In this Tapestry global update we will cover:
- Brazil – eSocial on-line tax reporting system now in operation
- France – clawback for financial services sector
- New Zealand – proposed tax change for share plans postponed
- Poland – tax advantage for share plans extended to non-EU companies
- USA – Tax Cuts and Jobs Act
Brazil has recently introduced the eSocial online system for reporting information about employees, tax and social security. The introduction of eSocial has been delayed several times but, under the latest timetable, companies with revenues over BRL78 million (currently USD24,398,400) in 2016 were required to start the process of complying with the new reporting regime on 8 January 2018. eSocial requires substantial input from employers (there are 45 different forms with 2,736 fields for data entry) and the introduction is being phased in over the next 12 months. For companies required to commence reporting on 8 January, the current timetable is:
Companies which operate incentive plans in Brazil will want to check that payments under the plan are not affected by the new reporting system. For example, concerns have been raised about the timing and manner in which payments to former employees under incentive plans will be reported. It is currently unclear how eSocial would deal with this type of payment. This, and similar issues, are likely to be addressed over the next 12 months as companies start to use eSocial and glitches in the system are identified and (hopefully) resolved. We will be following progress with our local counsel and are happy to raise any concerns that you may have.
As part of President Macron’s planned reform of the French labour code, on 23 November 2017 the French National Assembly adopted an amendment which will require companies in the financial services sector (i.e. credit institutions, asset management companies and investment companies) to include contractual clawback provisions under which companies can require the repayment of bonuses paid to identified staff in cases of reprehensible risk taking behaviour.
This amendment has not yet been adopted by the French legislator but that may happen during the current year.
The proposal marks a major change for French labour law and follows a similar development in Germany which introduced rules on clawback in bankers’ employment contracts last year. Enforcing clawback has always been incompatible with the French labour code and currently it is not possible to enforce a clawback provision against an employee in France. This change, if it becomes law, will be a dramatic step. We will keep you updated on developments.
In a newsletter in June last year (here) we outlined plans by the New Zealand government to change the taxation of conditional and ‘option-like’ share plans. The new rules were part of an omnibus piece of tax legislation – the Taxation (Annual Rates for 2017-18, Employment and Investment Income, and Remedial Matters) Bill (the ‘Bill’). The Bill lapsed at the time of the NZ general election in September but was reinstated in November and is currently back in committee stage.
Nothing new to report here but we just wanted to let you know that the Bill is still alive and may yet become law this year. We will include an update in a future newsletter.
What has happened?
The Polish Personal Income Tax Act (the PIT) has been amended to extend existing favourable tax treatment of share-based employee compensation to include incentive plans for employees in Poland where the parent company is based in a country with which Poland has a double-tax treaty.
What is the favourable tax treatment?
Under the rules, employees are able to defer the payment of tax on equity incentive income from receipt of the income (typically at exercise or vest) until the sale of the shares. This means that the income will be taxed at the capital gains tax flat rate of 19% rather than at progressive income tax rates between 18% and 32%. Prior to the change in the rules, this treatment was only available to employee share plans offered by companies based in the EU/EEA.
Are there any other requirements?
The only other requirement under the PIT is that the grant of the awards must have been approved by a resolution of the shareholders of the parent company.
How does this affect employer withholding?
As a general rule, there is no employer withholding or social security on equity incentive benefits paid to Polish participants, unless there has been a recharge or the local employer is actively involved in operating the plan. If an employer currently withholds tax and pays social security on payments made under an incentive plan, the withholding and social security should no longer be required if the tax deferral applies.
How do I know if our plan qualifies?
Companies are advised to check if it applies to share plans offered to their employees. In some cases companies are advised to seek a tax ruling to ensure that the plan comes within the deferral rules. This is particularly important before making any changes to existing withholding and social security arrangements.
What is the timing?
The new rules came into force at the start of 2018 and apply to income received from 1 January 2018.
This is good news for employers offering share plans to employees in Poland. The favourable tax regime is straightforward and offers tax advantages to employees at little cost to employers. As noted above, companies with existing incentive plans operating in Poland should seek advice to ensure that the regime applies to their plan. Employers will also need to advise participants of the change in tax treatment and subsequent reporting of the share benefit. If you would like any further information or advice on how to ensure that your plan qualifies, please let us know.
In newsletters at the end of 2017 (here and here) we looked at proposals in the US tax bill which affected employee share plans and executive compensation. The Tax Cuts and Jobs Act (the ‘Tax Act’) was signed into law at the end of 2017 and in this newsletter we briefly discuss the impact of some of the tax changes.
Section 409A – not repealed
The major concern for employee tax planning under the first draft of the tax bill was the proposed repeal of section 409A. This section of the tax code allows US taxpayers to defer the payment of tax on cash and shares until the point when actually received. The repeal provision was dropped from subsequent drafts of the bill and was not included in the Tax Act.
This was a very welcome reversal. The prospect of the repeal of section 409A sent a chill wind through the share plan world with the fear that it would result in the demise of stock options for US employees.
Section 162(m) – performance based compensation exemption removed
The changes to section 162(m), outlined in our previous newsletter, were included in the Tax Act so that:
- ‘qualified-performance-based’ compensation is now included in the USD1 million cap on deductions for executive compensation in section 162(m);
- the definition of ‘covered employees’ under section 162(m) has been extended to include the chief financial officer. In addition, any person who becomes a covered employee for any taxable year beginning after 31 December 2016 continues to be a covered employee in subsequent years, so severance pay will be subject to the cap;
- a covered employer includes foreign corporations whose stock is traded by American Depository receipts (ADRs).
The Tax Act includes a transition period which allows a company to deduct compensation paid under a written binding contract in effect on 2 November 2017, if the terms of the contract are not modified in any material way after that date.
The removal of the performance-based compensation exclusion was not a surprise as there was broad political support for this change. As many US companies refer to the section 162(m) performance compensation rules in their incentive plan documents, companies with executive share plans in the US should check that the removal of the exemption does not affect the administration of the plan. We also note that there is an expectation that the list of covered employees will continue to expand and companies might want to take this into consideration for future planning.
Reduction in top rate of personal tax
The top rate of income tax for individuals has reduced from 39.6% (on income over USD235,350 for a single taxpayer) to 37% (on income over USD500,000 for a single taxpayer).
Changes to individual rates means that employers must adjust their tax withholding procedures. Employers that make supplemental wage payments (which includes equity awards) to employees over USD1 million in a calendar year, must withhold on the amount over USD1 million (or on the full amount of the payment if applicable) at the highest marginal tax rate (down from 39.6% to 37%). For supplemental payments below USD1 million, the withholding rate has reduced from 25% to 22%. The IRS has issued new withholding tables (Notice 1036) which employers should comply with as soon as possible but by no later than 15 February 2018.
As you will be aware, the Tax Act introduced sweeping tax rate changes for individuals and companies. Please let us know if you would like more information on the new tax rates. The reduction in the top rate of tax will apply from 2018 to 2025 and is then due to revert back to 39.6%.
Section 83(i) – tax deferral on private company shares
A new section 83(i) allows ‘qualified employees’ of a privately held company to elect to defer tax for up to five years on illiquid shares issued to them on the exercise of non-qualified options or the settlement of restricted stock units (RSUs). There are numerous qualifying conditions, including:
- ‘qualified employees’ excludes the CEO, the CFO and related persons, the four highest compensated officers (current or at any point during the previous 10 calendar years) or a shareholder holding 1% or more of the company;
- the options/RSUs must relate to shares in a private company. The deferral will not apply if the employee can receive cash, including by transferring the shares back to the employer;
- at least 80% of all full-time US employees must be granted awards on the same terms under the incentive plan. The employees do not all have to receive the same number of shares but they must all receive more than a minimal number;
- the employee must make a tax deferral election within 30 days after the first time the employee’s right to the shares is substantially vested or is transferable, whichever occurs earlier;
- if an election is made, the shares will be included in taxable income on the earlier of the fifth anniversary after the first date the employee’s right to the stock becomes substantially vested or an early termination event;
- early termination events include the shares becoming transferable or publicly traded, the employee ceasing to be a qualified employee or if the employee revokes the deferral election;
- the taxable amount is the valuation at the time of vesting or exercise;
- there is no deferral for FICA or Medicare;
- the employer would be required to report any section 83(i) deferral and to advise employees of their right to make a deferral.
Section 83(i) applies to options exercised and RSUs settled after 31 December 2017 and would cover outstanding awards, subject to meeting all of the conditions.
At Tapestry we are always pleased to see tax advantages being offered to a broader category of employees. However, the section 83(i) deferral has received mixed reviews, with some commentators considering it overly complicated for too little benefit. The requirement that at least 80% of employees must receive grants may require employers to restructure their incentive compensation procedures. There is also a risk that an employee could end up with worthless shares and a high tax bill if the value of the share drops between vesting/exercise and the end of the deferral period. However, for employees in growing companies which include a broad-based incentive plan in their compensation package, the employee may well benefit from the ability to defer the payment of tax for 5 years and for the taxable amount to be based on the share price at the date of vest/exercise 5 years earlier.
If you would like to keep track of the legal and tax requirements around the world, our OnTap database covers over 120 countries and is kept up-to-date with all the latest legal and tax requirements to operate your incentive plans. We would be delighted to provide a demo and a free trial.