Tax on stock options

Revenue Commissioner Kim S. Jacinto-Henares. AP FILE PHOTO

Revenue Commissioner Kim Jacinto-Henares has just made the holiday season less merry for some people in the corporate world.

This is the time of the year when some employees and executives of listed or public companies enjoy the benefits of a privilege that can bring them extra cheer during the Yuletide season: Stock options.

The most common stock option scheme is the employee stock option plan where employees who meet certain criteria, e.g., length of service or level of responsibility, are granted the right to purchase the company’s stocks at a specific price (called the strike price) which may be exercised within a specific period.

The stock option plan is aimed at promoting employee productivity and loyalty to the company.

At the time the option is given, the strike price is usually lower than the stock’s trading price in the stock market, or fair market value, or valuation in the books of the corporation.

If at the time the option is exercised, the strike price is lower than the stock’s indicated value, the employee-optionee concerned can profit from selling the stocks to interested buyers.

For obvious reasons, it does not make sense to exercise the option in case there is no difference in prices or, worse, the strike price is higher.

Exercise

At the onset of the holiday season, when the odds are in the optionee’s favor, stock options provide a convenient way of obtaining the money needed to meet additional spending requirements.

Unfortunately, the Bureau of Internal Revenue (BIR) recently put a damper on the enjoyment of the benefits of stock options with the issuance of Revenue Memorandum Circular No. 79-2014, dated Oct. 31, 2014.

The circular covers two kinds of stock option programs presently practiced in the country: Equity-settlement option and cash-settlement option.

In the equity-settlement option, the stocks availed of are transferred to and registered in the optionee’s name. The transfer is recorded in the company’s stock and transfer book.

Upon such transfer, the optionee can immediately sell the stocks, or hold on to them as his personal investment in the company, or sell them later when their price goes up.

In the cash-settlement option, the optionee receives the peso equivalent of the difference between the actual fair market value and fixed nominal value of the stocks. No transfer of stocks is done from the corporation to the optionee.

According to the BIR, since stock options are considered shares of stock under the Tax Code and subject to taxes, the grant, sale, transfer or exercise of the stock option may result to tax liabilities to the optionee.

Benefits

Under the circular, the tax liability that may arise from the exercise of the stock option depends on the position of the optionee in the corporate structure.

If the option involves the company’s own stocks and the recipient is a rank and file employee, the amount “equivalent to the difference of the book value/fair market value of the shares, whichever is higher, at the time of the exercise of the stock option and the price fixed on the grant date” will be added to his compensation income and subject to income tax.

With the inclusion, his gross income will rise and there will be a corresponding adjustment in his withholding tax to match the income tax bracket of his compensation income.

In case the recipient holds a managerial or supervisory position, the “difference of the book value/fair market value of the shares, whichever is higher, at the time of the exercise of the stock option and the price fixed on the grant date” will be treated as a fringe benefit subject to a fringe benefit tax under Sec. 33 of the Tax Code.

A fringe benefit is “any good, service, or other benefit furnished or granted in cash or in kind by an employer to an individual employee (except rank and file employees).”

The notable examples of this benefit are free or subsidized housing, use of motor vehicles for personal use and membership in social clubs.

Liability

Unlike stock options of rank and file employees where their full value are added to their compensation income and taxed accordingly, stock option benefits of managerial and supervisory employees are accorded liberal treatment.

For these upper level employees, the value of their stock options (following the principle on taxation of fringe benefits) is determined by dividing its actual monetary value by 68 percent.

On top of the discounted treatment, the Tax Code provides that the fringe benefit tax shall be paid by the employer, not the employee.

This “double standard” does not come as a surprise. It is one of many instances in our revenue regulations where those who have more in life (or resources) have more in law or enjoy preferential treatment in the payment of taxes.

The same taxable subject—stock options —is treated differently depending on the taxable party. If it is a rank and file employee, it’s compensation income; if it is a managerial or supervisory employee, it’s fringe benefit.

Shouldn’t it be that what is sauce for the goose should also be sauce for the gander?

By withholding the classification of stock options for rank and file employees as fringe benefits, the BIR is cleverly circumventing Sec. 33 (C) of the Tax Code which states that “the following fringe benefits are not taxable under this Section … (3) Benefits given to the rank and file employees, whether granted under a collective bargaining agreement or not.”

The instant BIR circular should be a cause for concern for rank and file employees’ labor unions that have employee stock option plans in their collective bargaining agreements with their employers.

They could lose by default some of their hard-earned gains on the bargaining table.

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