In Part 1, we explored some FAQs about the basic mechanics and workings of an Employee Stock Option Scheme (“ESOS”). In Part 2, we address the basic tax implications on both the company and employee of an ESOS. As attractive and effective using ESOS may be, implementing one attracts compliance and tax consequences that should not be ignored.
Is ESOS treated as an employment income for the ESOS holders/ employee?
Yes. Gross income of an employee includes any wages, salary, remuneration, leave pay, fee, commission, bonus, gratuity, perquisite or allowance in respect of having or exercising the employment. Perquisites means benefits that are convertible into money received by an employee during employment. ESOS is a perquisite as it arises by exercising an employment and it is chargeable as such benefits are gains from an employment.
Will a director’s or founder’s participation in ESOS also be taxed and treated like an employee?
It depends on whether the individual can be said to exercise employment or is an employee. For example, a director or founder could be taxed on ESOS received if he is on the Company’s payroll, has an employment contract, receives a salary, or is entitled to similar benefits as other employees. On the other hand, he may not considered an employee of the company if he does not receive monthly remuneration or is entitled to other employee benefits. The surrounding facts need to be studied to make a determination.
How is tax on the employee/ESOS holder calculated?
The tax will be levied on the market value of the shares on exercisable date OR exercise date (whichever is the lower) LESS the price paid for the shares (offer/exercise price). For tax resident individuals, the applicable tax rate will be determined by their own income bracket.
How is market value determined for unlisted company shares?
There is no access to daily market values of shares in an unlisted company. However, net asset value per unit of share could be ascertained from the audited accounts as follows:
Unlisted companies may face challenges in tracking the market value of its shares at the various dates, but one possible way to obtain a justifiable market value for a start-up could be to refer to the last subscription / investment price. This may or may not be relevant given that different types of shares may have different rights attached to them (ie, ordinary shares vs preference shares).
Does an employee need to declare the benefit?
Yes. An employee is required to declare the benefit as part of his employment income in his annual personal tax return.
When must the employee pay for the tax?
Income tax on benefits derived from ESOS will be paid (i) by deductions by the Company from the employee’s salary or (ii) by employee’s election for the tax to be paid by instalment scheme.
What is the instalment period?
The number of instalments allowed is a maximum of 12 months.
If after exercising the ESOS the share valuation changes, will this influence the employee’s tax payable?
No. Any fluctuations in the value of the shares held (whether gain or loss) after the exercise of the options will not influence the taxable income as the key dates to calculate the tax are explained above.
Will the employee be taxed on the capital gain if he sells the shares received after exercising the option?
No. Any gains obtained from a subsequent sale of the shares (not options) received after exercising the ESOS are considered as capital gains and are not subjected to further tax.
What is the reporting obligation of the ESOS holder/employee?
At grant date, there will be no tax implications for the employee. Accordingly, there are no reporting obligations at this point in time.
At exercise date, the taxing point occurs when employee exercises his options and receives the shares. Accordingly, the employee must declare in his tax returns the same tax year he exercises the option.
Will the employee be taxed if the shares options are replaced with cash?
Yes. The replacement in the form of cash payments for the release of the right to the ESOS is also considered as a gain or profit arising from an employment and taxable as a perquisite (see first question).
EMPLOYER / COMPANY
What is the reporting obligation on the employer?
Upon launching of ESOS, the employer has to notify the Inland Revenue Board (IRB) within 30 days after the expiry of the period of acceptance of offer by the employees.
When an employee exercises his options to acquire the shares, the employer will also need to inform the IRB accordingly. Such notification is to be made annually and the deadline to submit the notification is 31st January of the following year.
Reporting of benefits will also need to be made in the Form EA of the respective employee in the tax year where options are exercised.
What are the supporting documents needed to be kept and prepared by the employer for tax audit purposes?
- By-laws of the ESOS;
- Board of Directors Resolution or the Shareholders Resolution approving the ESOS;
- Offer letter which states the offer price and the number of shares offered;
- Letter of acceptance of the offer;
- Proof of market value of shares based on market price on the relevant dates;
- For an unlisted company, audited balance sheet (on exercisable date or exercise date) of the company offering shares to its employees and sample copy of the share certificate to be issued to the employee, and
- Details of employees accepting the offer.
What is the withholding obligation on the employer?
When an employee exercise his options, the employer will need to deduct the applicable taxes from the employee’s salary based on the Monthly Tax Deduction Schedule.
However, the employee may apply for an instalment scheme from the IRB to settle the tax liability and in practice, a maximum of 12 monthly instalments is generally allowed.
Alternatively, the employee may opt to settle the tax liability by himself upon filing his tax return for the calendar year concerned. If this option is pursued, the employee is required to make the election in writing and furnish this to his employer and once this is done, the employer is absolved from withholding obligations on this matter.
About the Authors: This article was written by Shawn Ho with assistance from Yuna Cheah. Shawn Ho is a partner of Donovan & Ho and is experienced in corporate matters such as acquisitions, cross-border transactions, restructuring exercises, sale of businesses, joint venture arrangements, shareholder agreements, and franchise businesses. His background in tax advisory has enabled him to assist several multi-national companies achieve considerable tax-savings through cross-border tax planning, implementing tax-efficient structures using Labuan companies, and incorporate tax advice into commercial transactions.