An employee stock option is a stock option granted to employees of a company, offering them the right to buy a certain number of company shares at a predetermined price for a specific period of time. Stock options are typically awarded to compensate, retain and attract employees. Awarding stock options will align incentives to the employees with the interests of the shareholders of a company, in the sense that as employees perform better, the company’s stock value will increase, thereby benefitting both employees who own stock options as well as shareholders.
The Employees Provident Fund (EPF) is a social security institution in Malaysia that provides retirement benefits for members through management of their savings in an efficient and reliable manner. Its members include private and non-pensionable public-sector employees. Under the governing legislation known as the Employees Provident Fund Act 1991 (“EPF Act”), both the employee and the employer must pay monthly EPF contributions on the amount of the employee’s wages under s. 43(1), EPF Act.
The term “wages” is defined in s2, EPF Act as:
“all remuneration in money, due to an employee under his contract of service or apprenticeship whether agreed to be paid monthly, weekly, daily or otherwise and includes any bonus, commission or allowance payable by the employer to the employee whether such bonus, commission or allowance is payable under his contract of service, apprenticeship or otherwise, but does not include:
- Service charge;
- Overtime payment;
- Retirement benefit;
- Retrenchment, lay-off or termination benefits;
- Any travelling allowance or the value of any travelling concession;
- Any other remuneration or payment as may be exempted by the Minister.”
Since stock options are not explicitly mentioned in the EPF Act, the question is whether stock options are included within the definition of ‘wages’, for which EPF is payable.
As mentioned, wages is defined as ‘remuneration in money’. The word ‘remuneration’ means “payment or reward for service rendered by the employee to his employer”, as clarified by the Privy Council in Peter Anthony Pereira and Another v Hotel Jayapuri Bhd and Another. Many companies offer their employees stock options to reward them for their work by allowing them to benefit directly as the company grows and increases in value. Hence, stock options fall within the meaning of ‘remuneration’ if it awarded in consideration for the employee’s services performed, or more commonly, awarded contingent upon the employee fulfilling a certain length of service.
However, the EPF Act specifies that the remuneration must be monetary. Stock options are essentially contractual rights to purchase shares and do not take the form of money, and instead, the employees receive shares of the company when stock options are exercised. Hence, awarding stock options to employees, even when exercised, will not be subject to EPF.
On the other hand, applying the same principle, stock related incentives that result in money or cash being given to or received by employees could be subject to EPF. For instance, if the by-laws of the incentive scheme requires the company to pay the employee the difference between the exercise price of a stock option (being say RM50) and the market price upon exercise (say RM70), the remuneration is in monetary form and hence should be subject to EPF contribution. Unfortunately, there are no local precedents, guidelines or authority on this point so we have to turn to the treatment in foreign jurisdictions.
Treatment in Foreign Jurisdictions
Hong Kong’s version of EPF is called the Mandatory Provident Fund (MPF), where both employees and their employers have to contribute towards the MPF a percentage of the employee’s relevant income. “Relevant income” is defined in s.2 of the Mandatory Provident Fund Schemes Ordinance as “any wages… expressed in monetary terms”, and the Mandatory Provident Fund Association (MPFA) guidelines clarify that the provision of share options is considered non-monetary emolument, and hence is not subject to MPF. Even if gains are realized subsequently by the employee from disposing of the shares received from exercise of the share options, these gains should not be included as relevant income. (See: HK Guidelines on Relevant Income in Respect of a Relevant Employee ) This position and interpretation could be instructive in Malaysia.
The Central Provident Fund Board of Singapore states that CPF (Singapore’s version of EPF) is payable for cash proceeds for share options given to the employee, but not payable for sales proceeds if the share options have been exercised and the shares are held in the employee’s name. CPF is also not payable for payments granted in kind (for instance, token gifts) to employees where no cash payments are payable to employees. (See: Singapore CPF Guidelines) Since s2 of the CPF Act 1953 (revised 2013) also defined “wages” subject to CPF as “remuneration in money”, the CPF Board’s guidance in this respect is likely to be instructive in Malaysia as well.
Accordingly, stock options are generally not subject to EPF because they are not in the form of money, whereas other types of share incentive schemes could be subject to EPF if it results in the employee receiving “remuneration in money”.
About the Author: This article was written by Shawn Ho (Partner), with assistance from Denise Tia (Intern). Shawn 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.
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