The tax issues for internationally mobile employees cover a wide range of issues from tax and social security contributions on salary, benefits in kind and relocation expenses. There are complex arrangements for tax equalisation so that an employee does not pay more tax (and social security contributions) in the host country than they would pay in their home country. However, one subject that is often overlooked is the tax treatment of equity incentives. Equity incentives include share options, grants of restricted shares, restricted stock units (RSUs) and share appreciation rights (SARs). This article sets out a summary of how the tax treatment works and practical points on implementation.
Why should a company be concerned about the tax treatment of equity incentives? The main reason is to ensure that the correct amount of withholding of tax and social security contributions takes place in the correct country at the correct time and is paid to the correct tax authority. The relevant tax authority will also impose reporting obligations on the company or employing subsidiary.
An important tool to facilitate this is the proper tracking of the location of the internationally mobile employees in relation to the life cycle of the equity incentives. For example, the company needs to know in relation to a share option, where the employee was when the option was granted to the employee, where the employee was during the vesting period of the option and where the employee was at exercise of the option. Although the company may have a web-based system for the share options, this may not also track the location and this will require the involvement of the HR systems.
It is probably helpful to look at a simplified example. A UK resident and domiciled employee of a listed UK company is granted an option on 1 May 2017 whilst located in the UK over 20,000 shares at an option price of £1, with a vesting period of 4 years, the employee moves to work in Germany for a German subsidiary on 1 May 2020 and exercises the option on 1 May 2021 when the share price is £3. There is a total gain of £40,000 on the shares and both countries would want to tax the gain, because the option is granted in one country and exercised in another country. The UK tax legislation states that only the gain relation to the UK duties during the vesting period will be taxable. This is calculated on a time basis unless there is a just and reasonable basis to change this. In this example, 75% of the vesting period was spent in the UK so only 75% of the gain (£30,000) would be subject to UK tax and the remaining 25% subject to German tax. The UK income tax would have to be withheld through the PAYE system and accounted to HMRC.
There would also be social security contributions which do not necessarily follow the income tax treatment. This is because the employee might continue to be within the home country social security system whilst being sent to another country for a secondment. This is due to the employee going to a country within the EEA or to a country, with which the UK has a reciprocal arrangement for social security. In the example above, if the employee had obtained an A1 certificate from HMRC to remain within the UK social security contributions system whilst in Germany, all of the gain of £40,000 would be subject to UK social security and none subject to German social security.
Although most countries have similar legislation to the UK to apportion a share option gain between grant and vesting, the US/UK double tax treaty provides that the apportionment is to be on the period between grant and exercise. If this leads to an element of double taxation then there can be a claim for double tax relief.
The tax treatment of share options can be complex, as the timing of the tax charge is uncertain as the employee has a choice as to when to exercise the option and buy the shares, which will trigger the tax charge. It is often easier to deal with the tax treatment of an RSU where the employee does not have a choice on the timing of the tax charge. An RSU is a right to receive shares at a point in the future for no payment. It is a very common form of equity incentive for US companies and does not require the payment of an exercise price to acquire the shares. Normally a RSU vests on a particular date and the shares are automatically transferred to the employee on that date without any action from the employee. The Company would therefore know in advance the date of the tax charge and provided that the employee’s location has been tracked, it would be easier to calculate the necessary withholdings for the relevant countries.
An increasing number of internationally mobile employees may be working in a number of countries at the same time, rather than working in one country for a period of time and then in another country for a period of time. Under the UK tax legislation this would lead to similar types of apportionment of the income relating to equity incentives, but other factors would need to be considered as to whether the income has been remitted or brought back into the UK. Generally, where the options are over shares in a UK company, any gains are deemed to be remitted to the UK even if they are related to the proportion of the employee’s work for foreign duties.
The rules governing the income tax and social security contributions on equity incentives for internationally mobile employees are complex. They will need to be addressed carefully by the company issuing the equity incentives and the relevant employing subsidiary using a robust system.