1 It’s Worth the Effort: Targeting Awards to Ease Compliance Burdens and Maximize Plan Effectiveness Valerie Diamond -- Partner, Baker & McKenzie LLPJune Anne Burke – Partner, Baker & McKenzie LLPCT/Boston NASPP Regional MeetingJuly 19, 2013
2 Agenda Assessing the Compliance Burden Award Structuring by Country Type of AwardsTax-Qualified ProgramsRecharge ArrangementsOther Tax Saving IdeasOther Compliance ConsiderationsQuestions
3 Cost/Benefit Compliance Assessment Assess by award and by countryRegulatory issuesSecurities Offerings – generally territorial in nature / based on size of offering & headcountsProspectus filings/registration statements (e.g., EU, Japan)Securities notices/reports (e.g., Malaysia, Thailand)Exemption confirmations (e.g., Australia, Philippines)Show-stoppers (e.g., Indonesia, Colombia)Exchange Control Filings - for movement or holdings of foreign securities / fundsExchange control approvals (e.g., China, Vietnam)Notices (e.g., Italy)Show-stoppers (e.g., Ukraine)Other filings (e.g., Singapore MoM approval)
4 Cost/Benefit Compliance Assessment (cont’d) Employer tax issuesTax withholding/reportingEmployer social taxFavorable tax treatment (i.e., avoiding / minimizing social tax vs. cost/burden to implement/maintain)Reimbursement/charge-back arrangementsEmployee taxationTiming of tax / deferral of incomeSocial tax withholdingFavorable tax treatment (and cost/burden to implement/maintain)Other issues (e.g., Danish Stock Option Act)
5 Cost/Benefit Compliance Assessment (cont’d) Prepare Summary Compliance and Tax Charts / ChecklistsOrganize by County / Headcounts / AwardsNote locations where a particular type of award will be granted due to tax or regulatory benefitsTrack Regulatory and Tax Considerations per CountryAsk for and Note Recommendations of CounselConsider Administrative BurdenCheck with stock plan broker / administrator for exchange control issues to determine how difficult to implementBalance Burdens Against Competitive Risks / Employee DemandDocument Key DecisionsKeep a Record of Filings & Grant DocumentationUpdate (At Least) Once a YearThe more streamlined you can be year-to-year, the more cost effective the program
6 Award Structuring by Country Being Open to Grants of Different Kinds in a Country Can Save the Company (or the Employee) MoneyOptions vs. RSUs vs. RS vs. ESPPQualified vs. Non-QualifiedMany Companies Feel One Size Should Fit All – Not willing to consider award variationsWatch for Hidden Costs of Managing Different Awards with Broker / Administrator, Duplicate Systems, etc.
7 Award Structuring by Country Canada: consider granting stock options rather than other forms of award50% tax exemption on spread at exercisePrimarily employee benefit, except for tax-equalized expatsBrazil: consider granting stock options rather than other forms of award (where no recharge)Stock options taxed at sale of sharesTaxed as capital gains rather than salary income (15% vs. 27.5%)No withholding or reporting obligation for employer
8 Award Structuring by Country (cont’d) ItalyGrant stock options rather than other awardsExempt from social contributions – employee (approx %) and employer (approx. 30%)Don’t make broad-based grantsRSUs and other awards exempt from social insurance only if not offered on a broad basis (much lesser €2,045 broad-based plan exemption applies if plan is broad-based)
9 Award Structuring by Country (cont’d) Generally avoid cash-settled awardsOften subject to social contributions that don’t apply to equity awards, e.g., Brazil, Colombia, Japan, Malaysia, New Zealand, PortugalSpecial tax regimes available for equity often do not apply, e.g., French-qualified RSUs, Israeli trustee plansHowever, cash awards may allow for a local deduction not otherwise available, e.g., Canada, NetherlandsNote that cash awards are subject to liability accounting treatment – additional burden/volatility
10 Award Structuring by Country (cont’d) Avoid restricted stockGenerally taxed at grantSome exceptions: Australia, Singapore, U.K., U.S.Cash-flow issue with paying employer/employee social contributions and meeting tax withholding obligations at grant when amounts cannot be withheld from awardAdverse employee tax position – increased risk of non-compliance by employees in countries where no employer withholding
11 Tax-Qualified Plans France Qualified options or RSUs Avoid employer social security (up to 46%) on exercise/vestBut employer tax savings greatly reduced as of July 11, 2012 due to increased employer social tax due at grantGenerally, tax due at 7.5% of value of underlying shares for options; 30% of value of underlying shares for RSUsTax cannot be recouped if awards forfeitedIf forfeitures are high, grantees are top earners and/or stock price growth is slow, non-qualified awards may be tax favorable
12 Tax-Qualified Plans (cont’d) France (cont’d)Employee tax savings also greatly reduced following 2012 year-end tax reforms - employee now subject to a maximum combined rate of approx. 61% on qualified awards - effective for grants on or after September 28, 2012Likely that non-qualified awards will be more favorable for employeesIn all cases, any potential tax savings need to be weighed against administrative burden of implementing/maintaining qualified plan in France (e.g., RSU holding periods, special reports for options and RSUs) and new severe employer penalties for failure to file required special reports
13 Tax-Qualified Plans (cont’d) IsraelTrustee plan options, RSUs or ESPPCan avoid or reduce employer social security (5.9%, capped at approx. $11K per month) on gain at saleLocal employer qualifies for tax deduction on employee’s ordinary income – if recharge arrangement in placeRequires Israeli trustee and lock-up of shares, but trustee handles withholding at sale of shares so ensures tax complianceNew “deposit” requirements announced in July 2012 increase administrative burden
14 Tax-Qualified Plans (cont’d) United KingdomHMRC-approved options (CSOP)Avoid employer NICs (13.8%, uncapped) on exerciseSubstantial employee benefit – avoid income tax (up to 45%) and employee NICs on spread at exercise; gain at sale taxed as capital gains (18% or 28%), subject to annual exemption (£10,900)Rules recently adopted to simplify approved plansSavings limited by £30,000 cap on approved optionsNote: same employer saving via transfer of employer NICs to employee
15 Tax-Qualified Plans (cont’d) United StatesCode Section 423 ESPP and 422 Incentive Stock OptionsSave employer FICA and FUTA costsBut forgo tax deduction on spread/discount unless disqualifying dispositionOverall, not the best approach for employer tax savingsNote: requires shareholder approval within 12 months, holding periods, special reporting
16 Tax-Qualified Plans (cont’d) Plans that provide significant employee benefit – indirect employer savings for tax-equalized expatriates:Canada – 50% tax exemption on option spreadBelgium – options – elect tax at grant and undertake not to exercise for 3+ years – tax on only 11.5% of FMV at grant of 10-year optionChina – Tax Circulars 35 and 902 – equity income taxed separately from monthly salary, usually at lower rateSingapore – ERIS – tax exemption up to SGD 1M (US$800K) over 10-year period (must offer awards to 25% of employees) – for grants prior to December 31, 2013 onlyU.K. – CSOP/SIP – as discussed previouslyU.S. – ISO/ESPP – as discussed previously
17 Recharge Arrangements Where equity plans are sponsored by a non-resident parent company, tax authorities generally will not permit a local tax deduction for the employer absent a recharge agreementExceptions where no agreement required: U.S. and U.K.Exceptions where no deduction permitted, even with recharge: Netherlands and CanadaOther local requirements may apply, e.g., special signature or local board approval requirements, requirement to use treasury shares, tracking of cost of shares issued to employees, etc.
18 Recharge Arrangements (cont’d) How does a recharge save taxes?Foreign subsidiary may claim a corporate tax deduction not otherwise available (most countries allow deduction):Reduces foreign taxes paid by subsidiary on its earningsThus, reduces global effective tax rate
19 Recharge Arrangements (cont’d) How does a recharge save taxes for a U.S. issuer?Tax-free repatriation of cash from foreign sub to U.S. parent under IRC § 1032:1032(a) – U.S. parent not required to recognize gain or loss upon receipt of money for its stockNeed to ensure amount reimbursed by foreign sub does not exceed cost to U.S. parent, i.e., FMV of share less amount paid by employee (“employee benefit”)Foreign subsidiary’s reimbursement to parent for employee benefit is thus not treated as dividend for U.S. tax purposes
20 Recharge Arrangements (cont’d) Key implementation considerations:Foreign exchange controls may prevent rechargeArgentina – Central bank prohibits transfer and conversion of fundsBrazil – Local bank approval required for rechargeChina – SAFE approval generally required for rechargeSouth Africa – Reserve Bank approval required and not likely to be grantedIntercompany book transfer of funds not permitted in these countries
21 Recharge Arrangements (cont’d) Collateral issues to watchRecharge/local tax deduction may trigger withholding/reporting obligations and/or social contributionsEmployer social insurance triggered in several countries, mainly in Eastern Europe and Latin America, e.g., Brazil, Chile, Czech Republic, Mexico, PolandThus, need to make sure recharge produces overall tax savingNote – Belgium – recharge triggers 35% uncapped employer social tax – likely negates tax savings of recharge
22 Recharge Arrangements (cont’d) Collateral issues to watchRecharge/local tax deduction may increase labor law riskIncreased risk that awards included in “salary” for determination of severance payments, etc. (e.g., Argentina, Brazil)May increase acquired rights/entitlement risk (e.g., France, Italy, Spain)May trigger possible need to consult with works council (e.g., Czech Republic, Germany)
23 Other Tax Saving IdeasReduce, limit or cap grants in high employer tax countries, e.g.,Argentina – employer social contributions 23% or 27% uncappedEstonia – employer-paid FBT due at total rate of 68.4% (limited exception if options not exercised/RSUs don’t vest for three years from grant)Sweden – employer social contributions 31.42% uncapped
24 Other Tax Saving Ideas Transfer employer social charges to employee U.K. – transfer employer NICs at 13.8% to employeeNeed HMRC-approved joint election signed by employee prior to taxable event (transfers liability)Can also accomplish via unapproved agreement with employee (but no transfer of liability)Employee can deduct employer NICs paid from tax liabilityIsrael – transfer of employer social charges (5.9% capped) likely permitted if included in award agreement/initial terms
25 Other Tax Saving Ideas (cont’d) Transfer employer social charges to employee (cont’d)Romania – potentially transfer all income tax and employer/employee social contributions to employee via agreement with the employeeSaves employer social contributions applicable to “payor” of income (approx. 6.8% is uncapped)Need to register the agreementOften not permitted in other countries, e.g., Sweden
26 Other Tax Saving Ideas (cont’d) Avoid tax penalties through strong ongoing complianceDetermine country employer withholding/reporting and social insurance requirements when implementing equity awards and update annuallyIdentify countries with special year-end equity award reports and set up compliance systems, e.g., Australia, France (qualified plans), Ireland, U.K.
27 Other Compliance Considerations Create a Global Form of Agreement to Address Mobile Employee Risks and Ease AdministrationOne form given to employees regardless of location with a country-specific appendixEasier to update and administer because clear what country-specific terms applyIf employee moves from country A to country B over the life of the award, it is clear that terms of country B applyEstablish a tracking and compliance system for globally mobile employees – many countries currently stepping up enforcement in this area, e.g., Australia, Canada, Sweden, U.K., U.S.
28 Other Compliance Considerations Keep Equity Awards Out of Employment Agreements and Offer LettersIf employee work for separate subsidiary, then grant by issuer is not a benefit offered by the employerDocument new hire equity offerings through equity side letter on parent company letterheadKeep to a consistent policy of separating employment benefits and equity compensation to minimize exposure to entitlement claims and termination indemnities
30 Contact InformationValerie H. DiamondJune Anne Burke
31 Disclaimers This presentation was prepared for general information purposes for clients and friends of Baker & McKenzie LLP and should not be considered or relied on as legal advice or an opinion on specific facts. This presentation is not intended to create, and receipt of this presentation does not constitute, a lawyer-client relationship. IRS Circular 230 Disclosure: Pursuant to requirements related to practice before the Internal Revenue Service, any tax advice contained in this presentation (including any attachments) is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting, marketing or recommending to another person any tax-related matter, including, without limitation, any transaction or matter that is contained in this presentation.