Employee stock based compensation and its impact on Israeli companies looking to expand globally
What is the logic and motivation behind stock-based compensation?
Stock-based compensation is an employee benefit associated with many companies, including start-up companies. They are often issued in order to reward employees in anticipation of the company going public, or in the case of RSU’s in the granting of stock based compensation to employees of an already listed company. Stock options help align remuneration of an employee with company performance.
Stock based compensation can take the form of options, RSU’s or PRSU’s:
- Stock based options is when a company gives an employee the ability to purchase stock at a predetermined price at a given time. This may result in a number of shares becoming available each year over several years and is usually subject to particular vesting criteria.
- RSU’s (Restricted Stock Units) is stock granted to an employee with a nil purchase price. Employees can be granted either shares or the cash equivalent.
- PRSU’s are performance based restricted stock units, which is the same as an RSU except that a certain performance level is required in order to receive all or a portion of the RSU grant.
These benefits can serve as an incentive for employees to commit on a long-term basis to the company and to support the company’s success. Stock based compensation, specifically options generally vest over a three to five year period. Should employees leave before the end of the vesting period, the options will either be cancelled or apportioned over the vesting period.
Tax Treatment on Stock Based Compensation:
The tax treatment for SBC range from being straight forward to highly complex depending on the stock compensation option chosen and the country’s regulations in which the compensation is granted.
Specific guidance should be sought by experienced accounting and tax advisors in each jurisdiction.
Israel
In Israel tax treatment for SBC is regulated under section 102 of the Israeli Income Tax Ordinance.
Section 102 lays out different tracks for how and when the SBC is taxed (otherwise known as a “tax event”). Israeli multi-national companies are usually very familiar with local Israeli requirements, and this article will not discuss Israeli SBC in any further detail.
For purposes of comparison to Israel, we have provided a summarized explanation of how stock compensation is dealt with in several of the large start-up hubs around the world, specifically key countries where Israeli startups typically choose to open a material subsidiary. The US is specifically excluded from this analysis due its complexity.
Germany
In general, employee share plans (and other employee participation plans) are not common in Germany as there are no substantial tax benefits.
Any discount provided to employees on the granting of SBC is subject to tax at the regular rate of salary taxation. A tax exemption of up to €360 (which will shortly be increased to € 720) per year is possible on an employee share purchase plan if the plan is open to all employees (there are additional other requirements which need to be met).
As in many other countries the tax event in Germany is recognised upon exercise (purchase) of the share option. The benefit will generally be taxed in the month of the exercise. The tax rate will be the progressive standard income tax rate plus solidarity surplus charge according to the employee’s income. The employer withholds the relevant tax from its employee.
The sale of the shares (assuming there is an increase in value since the date of exercise) is generally taxed as a capital gain at a flat rate of 25% plus solidarity surplus charge (total tax rate of 26.375 %). There is no obligation for the employer to withhold tax from the employees because the taxation takes place at an individual level.
China
The tax implications are more straightforward in China. There are however certain formalities that need to be done early on, specifically:
- Registration of the SBC with the authorities is required prior to granting stock-based compensation. Failing to do so may have implications on the roll-out of the plan.
- A non-listed company can grant stock-based compensation, but employees will have difficulties exercising and selling stocks until the company is listed.
- Registration with the foreign exchange authority (State Administration of Foreign Exchange, or SAFE).
Upon approval of the above, a dedicated bank account is opened by the Company, the purpose of which is to receive / release transactions in relation to the stock option plan. In practice, SAFE does not grant approval to non-listed companies.
Taxable events arise when the employee exercises their stock options (which is taxed according to the employee’s marginal tax rate), or sells his/her stock (taxed as capital gain).
Japan
The tax approach in Japan with regards to employee SBC is more complex that the above-mentioned countries but generally consistent depending on the type of stock compensation being offered.
Employees are subject to income tax on the gain on exercise (the excess of the market value as at the date of exercise over the initial option price). Income from SBC is generally not subject to withholding tax by the Employer. Employees receiving such shares in a foreign parent company generally need to file a tax return with Japanese tax authorities.
As for the employer, a deduction on the payout is available if the Japanese subsidiary reimburses the issuer for the cost of the plan, subject to prescribed requirements for deduction including the fact that a written reimbursement agreement is required.
Additional regulatory requirements that a company needs to consider when granting SBC include, for example, if an employee pays ¥30,000,000 or more to exercise their options under a SBC Plan, then a payment report must be filed with the Ministry of Finance via the Bank of Japan.
Foreign share plans, relating to foreign entities with a subsidiary in Japan, must fully comply with applicable Japanese laws and regulations (particularly, the disclosure rule under the Financial Instruments and Exchange Act of Japan (FIEA)).
Conclusion
In conclusion and as can be seen from above, tax treatment on SBC differs from country to country with no one standard governing the process of employee stock-based compensation.
It is always advisable to speak with a professional service consultant who is an expert in his or her country to guide the process in order to mitigate risk or exposure for both the entity and its employees.
For more details please do not hesitate to contact us at Mazars Israel
Gavriel Lebens, Partner at Mazars Israel
Rachely Sitbon, Manager at Mazars Israel
Tel: +972 (0)3 613 5830
With thanks to Stefan Kirchmann for information provided on Stock Based Compensation in Germany
With thanks to Kevin Edwards-Yanofor information provided on Stock Based Compensation in Japan
With thanks to Thomas Granjardfor information provided on Stock Based Compensation in China
Please note that no information in this article constitutes any advice & which can be relied upon. The actual outcome may vary depending on the circumstances, and specific advice should be obtained depending on individual circumstances.