In today's globalized business world, many internationally active companies aim to attract and retain talent globally and align employees with their company's mission. One common strategy for achieving these goals is the issuance of stock-based compensation ("SBC") to employees. Companies may often underestimate the challenges associated with granting SBC to employees of foreign subsidiaries. The complexity lies in the fact that you need to consider different angles for quantification and allocation of SBC expense as well as several layers of tax considerations, in parent and subsidiaries’ jurisdictions. In practice, internationally active companies may overlook some of the above-mentioned angles in setting up their global SBC policy.

THIS ARTICLE IS WRITTEN BY RAFI MARDROOS, AND VERA ZHURAVLEVA. Rafi ([email protected]) and Vera ([email protected]) ARE FOCUSED ON ADVISING INTERNATIONALLY ACTIVE COMPANIES AS PART OF RSM NETHERLANDS BUSINESS CONSULTING. 

Quantification of expense at parent company level 

There are different kinds of SBCs that require a different quantification method. For example, in case of Stock Appreciation Rights ("SARs”), an employee will receive a disclosed cash remuneration that is based on the appreciation of the company’s stock. The quantification of the expense would be equal to the cash amount, given that the company providing the SAR will be impoverished equal to the cash amount. However, in case of Restricted Stock Units (“RSUs”), vesting thereof could lead to the emission of common stock to employees. Accounting principles that are applied at parent company level typically require that the quantification of the SBC expense is equal to the fair market value of the RSUs on the date of issuance. At the same time, in some countries there could be arguments to support that the emission of stock to employees may not be a corporate tax expense at the level of the parent company at all. 

Allocation of expense and deduction at the level of subsidiaries 

Purely from an accounting perspective, the accounting treatment of SBC expenses will depend on the local Generally Accepted Accounting Principles (GAAP). For example, in the Netherlands SBC expenses incurred by the parent can be recharged to its Dutch subsidiaries, provided they are related to employees and officers that contributed labour to these Dutch entities. Whilst accounting rules may provide guidance on whether SBC expenses could be recharged to the foreign subsidiary, the transfer pricing regulations help determine whether a foreign subsidiary should receive a recharge for the provision of the equity awards, and if so, how the amount of such recharge should be determined.

The decision to allocate a portion of the SBC expense to the foreign subsidiary may follow directly from the conclusion of whether the foreign subsidiary receives a benefit (i.e., for which it would be willing to pay) when its parent company issues SBC to personnel the foreign subsidiary employs. Answering this question typically requires a deep understanding of the nature of the SBC under review, the characteristics and purpose of the equity plan giving rise to the SBC and the functions performed and risks assumed by the Group entities involved. Ultimately, quantification of the benefit will follow the outcome of the characterization of the nature of the benefit in the hands of the foreign subsidiary.

We note that the economic value of the benefit received by the foreign subsidiary could depart significantly from the value of the benefit from the perspective of the employees receiving the SBC. From employee’s perspective (wage tax and social security implications), the quantification of the benefit may also differ. For a SAR, it is the cash value at payment. For other SBCs, it is generally the fair market value of the shares less any contribution (e.g., purchase price) due by the employee.

In case SBC expenses are quantified and allocated to the subsidiary, they may be subsequently subject to a local deduction limitation which could significantly increase the taxable profit of the subsidiary. In addition, it is important to take into account the transfer pricing model of the subsidiary. For example, transfer pricing regulations and court practice in many countries suggest that SBC expense should form part of the cost base under a cost-plus transfer pricing model (and/or where this is required by the pricing clause of the intercompany agreement).  Leaving aside the quantification of the SBC expense, if it has to be included in the cost base of the foreign subsidiary (e.g., service provider) and the deduction limitation is applicable this could lead to effective revenue-based taxation.

Takeaways

The angles discussed in this article should be carefully assessed when setting up and managing the global SBC policy, from a perspective of the parent company and local subsidiaries. In that context, you may consider the following actions: 

  • Determine the type of SBC that has been or is going to be implemented. 
  • Quantify the total SBC related expense at the parent company level, from an accounting and corporate tax standpoint. 
  • Allocate the SBC related expense to the relevant subsidiaries, in line with the benefit received. 
  • Consider the local tax treatment and implications for the subsidiaries, by consulting relevant local councils.
  • Ensure consistency of the policy group wise and that it is properly reflected in intercompany agreements and in tax compliance documentation.

Companies may often underestimate the challenges associated with granting SBC to employees of foreign subsidiaries. At a minimum, local finance and tax managers should be able to identify whether and what amount should be allocated to a subsidiary to apply the correct corporate income tax treatment (e.g., deduction limitations etc.) as well as which related employee benefits need to be accounted for, through payroll.