Taxation of equity-based compensation
By Ellaine Anne Bernardino on November 10,2022
TO incentivize employees to perform better and attract new talent, some companies offer equity-based compensation as part of compensation packages.
The term “equity-based compensation” covers all types of employee equity schemes and comes in different forms, which include but are not limited to stock options, restricted stock units, stock appreciation rights and restricted share awards. These are granted to existing employees for services rendered and are typically dependent on performance, outstanding business achievements awards and exemplary organizational, technical or business accomplishments.
Recently, the Bureau of Internal Revenue (BIR) issued Revenue Regulations (RR) 13-2022 that clarified the income tax treatment of equity-based compensation and superseded Revenue Memorandum Circular (RMC) 79-2014. Section 32 of the National Internal Revenue Code (the Tax Code) defines “gross income” as all income derived from whatever source, including compensation for services in whatever form paid, including but not limited to, fees, salaries, wages, commissions and similar items. Compensation includes payment in some form of medium other than money. Moreover, Section 2.78.1 of RR 2-98, as amended, provides that compensation may be paid in money or in some medium other than money, such as stocks, bonds or other forms of property.
Thus, equity grants under the applicable equity schemes may result in a realized benefit on the part of the grantee-employees. The grants, once exercised or availed of by the grantee-employees, are considered compensation to be taxed under Section 32 of the Tax Code. This rule applies regardless of the employment status of the grantee-employee, who could either be rank and file or occupying a supervisory or managerial position, considering that Section 32 of the Tax Code and all applicable issuances do not make a distinction for purposes of taxation of all forms of compensation, including equity-based compensation.
Previously, RMC 79-2014 taxed stock option plans and other plans granted by an employer to an employee differently based on whether the grantee was rank and file or supervisory/managerial. For rank-and-file employees who exercise their option and realize income, the income will be treated as additional compensation. However, similar income for supervisory and managerial employees will be treated as fringe benefits subject to fringe benefits tax (FBT).
For managerial and supervisory employees, RMC 79-2014 was more favorable in terms of tax liability since their exercise of the grant would not form part of gross compensation but would be considered as fringe benefits. The liability to pay FBT is also with the employer, not the employee. However, there is the risk of double taxation wherein the equity-based compensation is also subject to tax in a foreign country since the FBT paid in the Philippines cannot be claimed as a tax credit in the employee’s foreign income tax return because of the tax regime difference.
In relation to this, Department of Finance (DoF) Opinion 016.2022 provided clarification as to the tax treatment of equity-based compensation in view of RMC 79-2014 since multinational companies operating in the Philippines believed that equity-based compensation should be considered additional compensation under the Tax Code regardless of the employment status of the grantee-employee.
The DoF said that equity grants awarded to the employees were compensation in kind under Section 32 of the Tax Code and as implemented by RR 2-98. This rule is to be applied regardless of the employment status of the grantee-employee. RMC 79-14 was thus superseded. In view of this and with the issuance of RR 13-2022, taxation of equity-based compensation for both rank-and-file employees, and managerial and supervisory employees is the same.
Moreover, income tax paid for equity-based compensation in the Philippines of managerial and supervisory employees may now be claimed as a foreign tax credit. However, the shift from FBT to withholding tax on compensation means that the liability to pay the taxes is also shifted to the employee. The income tax rate ranging from 0-35 percent will be based on the total taxable income of the managerial and supervisory employee in contrast to the FBT rate, fixed at 35 percent based on the grossed-up income payable by the employer.
It is noteworthy that RMC 143-2022 provides that provisions of RR 13-2022 be applied prospectively. Therefore, any exercise or availment of by employee-grantee (whether rank and file or a managerial or supervisory employee) of equity-based compensation on or after Oct. 29, 2022 will be considered as compensation that will be subject to withholding tax.
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Ellaine Anne L. Bernardino is a junior associate of Mata-Perez, Tamayo & Francisco (MTF Counsel).