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Equity-based compensation plans for multinationals: compensation in a worldwide environment.

Introduction

In the past, entities viewed global expansion as a natural progression of a domestically mature business. Now, competitive pressures prompt many companies to enter the international arena at early stages in their corporate existence. As a consequence. there has been a surge in the number of companies dealing with human resource responsibilities in multiple jurisdictions.

Logically, the addition of foreign affiliates raises local legal issues relating to compensation since each jurisdiction imposes its own unique set of income, payroll, social security and other taxes. Thus, pay plans are generally tailored to each taxing regime to ensure compliance with local law. Many compensation arrangements, however, do not originate locally. One of the consequences of the great strides that companies have taken in enhancing interaffiliate communications is that employees are no longer content to be compensated in a vacuum. If the top domestic sales managers for a U.S.-based multinational are participants in a stock option plan the top manager for its Belgian subsidiary will expect the same.

Therefore, even companies that are generally familiar with U.S. law in this area now face with the daunting task of linking compensation pay practices among multiple legal jurisdictions in an attempt to maximize the benefits of incentive compensation. Unfortunately, although the initial objective of companies seeking to export their equity-based compensation plans is simplicity and uniformity, the tax law elsewhere in the world may produce unexpected consequences. As a result, this project requires active involvement by the tax professional.

This article discusses the most frequent tax issues disrupting simplification and unification, while keeping in mind the need to balance human resource objectives with the employer's cost and potential tax benefits. While the law in certain countries is discussed to illustrate these issues, this article is not intended to provide a comprehensive discussion of all the laws imposed by our major trading partners.

The State of the Law

With few exceptions, U.S. income tax law in this area is significantly more advanced that that of our trading partners. Thus, the certainty that we enjoy in the United States is lacking elsewhere. A number of factors contribute to this variance. First, the notion of granting individuals an ownership interest in their employer is an alien concept in many countries, where the employee reward philosophy does not embrace the idea of proletarian ownership. The limited statutory and administrative guidance in these countries is often the progeny of plans put in place by multinationals that do not share this view.

Further, many countries that have now become common trading partners were, for many years, governed by totalitarian regimes. In the past, these governments imposed severe exchange control restrictions on the citizens of these countries, where the ownership of foreign currency and stock was prohibited. In other words, private ownership of stock is a new legal concept in such countries, flowing both from the recent wave of privatization of state-owned enterprises and from the entry of multinationals into the local commercial environment.

Roadblocks, however, continue to exist. For example, many former Eastern Block countries continue to require central bank approval before its citizens are permitted to own stock offered by foreign companies. In Russia, central bank approval is still required by Russian nationals who wish to own stock of foreign companies. The application process is time consuming and approval for an individual to own shares in a non-Russian company is often denied.(1*)

Finally, other actions may be taken by certain countries that interfere with the exportation of compensation plans. For example, under a Belgian Royal Decree of December 1993 which remains in effect, it is illegal to introduce new employee compensation plans in Belgium unless they are a replacement plan providing essentially the same benefits as under an employee compensation plan in existence in December 1993.(2) Thus, unwitting multinationals that have introduced their plans to foreign subsidiaries may have committed a criminal violation to the extent they have a Belgian presence.

Equity Plans in General

Before addressing specific foreign tax concerns, it is best to summarize the most commonly used equity-based incentive compensation plans that are familiar to U.S. corporations. Equity-based plans can be grouped into two general categories: those that provide employees with actual stock, and those that provide employees with cash rewards based upon the performance of stock or other performance-like measures. These two groups can be broken down into the following subsets which are presented in the context of U.S. law and practice.

* Stock Options

[] Nonqualified

[] Qualified

* Incentive Stock Options

* Employee Stock Purchase Plans * Direct Stock Grants

[] Restricted

[] Unrestricted

* Other Equity-Based Plans

[] Phantom Stock

[] Stock Appreciation Rights

[] Performance Plans

A. Nonqualified Stock Options

Stock options are contractual rights granted by the employer to the employee that allow the employee to take possession of actual stock if they satisfy the terms of the option (typically to pay a fixed price per share of stock to be received). Generally, these rights have a fixed exercise period expressed in a term of years.

Under section 83 of the Internal Revenue Code, an employee is taxed only if he or she receives property. Under IRS regulations, the receipt of a contractual right that promises to pay property or money is not itself a transfer of property.(3) Thus, the grant of a stock option to an employee is generally treated as a non-event for tax purposes.(4) As a result, the employee does not incur a tax liability at grant. Rather, the bargain element is treated as wages to the executive upon exercise, at which time the company receives a tax deduction equal to the amount the employee takes into income. This compensation is subject to Social Security tax as well as income tax withholding. Future appreciation is treated as capital gain at sale.

B. Incentive Stock Options

Like nonqualified stock options, Incentive Stock Options (ISOs) are contractual promises that permit an employee to acquire stock from the employer at a future date under established terms. Because ISOs meet stringent restrictions and conditions, they are not taxable for regular tax purposes at either grant or exercise.(5) Instead, if the stock received as a result of the exercise is held at least two years from the date of grant and one year from the date of exercise, the employee will recognize capital gain when the stock is sold in an amount equal to the excess of the stock's selling price over the exercise price.

C. Employee Stock Purchase Plans (ESPPs)

ESPPs are plans that allow employees to purchase shares at a discount on a tax deferred basis. The purchase price may not be less than the lesser of 85 percent of the fair market value of the stock at the time the option is granted, or 85 percent of the fair market value of the stock at the time the option is exercised. These purchase opportunities are generally available via payroll deductions and are subject to rigid requirements regarding participation, stock holding periods, and administration.(5)

D. Stock Grants

These plans involve a direct award of actual stock to the employee, and may impose conditions on the employee's rights to such stock. Such conditions may have tax importance under the Internal Revenue Code. Specifically, an employee is taxed on the compensatory receipt of stock unless the stock is transferred subject to a "substantial risk of forfeiture."(7) The most common example of a substantial risk of forfeiture is a service term, i.e., the employee will forfeit the property unless he or she completes a specified employment period.(8) The risk of forfeiture provides an incentive to the employee, for if he or she does not satisfy the condition, the property must be returned to the employer. In these situations, taxation is deferred until the restrictions lapse, at which time the employee will recognize compensation income equal to the value at that point.(9)

E. Other Equity-Based Plans

"Phantom stock," "stock appreciation rights," and "performance units" plans are all essentially cash bonus plans, where the payment is tied to the market price of the employer's stock, corporate results, or a division's or business segment's performance. Under the Internal Revenue Code, a participant in these plans is generally taxed only when he or she receives cash or property payments from these plans.(10)

Equity Plans Under Foreign Law

A. Stock Options

In many foreign countries, local nationals are taxed at the option exercise date in a manner similar to that in the United States. Hence, ordinary income is recognized equal to the difference between the stock's exercise price and fair market value on that day. For example, in the United Kingdom, employees will be subject to U.K. personal income tax on the amount of the spread between the exercise price and the market value of the shares at the time of exercise.(11)

Thus, the implementation of a nonqualified U.S. stock option plan is relatively tax neutral among these countries other than with respect to relative tax rates. Also, while U.S.-based ISO or ESPP plans exported to these countries will not enjoy the same tax-favored treatment as in the United States, no major roadblocks exist for those that wish to use a similar or identical plan abroad as is used in the home country.

While the timing of tax may coincide with the United States, differences often exist in collateral issues such as tax withholding requirements, the assessment of social security-type taxes on the income, information reporting requirements, etc. In the case of stock options in the United Kingdom, for example, there is no U.K. wage withholding on the amount of the spread, nor will U.K. social security tax (U.K. National Insurance Contributions) be imposed. U.K. law, however, is not without its quirks. U.K. law limits the option exercise period to seven years. So-called long options -- those with an exercise period in excess of seven years -- may be taxable at grant. This presents a trap for U.S. employers that may be accustomed to granting options with an exercise period of ten years as is permitted under the ISO rules of section 422 of the Internal Revenue Code. Finally, a number of countries only impose withholding taxes if the local country is involved in the stock transfer. Therefore, if a US. multinational grants stock options to employees of a foreign subsidiary, and the subsidiary is uninvolved in the option exercise, certain reporting and withholding requirements may not apply.

While most countries tax an employee at the date of exercise, some countries impose taxing regimes that seem peculiar to those versed in U.S. taxation. The Netherlands is one such example. Under Dutch law, tax may actually be assessed prior to the time the option is exercised. Stock options are taxable for Dutch wage, social security, and personal income tax purposes when the employee can exercise the stock option for the first time. The taxable amount consists of the sum of: the intrinsic value of the options (the spread between the exercise price and the fair market value of the underlying shares) and the so-called expectation value of the stock option.(12) There is no safe harbor that is used in determining the amount of the "expectation value" of a particular option; instead, the valuation is based on all facts and circumstances.(13) After being taxed at grant, any future capital gain can be realized free of tax since there is no capital gains tax under Dutch law.

In Canada, the spread is taxable at exercise, although the capital gain on the later sale of the stock may be reduced by one-quarter of the amount included in income at exercise. In Mexico, although tax is assessed on the spread in the options at the exercise date, tax is deferred if the spread is less than 10 percent of the stock's value at that date. Instead, that gain will only be taxed when the stock is sold. Finally, Japan is in the process of changing its approach to the taxation of stock options. Previously, the employee would be taxed at exercise on the difference between the fair market value at exercise and the fair market value of the stock at grant.(14) Japan, however, has just enacted legislation enabling eligible companies to grant options under which the acquired shares will be taxed only upon disposition.(15)

B. "Qualified" Stock Option Plans

While the tax benefits associated with Incentive Stock Options (ISO) and Employee Stock Purchase Plan (ESPP) are limited to the United States, other taxing jurisdictions provide favorable tax consequences for certain stock option income -- most notably, the United Kingdom and France.

1. The United Kingdom. Two opportunities for tax-favored treatment exist in the United Kingdom. The first is an Approved Share Option Scheme."(16) Under these rules, options granted under plans approved by U.K. Inland Revenue are tax-free at both grant and exercise, so long as the total value at grant of the stock subject to the option and the other options held by the employee does not exceed 30,000[pounds]. When the shares are sold, the spread will qualify for capital gains treatment, with up to 6,300[pounds] of the gain being exempt from U.K. tax.(17) The balance of the spread will be taxed as ordinary income under U.K. law. Inland Revenue approval is rather easy and relatively expedient, though it must be obtained before the options are granted.

Under another regime, options may be granted under an Approved Savings-Related Share Option Scheme (SAYE). The plans allow for payroll deductions that may be used to buy employer shares at a discount of up to 20 percent, based upon the stock's value at grant. Purchase periods of three, five, or seven years are permitted. Monthly minimum investments are 5[pounds]. Interest is effectively paid on the amounts saved. Thus, the employee's eventual amount available for purchase is actually higher than the amount deducted from payroll. If at the end of the purchase period the employee decides not to purchase shares, the employee can elect to withdraw the savings and interest bonus without purchasing stock. Thus, the SAYE is similar to the ESPP in the United States, though U.S. companies seeking to export their ESPP plan to the United Kingdom must substantially modify the plan and submit it to Inland Revenue for approval before favorable tax treatment is available.

2. France. Under French law, qualifying plans provide employees with tax-free treatment at exercise, with the conversion of would-be ordinary income into capital gain at the sale of the stock. The conditions that must be met to qualify a plan include:

* The foreign company must own at least 10 percent of its subsidiary.

* On exercise, shares must not be sold for five years from grant and one year from exercise.

* The plan must be authorized by the board of directors and must be adopted by the company in a general meeting.

* Exercise price must be determined at the time of grant.

* The option holder must be employed on the day of grant but not necessarily on day of exercise, and

* The capital of the company must be increased or the shares under option must be purchased on grant.

C. Restricted and Unrestricted Stock

While U.S. income tax law allows tax deferral when stock is received subject to a substantial risk of forfeiture, such a risk of forfeiture is generally disregarded under foreign tax law. Thus, most countries will generally tax the employee upon receipt of such stock, even though the stock is subject to return if the underlying conditions are not satisfied.(18) Exceptions do exist, however. For example, approval can be obtained from U.K. Inland Revenue that allows for tax deferral until such time as the restrictions expire. As another example, Switzerland imposes a tax at grant, but allows for a discount that takes into account the restrictions.

As a result, many U.S. companies provide phantom stock plans to their employees abroad where restricted stock is not tax-effective locally. Rather than provide their employees with actual shares at grant subject to restriction, a promise is made to deliver shares at the date the restrictions would have lapsed. As discussed below, most countries do not impose tax on such plans until actual payment of shares or cash is made. To further equate the two approaches, cash payments (often titled "dividend equivalents") are paid to the employees in an amount equal to the dividends the employee would have received had they actually received shares at the date of grant.

D. Deferred Compensation Plans

Deferred compensation plans often include an equity-based element. Like the case of restricted stock, the United States is considerably more lenient than the rest of the world in permitting tax deferral in cases where compensation is paid in the future for services that are performed currently. For example, the United States stands alone in permitting employees to elect to defer the receipt of compensation. Under the Internal Revenue Code, employees need only be at risk of general corporate creditors in order to defer taxation until receipt.(19)Furthermore, employees in the United States may choose to either receive compensation currently or defer receipt until a future date.(20)

Such is not the case elsewhere in the world. Virtually all of our trading partners are more restrictive than the United States in permitting a deferral of taxation when the employee electively defers the receipt of a compensatory payment. Most countries focus on the "right to receive" and have enacted laws that tax the employee at the time such right exists, rather than taxing the employee upon the actual receipt of payment. The most lenient laws abroad permit the employee to elect a deferral in the year prior to the year in which services are performed, though many of these countries impose additional restrictions on the use of this approach. For example, nonelective deferrals are not permitted in Canada if the deferral is for a period in excess of three years. Specifically, Canadian law denies tax deferral to so-called Salary Deferral Arrangements (SDAs). A plan is considered an SDA if a person "has a right in a taxation year to receive an amount after the year where it is reasonable to consider that one of the main purposes for the creation or existence of the right is to postpone tax... that is, or is on account or in lieu of, salary or wages of the taxpayer for services rendered in the year or preceding year."(21) In contrast, an SDA does not exist where a company agrees to issue shares to an employee.(22) Thus, while a deferral which payment is reflected in cash is unacceptable, a deferral that may be settled in stock would be permitted, as long as either the deferral is nonelective or the deferral election is made prior to the time that services are performed.(23)

Fortunately, most countries permit employers to unilaterally establish plans to pay the employee in the future for current services. So long as the deferral was not elective on the part of the employee, tax will only be assessed when paid. As previously discussed in respect of restricted stock, this allows employers to adopt alternative strategies in certain foreign jurisdictions that mirror equity plans in the United States.

The Employer's Tax Benefit

Under U.S. income tax law, employers that compensate employees with employer stock are entitled to a deduction for the value of such stock.(24) This concept is unfortunately not shared by virtually all of our trading partners. Rather, they permit a deduction only where a cost has been incurred by an employer. Because no out-of-pocket expense is incurred where an employer issues its shares to its employees, the deduction is denied. For example, if a German corporation issued its shares to one of its employees as compensation for services performed, no deduction would be permitted to the German employer, even though the employee would be taxed on the stock received.

In the case of U.S.-based multinationals, this limitation might seem irrelevant. In most cases, stock is generally issued by the U.S. parent directly to the employees of both domestic and foreign affiliates. Thus, because they were the ones to provide the stock, it might be reasoned that the deduction would be taken by the U.S. parent under U.S. rules. Under this rationale, the parent would deduct the value of its stock transferred to worldwide employees, net of any cash received.

Unfortunately, this conclusion is not supported by U.S. tax law. Specifically, section 83(h) of the Code provides for a deduction "to the person for whom were performed the services in connection with which such property was transferred" in an amount equal to the amount included by the employee under section 83 and in the taxable year in which the employee is required, by section 83, to include such amount in income. Regulations under this section create the notion that the transfer of parent stock to employees of a subsidiary should be viewed as a contribution of capital in the form of the employer's stock to the subsidiary, followed by a compensatory payment by the subsidiary to its employee.(25) Thus, the deduction offered by section 83(h) is only available to the employer, even when the employer is not the person who made the actual transfer of property to the employee. Any cash received by the parent in return for its shares should be treated as a dividend under section 302.(26)

Rev. Rul. 80-76, 1980-1 C.B. 16, addresses this construction. This ruling provides an example where, A, an individual, owned a majority of the outstanding stock of P, a domestic corporation. S, a domestic corporation, is a subsidiary of P. A transferred to B, an employee of S, 10 shares of P stock as compensation. The Internal Revenue Service held that, pursuant to section 83(h), S was allowed a deduction for the stock's value in the year of the transfer. This principle has been consistently applied by the IRS in its administrative practice.(27)

A. Effect in a Multinational Environment

This analysis is unchanged when one of the subsidiaries involved is a foreign entity. Neither Section 83(h) nor the applicable regulations distinguish between domestic and foreign employers. Moreover, there are a number of private letter rulings that apply this concept to situations where domestic corporations transferred their stock to employees of their foreign subsidiaries.(28) These private rulings apply the revenue ruling and the regulations just as they are applied in wholly domestic situations, without any suggestion that the cross-border nature of the transaction has any effect on the analysis.

For example, Letter Ruling No. 8904027 (Oct. 28, 1988) addresses the grant of stock appreciation rights and phantom stock by a foreign corporation to employees of its U.S. subsidiary in a transaction subject to section 83. Citing section 83(h) and Rev. Rul. 80-76, the private ruling holds that the U.S. subsidiary employer receives the deduction. Thus, the IRS has applied Rev. Rul. 80-76 in the context of an inbound section 83 transfer to hold that the domestic subsidiary employer receives the deduction when the section 83 property is transferred from the foreign parent to the employees of the domestic subsidiary employer.

B. Securing a Deduction Abroad

Given the fact that a deduction is unavailable under U.S. law for stock transferred to employees of foreign affiliates, the only available deduction belongs to the foreign subsidiary. As discussed earlier, in most countries a deduction is only permitted if a cost is incurred locally. This presents a problem in the case of equity plans since there is no outside "cost." Thus, a cost must be created in order to salvage a deduction that would otherwise have been available had the plan operated solely in the United States.

In general, companies meet this requirement through the use of a so-called recharge agreement. A recharge agreement is an agreement between the U.S. parent and the local subsidiary providing that the subsidiary will reimburse the parent for the fair market value of the shares that is above the exercise price. Therefore, the employer receives cash equal to the entire value of the shares, part from the employee in the form of the exercise price and the remaining amount in the form of the recharge payment by the subsidiary.

With this agreement in place, the local subsidiary will incur the cost of the plan and in most cases be allowed a deduction. Care must be taken in establishing such plans promptly in order to ensure compliance under local laws. For example, Germany and the United Kingdom require that recharge agreements be put in place prior to the award of stock options in order for the recharge payment to be deductible.(29)

In some countries, a recharge alone will not suffice. For example, in Brazil, it is generally illegal for a Brazilian subsidiary to reimburse a U.S. parent company for payments to be made to Brazilian employees.(30) In Japan, the subsidiary must currently purchase treasury stock in order to deduct the compensation expenses associated with an option exercise.

C. Effect of Recharges to the U.S. Parent

As previously stated, section 83 provides that money paid to the transferring shareholder (the U.S. employer) for stock transferred to employees of a subsidiary is viewed as a potential dividend. Thus, the recharge payments might be deemed to be a taxable dividend from the foreign affiliate. Fortunately, the IRS has ruled that these payments are protected by section 1032, which provides that no gain or loss is to be recognized by a company on the receipt of cash for its stock.3l Hence, the use of a recharge can effectively provide two benefits, one in the form of the foreign deduction and the other as a means of achieving a tax-free repatriation of foreign earnings.

While the recharge approach secures a deduction abroad, multinationals may desire to shift the deduction to the United States, depending on relative tax rates and the earnings history of the foreign affiliate and U.S. parent (i.e., a deduction is only of value if taxable earnings exist in that jurisdiction.) Thus, attempts are often made to link the recharge approach with transfer pricing adjustments, e.g., via management fees and other charges, as a way to accomplish this objective.(32)

Effect on Expatriates

A. U.S. Tax Implications

While the previously discussed rules are fairly easy to apply in the case of an individual who receives remuneration in a single taxing jurisdiction for the entire compensation period, complications arise where the employee is granted an equity-based compensation device whose compensation element is held open for a period in which the employee's tax presence may have crossed borders. A common example of this situation arises when an employee of the U.S. parent has been granted stock options while resident in the United States, and is later relocated to a foreign subsidiary.

Perhaps the most important issue created by relocation relates to sourcing. In an international environment, compensation must be sourced to the location in which it was earned. Sourcing is important for a number of purposes, even though U.S. citizens are taxed on their worldwide income, it impacts the foreign tax credit and also affects the section 911 income exclusion. If the services are performed both in the United States and abroad, the facts and circumstances (usually, the relative time spent in each country) are to be used in allocating the income between United States and foreign sources.(33)

Where an employee is taxed on the date of the exercise of a stock option or upon the vesting of restricted property, IRS rulings dealing with income sourcing suggest that the "spread" (the excess of market value over price paid) or other compensation is sourced based on where the employee worked starting on date of grant and ending on date of exercise -- a period that could have seen a mobile employee performing services in multiple domestic and foreign taxing jurisdictions. Thus, absent treaty provisions to the contrary, a nonresident alien that had worked in the United States during the exercise period would be taxed for U.S. purposes on all of the compensation resulting from the property transfer, though some of the income could be sourced abroad and, if subject to tax in another jurisdiction, would be eligible for foreign tax credit.

B. Taxation in Foreign Countries.

Employees are generally taxed on stock options on the date of exercise. If a stock option has been granted before moving into a foreign country, however, that country may not tax the spread at all upon exercise. As a result, a U.S. expatriate may see foreign law treating the spread as U.S. source, effectively eliminating foreign tax on the spread.

For example, tax law in the United Kingdom focuses solely on options granted to those who reside in the United Kingdom, meaning that an option granted to United States nationals immediately prior to their relocation to England will escape U.K. taxation, even though they resided in the United Kingdom for the bulk of the period prior to the option's exercise. By the same token, U.S. nationals who had resided in the United Kingdom for some time and were granted options by the U.K. employer shortly before they moved back to the States, will be subject to U.K. taxation at the point of exercise some years later.

In the case of phantom stock or similar stock appreciation rights arrangements, foreign countries will generally impose a tax treatment similar to the tax rules governing vested but unfunded bonuses. Countries that tax such bonuses on an "accrual" basis may tax it currently, while countries that tax on a cash basis would defer taxation until payment.

Conclusion

Once the of territory of corporate behemoths, companies large and small have entered the global market at a feverish pace. As a consequence of their global expansion, many of these companies have elected to implement their U.S. incentive compensation plan throughout the world.

U.S. law is generally more flexible than that of our trading partners. Around the world, wide variances often exist in the tax treatment of stock options, direct stock grants, and equity-based deferred compensation plans. These differences reside in many areas, including the timing and rate of taxation, as well as collateral issues such as the employer's reporting and withholding responsibilities.

Thus, U.S. multinationals may be faced with the fact that their incentive compensation plan is either incompatible with local law or is not offering equitable benefits to its worldwide employees. These companies face the following dilemma: should they implement a plan that offers uneven benefits worldwide or otherwise implement an alternate plan designed to offer the same benefits while minimizing adverse tax, exchange control, or labor law consequences. For this reason, it is essential for companies to do their homework prior to the time of plan introduction to determine if retooling of their U.S. plan is necessary.

Notes

(*) Footnotes appear on page 382. (1) Hungary presents an example of reform in this area. Effective July 1, 1996, Hungary removed many of the exchange control restrictions that had interfered with the use of multinational equity plans. Rather than needing advance government approval, Hungarian nationals must simply notify the central bank before participating in such plans. (2) Effective January 1, 1997, Belgium law permits the introduction of new compensation plans, subject to overall caps on employee remuneration. (3) See Treas. Reg. [sections] 1.83-3(a)(2). (4) In rare situations it is possible for stock options to be taxed at grant. See Treas. Reg. [sections] 1.83-7, which governs the tax treatment of stock options. (5) Section 422 of the Code sets out ISO requirements, the most important of which are that the exercise price is at least equal to the stock's fair market value at grant, that the option be exercised only while the individual is employed (or within three months of termination), and that options granted to an employee that are exercisable in any one year be capped at $100,000 in underlying stock value. Although the exercise of the ISO is exempt from regular income tax, it is taxable for alternative minimum tax purposes. I.R.C. [sections] 56(b)(3). ((6) See I.R.C. [sections] 423 for the rules dealing with ESPPs. (7) I.R.C. [sections] 83(a). (8) See Treas. Reg. [sections] 1.83-3(c). (9) It is possible for the employee to make an election under section 83(b) of the Code that has the effect of disregarding the existence of the substantial risk of forfeiture and, thus, closes the compensatory nature of the transaction at the original date of transfer. Any appreciation in the property from that point forward is treated as capital gain. (10) Taxation is deferred so long as the employee is not in constructive receipt under Treas. Reg. [sections] 1.451-2(a), i.e., the employee is not protected from the risk of corporate creditors and is unable to withdraw funds from their account. (11) This amount will be taxed in the same way as the employee's other remuneration from employment. Section 135 of ICTA 88. Stock plans in the United Kingdom are generally known as "share schemes." This is also the case for many of our common trading partners, including Germany, Spain, and Hong Kong. (12) This expectation value is referred to in the United States as the "option privilege." (13) In many cases the amount of the expectation value can be agreed to in advance with the Dutch tax authorities. Experience teaches that the expectation value can range as low as 7.5 percent to as high as 30 percent of the exercise price, with the "average" amount ranging from 15 percent to 20 percent. If the option price is higher than the market price on the date of grant, the tax authorities might agree to an expectation value of less than 7.5 percent on the vesting date. (14) This income was treated as employment income, subject to a 55 percent tax rate. If a discount existed at the date of grant, it was taxed at that time at the 55 percent rate. (15) The basis of the tax will be the difference between the market value of the shares at the date of disposal and the exercise price. The gain will be taxed at a special discounted rate of 26 percent. (16) Approved share schemes have existed in the United Kingdom for a number of years, the most recent version of which is based upon provisions contained in the U.K. Finance Act of 1996 which was passed on April 29, 1996. (17) This amount represents the capital gains tax exemption for the 1996-1997 U.K. tax year. (18) Most European countries follow this approach, including Germany, France, Italy, and Spain. (19) Under this concept, promises from an employer that place the employee in a position of general corporate creditor are deemed to have satisfied this test. (20) See Treas. Reg. [sections] 1.451-2, which provides that an employee is taxed at the time that funds are set aside, credited to his account, or otherwise made available. Thus, if the creation of a deferred compensation obligation takes place prior to the occurrence of these three events, the assessment of taxation will be postponed. Although beyond the scope of this article, considerable controversy exists about the timing of elections to defer, with case law seemingly permitting a deferral election at a later date than is permitted by the IRS. See Martin u. Commissioner, 96 T.C. 814 (1991), and Veit v. Commissioner, 8 T.C. 809 (1947), acq. 1947-2 C.B. 4. (21) An SDA does not exist, however, if the promise is subject to one or more significant conditions akin to the substantial risk of forfeiture. (22) Section 7(3) of the Income Tax Act, S.C. 1970-71-72, c. 63. (23) Social security taxes will be assessed at the same time the employee is subject to income tax. There may also be other implications (e.g., Employer Health Tax in Ontario) depending on the province(s) where the employer has a permanent establishment. (24) Section 83(h) of the Code provides a deduction for property transfers to employees. The definition of "property" is all-inclusive, and thus includes an employer's stock or securities. See Treas. Reg. [sections] 1.83-3(e). (25) Treas. Reg. [sections] 1.83-6(d). (26) Treas. Reg. [sections] 1.83-6(d). This generally would result in dividend treatment under section 301 due to the fact that the shareholder usually retains a significant interest in the entity after such a transfer, thus denying them capital gain treatment. (27) See, e.g., Letter Ruling No. 9351029 (Sept. 28, 1993), in which M, a domestic corporation, was required to transfer its own stock to the employees of its domestic subsidiaries when those employees exercised stock options, prior to a spin-off. Citing Rev. Rul. 80-76, this private ruling provides that the subsidiary employer (not the parent that actually transferred the property) would receive the deduction. See also Letter Ruling Nos. 8904027 (Oct. 28, 1988) and 9505012 (Nov. 4, 1994). (28) See, e.g., Letter Ruling Nos. 8432049 (May 4, 1984) and 8728065 (Apr. 16, 1987). (29) Other odd situations exist, where some countries have special rules related to the purchase and grant of stock options. For example, in France the shares that are granted may not be newly issued shares, i.e., the shares must be purchased on the market. (30) It is possible to reimburse the parent company, and thus obtain a deduction if prior approval of payment by the Brazilian central bank is secured. Unfortunately, central bank approval is almost impossible to receive. (31) See, e.g, Letter Ruling Nos. 8208113 (Nov. 27, 1981) and 8728065 (April 16, 1987), which hold that the receipt of cash by the employer is not tested under section 302 of the Code because the cash is received in respect of shareholder stock. However, if a corporate shareholder transfers stock of its subsidiary to an employee of the subsidiary, thereby reducing the parent's holdings of subsidiary stock, any cash received for the stock is properly tested under section 302. (32) See Treas. Reg. [sections] 1.482-2(b)(4)(i), which provides that where an arm's-length charge is determined with reference to the costs or deductions of performing the service, all costs -- direct and indirect -- related to the service shall be taken into account. (33) See Treas. Reel [sections] 1.861-4(b).

WILLIAM DUNN is a partner in the National Tax Office of Coopers & Lybrand LLP. He is based in Philadelphia where he directs the firm's national executive compensation tax practice. He specializes in compensation issues facing multinationals, assisting U.S. corporations that wish to implement their incentive compensation plans abroad.

JULIE COTE RUMBERGER is an associate in the Philadelphia office of Coopers & Lybrand LLP. She specializes in multinational compensation matters and has extensive international experience including assignments in Moscow and London.
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Author:Rumberger, Julie Cote
Publication:Tax Executive
Date:Sep 1, 1996
Words:6532
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