite significantly).

Given the above, before rushing into relying on the CRA interpretation to take a tax deduction in Canada, companies should carefully consider if retaining the discretion to settle the award in cash or shares makes sense in light of the challenges posed by the salary deferral rules.


¹  For options, it is also important to point that, even if companies are able to retain discretion to settle the option in cash or shares, such discretion will eliminate the 50% tax exemption that otherwise applies to options.  Therefore, going this route for options is hardly going to be popular with employees.

Tax Deduction and Other Troubles in Israel

I hope most of you have seen our client alert on the recent Israeli Supreme Court ruling that confirmed that stock-based compensation has to be included in the cost base of Israeli subsidiaries of multinational companies.  As a result of the decision, we have already seen a flurry of activity as many companies are evaluating how to obtain a tax deduction for awards granted to Israeli employees.

As a reminder, for companies with a cost-plus arrangement with their Israeli subsidiary, the decision means that the income of the Israeli subsidiary is effectively increased by the amount of the stock-based compensation, plus the mark-up.  To mitigate the tax due on this increased income, it will be crucial for most companies to deduct at least a portion of the equity award income.

The problem is, however, that a tax deduction for equity award income is available in Israel generally only for awards granted under a trustee plan.  Many companies have already set up a trustee plan to grant awards in Israel because trustee awards can provide for beneficial tax treatment for the employees and, thus, most Israeli employees push hard to receive trustee awards.

So let’s look more closely at the requirements of a trustee plan and the corresponding tax benefits.

Trustee Plan Requirements

As the name indicates, a trustee plan has to be administered by an Israeli trustee which has to hold the awards and underlying shares for the duration of the holding period (more on this below), and which will satisfy the applicable tax withholding and reporting obligations.  Most companies enter into a “supervisorial” trust arrangement with the trustee, which means the awards and shares are not physically held by the trustee.  Instead, they are held by the existing broker (e.g., in the U.S.) and the Israeli trustee works with the broker to ensure the awards/shares are not sold before the holding period ends.

There are a number of companies in Israel which can act as a trustee for this purpose, and several are very familiar with U.S.-style equity plans and can work with the brokers that generally administer the plans.  The fees vary by trustee, and usually depend on the number of grantees in Israel and the number of transactions.

Further, to implement a trustee plan, an Israeli sub-plan to the parent plan will need to be adopted and filed for approval with the Israeli Tax Authority (“ITA”).

Once the initial filing has been made, companies must report each grant to the trustee within 45 days of the grant date.  This can be done by sending the trustee a copy of the board resolutions approving the grants.

There are two possible tracks for a trustee plan: the capital gains track and the ordinary income track.   Almost all companies we work with opt for the capital gains track because only this track also provides tax benefits for the employee.

Capital Gains Track

Under the capital gains track, employees will be taxed at sale on the sale proceeds minus any price paid by the employee to acquire the shares (i.e., exercise price for options, purchase price under an ESPP, nil for RSUs).  For public company awards, the tax treatment at sale is bifurcated: the value of the shares underlying the award at grant minus any price paid by the employee to acquire the shares is taxed as ordinary income at the employee’s marginal tax rate.  Any appreciation in value between grant and sale is taxed as capital gain at a rate of approximately 25%.

The employer will be able to claim a tax deduction for the ordinary income portion, provided the employer is charged for this cost.  The tax deduction can be claimed only once the shares have been sold.¹

To qualify for the capital gains track, the trustee must hold the shares for a minimum of 24 months from the date of grant for options and RSUs and 24 months from the purchase date for ESPP.

For RSUs, the ordinary income portion is equal to the value of the underlying shares at grant.  Because this typically will equal the amount that has to be included in the cost base, companies will be able to offset the additional tax burden with a corresponding tax deduction.  However, a timing issue remains because the tax deduction is available only in the year of sale, while the additional tax burden is created in the year of grant.

For options, given that the exercise price will in almost all cases be equal to the value of the shares at grant, there typically will not be any ordinary income portion at grant and, hence, no deductible amount.²

For ESPP, the ordinary income portion is equal to the value of the shares at grant minus the purchase price.  However, offering an ESPP under a trustee plan usually is not very beneficial to the employees.  Furthermore, because the 24-month holding period for an ESPP starts running on the purchase date, employees have to hold the shares for a longer period of time than the shares subject to options and RSUs.³

Ordinary Income Track

Under the ordinary income track, the entire gain at sale (i.e., sale proceeds minus any price paid by the employee to purchase the shares) will be taxed as ordinary income and, thus, deductible to the local entity, provided it is charged for this cost.4

To qualify for the income tax track, the trustee must hold the shares for a minimum of 12 months from the date of grant for options and RSUs and 12 months from the purchase date for ESPP.

Given the treatment of the entire gain as ordinary income and the 12-month holding period, this track is obviously not popular with employees and rarely implemented.

Conclusion

To maximize the tax benefits for both the company and the employee, granting RSUs under the capital gains track of a trustee plan is (and will be) the preferred approach for most companies that are interested in seeking a tax deduction.  As noted above, a timing issue still remains because the tax deduction cannot be taken until the shares are sold (even though the deductible amount will be limited to the value of the shares at grant).  In order to claim the tax deduction, the local entity has to be charged for the deductible amount pursuant to a written reimbursement agreement.

One additional wrinkle to consider for U.S. parent companies is that the amount that can be charged to local entities should not exceed the value of the shares at vesting.  Any amount charged in excess of this value could be considered as a taxable dividend under Section 1032 of the U.S. Internal Revenue Code.  Therefore, the charge-back amount should be limited to the lower of the value of the shares at grant and the value of the shares at vesting.  If the stock price drops between grant and vesting, this will reduce the value of the reimbursement amount and, thus, of the deductible amount in Israel.

 


1  For awards granted by a private company, the entire sale proceeds (minus any price paid for the shares) are treated as capital gain, which means no deduction is available.

2  Note that, to determine the value of the shares at grant under a trustee plan, companies will need to look to the prior 30-trading day average price of the shares.  Therefore, if the exercise price is determined based on the closing price on the grant date (or prior day closing price), a small discount could exist.

3  It used to be possible to obtain tax rulings for ESPP granted under a non-trustee plan in Israel whereby the ITA would agree to allow companies to treat the discount at purchase as ordinary income and take a tax deduction for this amount.  While it is still possible to get the ITA to agree that the discount at purchase should be treated as ordinary income, in recent years, the ITA has refused to allow a tax deduction for this amount.

4  It may be problematic for U.S. issuers to charge the local employer for an amount that is greater than the market value of the shares at vesting.

Data Privacy Compliance for Equity Awards Post-GDPR

Background

As most of you are aware, the collection, processing, use and transfer of personal data is regulated and restricted in most countries outside the US. This is especially true for countries in the EU and EEA, where any such action generally requires a valid basis, or risks being illegal.

Compliance with EU data privacy requirements can be challenging for US-based multinationals which collect, process and transfer personal data of EU/EEA-based employees to administer the employees’ participation in an equity or other incentive plan offered by the US parent company. Additional challenges arise if the parent has engaged a US-based broker or third-party plan administrator to assist with the administration of the plan.

GDPR

On May 28, 2018, the General Data Protection Regulation (GDPR) will take effect in the EU/EEA, replacing the Data Privacy Directive which has been in place since 1995. Under GDPR, increased penalties will apply if the collection, processing and transfer is effected without a valid basis. Enforcement activity from EU regulators may also increase once the GDPR takes effect.

In terms of satisfying local data protection requirements in the context of equity award offerings, the most challenging aspect is to find a justification to transfer an EU/EEA employee’s personal data from the EU/EEA to the US, which is generally necessary to administer the employee’s participation in an equity plan offered by a US-parent company. To further complicate matters, the personal data not only has to be transferred to the parent company but usually also to third-party vendors, which are assisting the company with the administration of the plan (i.e., US brokers/plan administrators).

To justify such transfers, companies can take any one or a combination of approaches, e.g., (A) obtaining employee consent, (B) establishing the use of data is necessary to perform a contract, (C) establishing the issuer has a legitimate interest in transferring the data, (D) registration under the EU-US Privacy Shield Program, or (E) entering into Standard Contractual Clauses or binding corporate rules with the various parties involved in the data handling.

A.   Consent

For purposes of establishing a valid basis under GDPR for collecting, processing and transferring personal data to administer equity awards, it may be possible to rely on the employee’s consent.  The consent language can be included in the award agreement (and has historically been included in most of our clients’ award agreements). However, to comply with the specific requirements under GDPR, updates to the consent language are likely required. Furthermore, although it is permissible to obtain consent within the award agreement, it is highly recommended to have employees separately accept the consent language. This could be achieved by having a separate call-out box for the data privacy consent when the employee accepts the agreements electronically, or by having an entirely separate consent document.

The consent will cover both the transfer of personal data from the EU/EEA employing subsidiary to a US-based issuer and from the US issuer to the broker/plan administrator. This is a significant advantage of the consent approach, as further discussed below.

Notwithstanding the above, companies should be aware that consent may be viewed as an invalid basis under GDPR based on the arguments that (i) it is not obtained before the data is actually collected, processed and transferred, and (ii) some countries may not deem employee consent a valid basis because employees are viewed as coerced to give consent if it is requested in the context of the employment relationship. Furthermore, consent is problematic because it can be withdrawn by the employee at any time.

B.   Necessary to Perform Contract

If the US issuer is able to identify and limit the data being collected, processed and transferred to that which is absolutely necessary to perform its contractual duties under the award agreement and plan, this complies with the GDPR requirements. In this case, the issuer will need to prepare a data privacy notice (rather than consent) for grantees in EU/EEA jurisdictions which sets out the data being collected and the purpose for which the data is being processed and transferred.

C.   Registration with the EU-US Privacy Shield Framework

Registration with the EU-US Privacy Shield certifies the transfer of data between the EU/EEA and the US is operated in compliance with applicable protection regulations, including GDPR. The registration process is fairly straightforward and is done completely online. However, the issuer should ensure it has undertaken appropriate measures in advance of self-certifying during the registration process to confirm compliance with the self-assessment and preparation of the due diligence documentation required by the Privacy Shield.

Additional information on the certification process and compliance with the Privacy Shield is available on the framework’s governmental website. The issuer should also consider that, once self-certified, annual re-certification is required. However, changes in the practical details of data processing do not need to be notified.

D.   Legitimate Interest

Similar to the argument that the transfer of data is necessary to perform a contract, the issuer could take the position that it has a legitimate interest in doing so in situations where the local entity is not equipped from a Human Resources (or other) perspective to handle the data locally. Particularly in the context of equity incentive awards granted exclusively by the US-parent company, this position may be viable. However, this could become challenging to the extent there are larger, well-equipped EU/EEA entities that may have more independent administrative functions.

E.   Standard Contractual Clauses / Binding Corporate Rules (BCRs)

Another basis on which an issuer can rely to validly transfer data under GDPR is by way of Standard Contractual Clauses approved by the European Commission. If the issuer’s EU/EEA entities agree with the US parent company to comply with the Standard Contractual Clauses, then “adequate safeguards” will be presumed. However, the Standard Contractual Clauses cannot be modified in any manner that would contradict the clauses or data protection rights of individual employees. Although there is discretion for companies to draft their own contractual clauses, such clauses would be subject to scrutiny in each EU/EEA member state, increasing any risk of local non-compliance. It also should be noted that the Standard Contractual Clauses require a great level of detail on the data processing practices and purposes, which can result in voluminous data transfer agreements and support for same.

Similarly, the issuer could enter into BCRs (i.e., binding commitments reflecting data protection safeguards implemented to comply with GDPR within a group of companies) with entities within its company group.  The required content of BCRs is provided in the text of GDPR, and may be specifically prescribed by the European Commission.

Challenges Remain

It should be noted that approaches B. and D. arguably cover and approaches C. and E. definitely cover only the transfer of personal data between the EU/EEA employing entities and the US issuer.  Therefore, under these approaches, the issuer may have to devise other methods to legitimize data transfers to the US-based broker/plan administrator. As mentioned, consent would be one approach, but has the issues described above.

One other approach would be to ask the broker/plan administrator to enter into Standard Contractual Clauses with the issuer, pursuant to which the broker/plan administrator would undertake to protect the personal data of the EU/EEA employees. This requires negotiations with the brokers/plan administrators and, possibly, an amendment to the services agreement.

Conclusion

There are a number of methods by which personal data for purposes of equity plan administration may be transferred from the EU/EEA to the US, with no single alternative satisfying all competing interests.

Compliance with GDPR cannot be evaluated solely in the context of the issuer’s equity grants. Rather, all collection, processing, use and transfer of data between the EU/EEA and US (and, of course, other countries) must be analyzed for compliance with applicable law/regulation. Therefore, it is important for equity plan professionals to connect with their internal data privacy experts and ensure that the measures taken to comply with GDPR also take into account personal data used in the context of equity plan administration.

Please make sure to connect with your equity plan counsel to reflect any new approach in the grant documentation provided to employees.

ANOTHER French-Qualified RSU Regime on the Horizon

If it seems that most of my blog posts are dedicated to France, then you are correct.

For this, we can blame the many changes that have been adopted to the French-qualified regime for RSUs over the last few years, most recently discussed in my post from April 2017.  And, alas, another change is on the horizon. Continue reading

Tax-Qualified Plans – Blessing or Curse?

When granting equity awards, one of the most important questions is the tax effect of such awards.  Granting awards that have a negative tax impact on the employee or the company is counter-productive and should lead companies to consider other ways to incentivize their employees.  On the other hand, should companies maximize the availability of favorable tax treatment for equity awards in certain countries?  This is not an easy question to answer.

Favorable Tax Treatment – The Company vs. the Employee

When we talk about favorable tax treatment, it can mean different things depending on the country and the qualified-tax plan.  The most basic distinction is whether the treatment is favorable for the employee, the company, or both.

  • For employees, favorable treatment often means that taxation can be deferred (usually until the shares are sold), the taxable amount can be reduced or characterized more favorably (e.g., as capital gain, rather than employment income), social taxes can be mitigated or avoided, or a combination of the foregoing.
    For the company, favorable treatment usually means that employer social taxes can be reduced or avoided, tax withholding/reporting obligations can be eliminated, or a tax deduction becomes available.
  • Companies will need to consider which of the above are most important to them.  In my experience, it is usually a combination of employer social tax savings and employee tax savings that prompt companies to implement a tax-qualified plan.

The prime example for this is France, where a tax-qualified plan can reduce the very high employer social taxes (up to 46%) that are due on non-qualified awards, but also allow for a tax deferral and potential tax savings for employees.  Of course, French-qualified awards are famously complex, due to the many changes the French legislator has adopted over the last few years (described in more detail in my prior blog post here).

By contrast, in Israel, a trustee plan (Israel’s version of a tax-qualified plan) benefits almost exclusively the employee, but has become so common that companies are almost forced to adopt one, due to competitive pressures. More recently, however, several of our clients have adopted trustee plans in Israel for the main reason of obtaining a local tax deduction, which has become more important in the wake of the Kontera decision, so there is now also a dual reason for such plans in Israel.

The Cost-Benefit Analysis

Before companies decide to implement a tax-qualified plan, they should undertake a careful cost-benefit analysis.  In working with private companies, I have observed that they tend to almost reflexively adopt a tax-qualified option plan in the UK or a French-qualified plan.  This is usually based on advice from local advisors who claim that these plans are common place for companies offering awards in their jurisdiction and that, to remain competitive, awards have to be granted under these plans.

While it is true that tax-qualified plans in these countries can be especially beneficial for private companies and their employees, this advice often omits the administrative burden and cost of maintaining such plans.  Virtually all tax-qualified plans (with France and the UK being no exception) come with various special conditions (such as minimum vesting and holding period requirements) and ongoing filing obligations (such as special annual reporting requirements).  And while the initial preparation and implementation of the tax-qualified plan can be handled by an outside advisor, ensuring that the special conditions are met and completing the ongoing filings typically falls on the company which, in the case of many private companies, may not have sufficient resources to deal with these issues.

Another important consideration is the treatment of qualified awards in a corporate transaction.  This is again especially relevant for private companies which are more likely to be acquired before awards can first be exercised or vest.  If an acquisition disqualifies the awards from the favorable treatment, the qualified plan essentially would have been implemented for naught.

Of course, companies don’t have a crystal ball and whether or not an award could be disqualified depends on the type of acquisition, the treatment of the awards in the acquisition, whether holding periods have been satisfied at the time of the acquisition and many other factors.  Still, dealing with qualified awards in an acquisition is usually cumbersome and, in many cases, it will be necessary or advisable to obtain tax rulings to preserve the qualified status of awards.  For example, in Israel, it seems that any modification of an existing award granted under a trustee plan requires the approval from the Israeli Tax Authority to maintain trustee plan status.

Embarking on a New Tax-Qualified Plan? Answer These Questions First!

As companies decide whether or not to implement a tax-qualified plan in a particular jurisdiction, they should ask themselves the following questions:

  • What is the benefit of the tax-qualified plan?  If the benefit is purely, or mostly, for the employee, how does this affect employees in other countries who may not be able to receive the same tax benefits?  Are the employer social tax savings significant enough to warrant the implementation and maintenance cost of the plan, as well as the administrative burden?
  • Has everyone weighed in on the decision to implement a tax-qualified plan?  Operating a qualified plan will most likely have a significant effect on the stock plan administrator who will need to administer special terms, such as holding periods, and comply with ongoing requirements.  It can also have corporate tax and accounting consequences which should be socialized with the right people within the organization.
  • Who should pay for the implementation and maintenance of the plan?  If the main benefit of the plan is employer social tax savings, perhaps it is appropriate to allocate the cost to the local entity.
  • Do we have the administrative capacity to administer the qualified plan?  In this respect, it is important to understand all of the requirements and any ongoing filing requirements.  I would also consider creating a detailed checklist that can be used to track the requirements and obligations, which can be especially useful if there is turn-over at the company.
  • What does the future hold?  If a company is about to implement a new equity incentive plan, does it make sense to implement a qualified plan under the “old” plan, given that most qualified plans are tied to the parent plan and have to be re-done when a new plan is adopted?  If a corporate transaction is probable, what is the impact of such a transaction on a qualified plan?

At the end of the day, as always seems to be the case with global equity awards, the answer of whether a tax-qualified plan should be implemented is highly fact-specific and depends on the particular circumstances of each company.  The best advice is to not jump into implementation of a qualified plan, but carefully consider all of the benefits and requirements and seek input from multiple stakeholders.

To Learn More

In case you are planning to attend the 2017 GEO National Equity Compensation Forum in Rancho Palos Verdes from September 13-15, I invite you to attend the presentation on this topic that I will participate in, together with Jennie Anderson from Microsoft and Wendy Jennings from Cisco.  Jennie and Wendy are among the most experienced stock plan administrators in the industry and will no doubt have great tips when it comes to tax-qualified plans!  If you have not registered yet, please see our invitation here for a special discount offer.

Total Reward Statements and Equity Awards

The Rise of Total Reward Statements

Starting a few years ago, many companies embraced the use of Total Reward Statements (TRS) in which they tried to summarize all of the different compensation items paid to an employee in one statement, ostensibly to make it easier for an employee to see, at a glance, how much money they were actually making.  A TRS usually includes base salary, bonus payments, commission payments and, of course, equity awards.

Because only the parent company has all of the information regarding the various compensation items, it is the parent company that prepares and issues the TRS (typically by posting it on an intranet site), even for employees employed by (foreign) subsidiaries.

Equity Award and Local Employer Compensation Information Do Not Mix

For these employees, however, mixing information related to equity awards with information on compensation paid by the local employer is a bad idea.  As you may have heard me or one of my colleagues say repeatedly: the equity awards always should be communicated, administered and generally be kept as separate as possible from the employment relationship.  This is to mitigate the risk of various claims the employee otherwise might raise, such as joint employer liability (i.e., that the foreign parent is another de-facto employer that can be sued over grievances related to the employment relationship), vested rights and entitlement claims or increased severance claims (i.e., that the equity award income has to be factored in when calculating severance or other termination benefits).  If the equity awards are considered part of the employment relationship, it can also lead to a requirement to translate award documents into local language or to consult local works council before equity award programs can be implemented, modified or terminated.

Consequently, even though equity awards are undeniably part of the total incentive package, ideally, they should not be mentioned in a TRS which also covers compensation paid by the local employer.  Instead, they should be communicated separately by the parent company (i.e., the grantor of the equity awards).

Of course, communicating the equity awards separately somewhat defeats the purpose of the TRS, so invariably, HR will not go for this advice and push to keep all of the compensation items in one statement.

In this case, consider making certain changes to the TRS to make it clear that the equity awards are provided by the parent company and are separate from the compensation paid by the local employer.  This usually can be done by including disclaimer language in footnotes or elsewhere.

In addition, pay attention to how the value of the equity awards is communicated.  I have seen several TRS which set forth a dollar amount for equity awards which is based on the current share price of the underlying shares, without further explanation.  This is misleading and can create unrealistic expectations for the employees in case the awards are unvested.  It is important to be clear that the awards will be of value only if they vest (and, in the case of options, the employee exercises the options) and that the income that may eventually be realized can differ greatly from the current (estimated) value, due to share price fluctuation.

With these additional disclaimers and clarifications, the risks described above of mentioning equity awards and “local” compensation in one TRS can be mitigated.

Not All It’s Cracked Up To Be

As a side note, I have heard from several companies that TRS are not all what they hoped them to be.  First, many companies find it very challenging and labor intensive to keep the statements up-to-date (unless an automatic feed is implemented, which is also challenging).  Second, it seems employee engagement quickly fades, most likely because even with a TRS, it is difficult to assess total compensation at a glance (especially if it is comprised to a large extent by incentive compensation subject to performance conditions).

So, maybe you will be able to talk HR out of using a TRS altogether!

Ready for Australian and UK Year-end Share Plan Reporting?

There are a few countries that require special annual reports for share plan transactions (in addition to regular annual payroll reports).  Australia and the UK are among these countries and are both on a fiscal year that differs from the calendar year.  The UK tax year ended on April 5 and the Australian tax year will end on June 30.

  • The UK Annual Share Plan Return (formerly known as Form 35, for tax-qualified awards, and Form 42, for non tax-qualified awards) is due to Her Majesty’s Revenue & Customs (“HMRC”) by July 6.
  • The Australian Employee Share Scheme (ESS) Return must be filed with the Australian Tax Office by August 14.  In addition, companies are required to provide their Australian employees with ESS statements by July 14.

Both returns (and the Australian ESS statements) can take a while to prepare (especially if companies need to report transactions for mobile employees and/or awards that were adjusted in a corporate transaction) and will need to be submitted electronically.

Please see our client alerts for Australia and the UK for more information on how to prepare the returns and make the submission.  We are aware that the HMRC website was affected by an outage during the month of May, so companies may have less time than normal to make the UK submission.

Our Sydney and London offices are available to assist with the preparation and submission of the returns.

Oops, the French Did it Again……

Less than 18 months after the latest amendment to the regime for tax-qualified RSUs in France, another amendment became effective on December 30, 2016.  This amendment is the third amendment to the regime in five years, meaning that companies may (in theory) have to administer tax-qualified RSUs that are subject to three different income tax and social tax regimes.  The three different qualified RSU regimes are as follows:

  • French-qualified RSUs granted after September 28, 2012 (“Pre-Macron RSUs“)
  • French-qualified RSUs granted under a plan approved by shareholders after August 7, 2015 (“Macron RSUs“)
  • French-qualified RSUs granted under a plan approved by shareholders after December 30, 2016 (“Modified Macron RSUs“)

For companies that have granted tax-qualified RSUs in the past, the question is whether they will want to continue to grant qualified RSUs after the latest changes.  Similarly, companies that have granted non-qualified RSUs in France or that are starting to grant RSUs in France for the first time will want to evaluate whether they can and want to grant tax-qualified RSUs under the new regime.

Background

Granting equity awards to employees in France can be expensive because of the high employer social taxes.  In particular, any income realized from a non-qualified equity award (e.g., spread at option exercise, FMV of shares at vesting of RSUs) is subject to employer social taxes at a rate of up to 46%.  The 46% rate is comprised of different social insurance contributions, only some of which are subject to a cap.  This means that even awards granted to highly compensated employees will remain subject to employer social taxes at a rate of approx. 25%(while the employees will have reached the contribution ceilings for the other contributions with their other compensation).  If a company grants awards on a broad basis in France, makes large awards to some employees or if the stock price increases significantly after grant, accordingly, the French employer is looking at a big employer social tax liability.

Many companies have been trying to mitigate employer social taxes by granting tax-qualified awards.  Several years ago (before it was possible to grant French-qualified RSUs), no employer social taxes whatsoever applied to French-qualified options.  Recognizing the loss of significant tax revenue, the French government started to impose employer social taxes on tax-qualified awards, but the timing of the taxation and the tax rate have changed significantly over the years.  Some of the changes have made it very difficult for companies to determine whether granting tax-qualified awards is, indeed, beneficial for them.

Determining Which Tax Regime Applies

Before we look at the possible tax benefits of granting tax-qualified RSUs (versus non-qualified RSUs), let’s first discuss under which regime companies may be able to grant qualified RSUs.

Strangely, this depends on when the plan under which the RSUs are granted was last approved by shareholders.  If the plan was last approved on or before August 7, 2015, qualified RSUs can be granted only under the Pre-Macron Regime.  If the plan was last approved after August 7, 2015 and before or on December 30, 2016, qualified RSUs can be granted only under the Macron Regime.  If the plan was last approved after December 30, 2016, qualified RSUs can be granted only under the Modified Macron Regime.

Because it is unlikely that companies would take their plan to shareholders just to be able to grant qualified RSUs under a particular regime (or obtain approval just for a French sub-plan), the application of the different regimes is somewhat random*.

Employer Social Tax Treatment Under Different Regimes

As mentioned, the timing and rate of the employer social taxes varies significantly depending on the applicable regime and can be summarized as follows:

Non Qualified RSUs Pre-Macron RSUs Macron RSUs Modified Macron RSUs
Rate Up to 46% (same as for salary) 30% 20% 30%
Taxable event Vesting date Grant date Vesting date Vesting date
Taxable amount FMV of shares at vesting FMV of shares at grant or fair value as determined under IFRS 2 (at election of employer) FMV of shares at vesting FMV of shares at vesting

It is important to note that, if the employee forfeits the RSUs before vesting (typically because the employee terminates prior to vesting), no employer social taxes will be due under any of the regimes, except the Pre-Macron Regime.  For RSUs granted under the Pre-Macron Regime, the employer has not been entitled to a refund for the employer social taxes paid at grant (which has been one of the reasons why it has been so difficult to evaluate whether such RSUs can result in employer social tax savings when compared to non-qualified RSUs).  However, this might change due to a challenge that is currently pending with the French Constitutional Court.

If successful, employers will be able to apply for a refund (likely both for previously granted awards and for future awards).

Employee Tax Treatment Under Different Regimes

The employee tax treatment also varies quite a bit depending on the applicable regime, as follows:

Non Qualified RSUs Pre-Macron RSUs Macron RSUs Modified Macron RSUs
Annual vesting gain not exceeding €300,000 Portion of annual vesting gain exceeding €300,000
Taxable event / Taxable amount Vesting date/FMV of shares at vesting Sale of shares/Gain divided into Vesting Gain (FMV of shares at vesting) and Capital Gain (sale proceeds minus FMV of shares at vesting)
Income tax Taxation as a salary income

Taxed at progressive rates up to 45%

Taxation as sui generis gain

Taxed at progressive rates up to 45%

Taxation as a capital gain

Taxed at progressive rates up to 45%, but application of rebate on entire gain (i.e., vesting and capital gain) if shares held for certain period: 50% if shares held at least 2 years; 65% if held more than 8 years

Same as Macron RSUs Same as Pre-Macron RSUs
Social taxes Up to 23% (same as for salary) of which approx. 20% is tax deductible 8% of which approx. 5.1% is tax deductible + 10% specific social contribution 15.5% on entire gain of which 5.1% is tax deductible

The gist of the above is that RSUs granted under the Pre-Macron regime are not very beneficial to the employee, even compared to non-qualified RSUs.  For Macron RSUs (and for Modified Macron RSUs, provided the employee does not realize more than €300,000 in annual gains), the tax treatment can be dramatically better, but only if the employee holds the shares for at least two years after vesting.

Main Requirements under Different Regimes

Various requirements have to be met to qualify for the special tax treatment under any of the French-qualified RSU regimes.  The most significant ones are as follows:

Non Qualified RSUs Pre-Macron RSUs Macron RSUs Modified Macron RSUs
Minimum Vesting Period None Two years One year One year
Minimum Holding Period None Two years from relevant vesting date Two years from grant date Two years from grant date

For Pre-Macron RSUs, this means shares generally cannot be sold any earlier than after the fourth anniversary of the grant date, as opposed to two years under the Macron and Modified Macron Regimes (exceptions may apply in the case of death or disability).  This makes the Macron and Modified Macron Regimes a lot more attractive for employees.

However, several additional requirements apply that can be difficult to administer for the issuer (e.g., closed period restriction at sale, accelerated vesting at death).  These requirements are the same under all of the different qualified RSU regimes.

Conclusion

Given all of the complexities related to the tax treatment and the requirements of qualified RSUs, it is almost impossible to say whether it is a good idea to grant qualified RSUs in France.  So much depends on the company’s circumstances, not least on the regime under which the RSUs can be granted.

However, I would generally caution companies to grant qualified RSUs, unless they have a strong stock administration team that can properly administer these awards and keep track of the many changes that have occurred.  If qualified RSUs are granted, but then not correctly administered (e.g., holding periods are disregarded), companies risk disqualifying the RSUs which can have disastrous tax consequences for both the employer and the employees (and be way worse than if the company had granted non-qualified RSUs).  Companies should also consider that disqualification can occur if awards are adjusted due to corporate transactions, with the same negative tax consequences.

Furthermore, I am not convinced that we have seen the last of the changes to the qualified RSU regimes.  As France prepares to elect a new President and usher in a new government, it is very possible that more tax reforms are on the horizon (especially if Mr. Macron wins the election…..).

On the other hand, I recognize that some companies have granted qualified RSUs for years and that changing to non-qualified RSUs can be a difficult “sell” to employees (and maybe the French employer).  Similarly, companies that are fortunate enough to be able to grant Macron RSUs may be happy to shoulder the burden of administering French-qualified RSUs in return for a flat 20% employer social tax at vesting.

So, again, every company should carefully consider whether it makes sense to grant qualified RSUs.  And, in any event, we all must stay tuned for further changes!

*That said, we are aware of a few companies that have either timed their shareholder approval to be able to rely on a specific regime (typically only possible for private companies) or that have sought shareholder approval for a French sub-plan (even though no amendments were made to the general plan).

The Go-To Guide to 2016-2017 Filing / Reporting Requirements for Global Employee Share Plans

2016-2017

It is almost the end of the calendar year, and in addition to wrapping up gifts and holiday parties, it is time for multinational companies to consider the necessary tax and regulatory filings for global stock plans triggered by the close of 2016. As you consider the steps your company may need to take to start the new year right, please see our Global Equity Services Year-End / Annual Equity Awards Filing Chart, which contains key filing and reporting requirements for 2016 and 2017.

Happy Holidays from Baker McKenzie – wishing you prosperity in the New Year and favorable equity regulations around the globe!