In the first part of this white paper, we looked at what your colleagues on the HR team need to know about granting equity globally. In part two, we focus on the common pitfalls faced by your legal and finance teams. Securities law, employment law, corporate transactions and communication misfires between teams can all lead to serious headaches. Note that while several issues cut across all three groups, they must be considered from the perspective of each team.
The legal team
Even if the in-house legal team manages outside counsel’s work in connection with the company’s share-based plan, at least one member of the company’s in-house legal team should be aware of the general issues associated with global implementation. It’s important to understand the securities and tax laws in every country where you grant equity and how those laws may affect a plan’s design and features.
Know securities laws
In many countries, you’ll need to register and prepare various filings for the local securities exchange authority before you launch share-based plans (e.g., stock option and employee stock purchase plans). Registrations and filings can be expensive and burdensome, so it may make sense to tailor the company’s plan to qualify for one of the exemptions that may be available. Just note that exemptions based, for example, on plan type or number of employees may be available in one country but not another. But, of course, exemptions come with further administrative hoops – you may need to file financial reports and provide employees with certain information about the company, such as a description of the company’s business and the potential risks of investing in company stock. Some countries have even more rules. Italy, for instance, may require an issuer to engage a financial intermediary to counsel employees before they enter into an employee stock purchase plan (ESPP) – the same goes for stock option plans (unless the company only allows exercise-and-sell transactions). In jurisdictions where the costs outweigh the benefits of extending the plan to local employees – say, because the local employee population is very small and exemptions are not available – it may make sense to consider granting other types of incentive compensation.
Do your tax homework
Almost every country considers equity compensation to be income of one sort or another, but the timing and rate of taxation vary from jurisdiction to jurisdiction. A stock option exercise is generally considered the taxable event, as is the vesting of a restricted stock unit. But restricted stock awards are taxed at grant in several countries. And Australia recently began taxing stock options granted after July 1, 2009, at vest, albeit with certain exceptions. Consider whether the timing of taxation may pose a financial hardship for an employee and whether administrative challenges are worth the effort. Some countries, such as France, the UK and the United States, give more favorable tax treatment to both the company and employee if the share-based arrangement meets certain requirements. But to enjoy those benefits, issuers must grapple with some potentially onerous administrative challenges, such as option pricing requirements, minimum vesting periods, holding periods that must be tracked both pre- and post-exercise, and periods during which the issuer can’t grant.France imposes a four-year holding period on tax-qualified stock options from grant to sale and restricts when tax-qualfied stock options can be granted and at what price. In the UK, the market value at grant of stock options subject to a tax-advantaged scheme may not exceed GBP 30,000, and tax-approved options may only be exercised more than three and fewer than 10 years from grant. It makes sense to weigh the tax advantages against the cost of compliance and administration. The legal team should also be aware that many jurisdictions have stepped up their audit and enforcement of share-based plans, particularly with respect to taxation. “The most significant penalties I have seen for companies offering global stock programs have involved mistakes on tax withholding and reporting,” says Valerie Diamond, Partner and Chair of Baker & McKenzie LLP’s Global Equity Services.“One U.S. company was penalized several million euros because its HR team in the Netherlands provided its employees with out-of-date tax information that indicated no taxes were due,” she explains. “The Dutch tax authorities held the company responsible for the payment of the past due taxes – both the amounts due from the employee and the employer.” To have a successful share plan, the legal team needs to understand the company’s tax obligation and help properly communicate tax information to employees.
Study up on employment law
If anything can sneak up on a company that grants equity globally, it’s employment law. Generally, the objective is to ensure the benefits offered under share-based plans are considered discretionary, not contractual, rights. Otherwise, the company loses the flexibility to operate the share plan as it deems appropriate (e.g., to skip a grant or to grant fewer options), and the awards under the plan become subject to the same rules and regulations as an employee’s other compensation. The company may then face legal challenges and increased termination costs, among other things. The legal team needs to carefully craft the plan document, offer letters, award agreements and other communications materials to ensure the company maintains its legal position once it launches the plan. “The simple step of keeping the offer of equity awards separate from any employment offer letter can go a long way to avoid exposure on entitlement issues,” says Diamond. Companies based in the United States, in particular, should also keep in mind that data privacy laws in other countries are significantly different from U.S. laws and may even require additional administrative procedures to ensure compliance.
Think before you act – corporate transactions
As we’ve explained, the most minor changes in plan design and even the simplest of corporate transactions must be examined in a global regulatory context to ensure the issuer doesn’t inadvertently trigger a taxable event, overlook a filing requirement, or reduce or violate the rights of plan participants. For instance, imagine that an acquiring company pays cash to the acquired company’s employees for their outstanding stock options – without researching the implications of the exchange in each country where the acquired company has employees. The transaction triggers a taxable event in several countries and exposes the affected employees and the acquiring company to penalties and interest – all because the company didn’t report the resulting income on time and withhold taxes. A little preparation would have precluded a costly problem for everyone. “The simple step of keeping the offer of equity awards separate from any employment offer letter can go a long way to avoid exposure on entitlement issues.” – Valerie Diamond
The finance team
Where the legal team may only be peripherally involved in equity plan design and implementation, the finance team is intimately involved in the administration of an equity plan, regardless of whether the stock plan administration (SPA) team resides in the finance department. Tax, accounting and payroll all play key roles in both a plan’s design and its ongoing administration and serve as the focal point for compliance.
Engage the corporate tax team
We’ve already discussed some of the broader issues related to taxation of share-based awards, but only in the context of a plan’s design and the impact of its underlying features on the tax treatment of both the company and the employee – issues in which the corporate tax department typically does not get involved. But the tax group should be consulted regarding the type of entity being established in the new country. In some countries, such as China, the type of entity determines the applicability of certain regulatory requirements. The tax group will also know or determine if the new corporate entity will need to reimburse the parent company for the spread at exercise. The existence of a recharge agreement may determine the timing of taxation, whether the income is subject to both income and social taxes, and whether withholding is required. Some national tax authorities require companies to make tax filings initially and sometimes periodically, an effort that the tax group may coordinate with input from the SPA group. Be sure to allow plenty of lead-time for the SPA group to collect, prepare and distribute the requested information. Tax, accounting and payroll all play key roles in both a plan’s design and its ongoing administration and serve as the focal point for compliance.
Don’t forget about accounting
People often run the other way when the discussion turns to accounting. And to be fair, many of the share-based compensation accounting rules around the world are unclear. But it’s important to involve the accounting team up front to determine how share-based awards will be accounted for in each jurisdiction, and how those decisions will affect the financials of the company and local entities.
Coordinate with payroll
Where withholding and reporting are required, administrative systems and processes must be in place to capture the gain and withholding rate and distribute the information, as required, internally and externally. The rubber meets the road here with the local payroll teams, who must be kept apprised of changes in withholding rates and rules. Along that line, the local team must let the SPA group know its requirements for getting exercise and other transaction data to ensure timely withholding and reporting. As with the tracking of globally mobile employees, periodic audits should be scheduled to ensure that no transactions are overlooked. Local payroll is the best friend of the SPA group. It acts as a sort of local contractor to the SPA team and makes sure local employees’ share-plan income is reported properly and on time. When necessary, local payroll makes sure that the appropriate amount is withheld by effecting the true-ups that the SPA group logistically can’t manage. And they provide the information needed to administer a purchase under an ESPP. Internal communication can also fall under payroll’s area of responsibility. But, recall the botched ESPP communication in our nightmare scenario from part one of this paper, where the local payroll manager sent a well-intended but inaccurate summary of the ESPP. Communications of this nature should be done with the knowledge and input of a subject-matter expert, likely someone on the SPA team. Again, close coordination and communication is essential. Implementing and maintaining a share-based plan globally requires terrific cross-functional teamwork and a strong commitment to continual learning. The SPA, HR, legal and finance teams, as well as your third-party administrator, need to keep abreast of global issues and stay in tune with each other – both before that first global grant is made and continually as the plan evolves. One way to help ensure a smooth operation is to centralize the administrative function at company headquarters. Centralization can help facilitate clear and regular communication among those responsible for the global plan. Consistent policies, procedures and processes along with strong employee communications and a clear point of contact for plan-related issues will serve the objectives of the company and help keep everyone sane.