Managing equity withholding risk - Ernst & Young · Managing equity withholding risk Stock and...

Stock and Mobility Service

Managing equity withholding risk

3 Managing equity withholding risk Stock and Mobility Service

Managing equity withholding risk Stock and Mobility Service 1

Companies with internationally mobile employees who include shares or cash equivalents in compensation usually have multiple country payroll withholding obligations.Because the withholding calculations are difficult, many companies have in the past failed to manage this area of tax compliance properly.

In the UK alone, there has been a marked increase in the incidence of employers who have settled tax and penalties on international equity awards of more than £1 million each.

Historically this issue has centered on expatriate employees, many of whom are senior individuals. The high value of their equity awards exacerbates the penalty exposure, cash flow issue around gross up tax and the repercussions of calculation errors and timing failures.

Share plan withholding is now recognized internationally as a key area for tax authority investigation, and substantial penalties, interest payments and criminal charges may be applied for corporate compliance failures.

This document considers the following areas:

The problem of cross-border tax ►withholding on equity income

Tax calculation and processing issues ►Ernst & Young’s withholding calculation ►service EYSMS

The advisory services that Ernst & Young ►Stock and Mobility Group provide to support our clients to identify and address this area

Equity withholding

SummaryThe risks of failing to manage equity withholding correctly include:

Multiple penalties and interest ►Reduced employee confidence ►Increased chance of tax investigations ►Potential criminal charges ►Reputational risk ►


What makes this issue complex is the movement of employees among different country tax jurisdictions between the key equity plan events such as grant and exercise.A significant number of countries require employers to withhold income tax and social security in respect of stock options, restricted stock units or other share award income.

As anyone who deals with equity plans on an international basis knows, tax and social security obligations vary from country to country; for example the liability on stock options does not arise consistently at exercise.

Withholding and reportingMultiple country withholding obligations arise not only in relation to individuals who move across country borders on assignment but also transfer as part of localization and short term business visitors. Additionally, moves within a single country can give rise to multiple withholding requirements, for example when moving from state to state in the USA.

The withholding tax due needs to be determined through:

Analysis of domestic law ►Analysis of double tax treaties ►Analysis of international social ►security agreements

Additionally, some countries will have different rules for employer reporting, typically in locations where the tax is to be collected through the end of year tax return process.

From the employees perspectiveAs well as the cash cost there is a more subtle motivational cost in terms of the reduction in the international assignee’s perceived value

from the share award if the tax calculation causes delays, uncertainties and/or aggravation, particularly if large unexpected balances of tax are payable on tax returns.

Given the often high profile nature of the plan participants, these individuals are often those members of the organization who the business wishes to ensure are not distracted by an inefficient internal tax process.

The timing issueTiming is also critical. A delay in calculating the tax retention from proceeds of sale will delay the receipt of cash by the stock plan participant creating both commercial and regulatory risk.

The sum withheld must be paid over to the taxation authorities within a specified period which can range from 48 hours to several months.

Legal requirements limit the holding period and if the withholding amount is unknown too much of the cash proceeds may be released to the employee. This then leaves the employer with the problem of recovering the withholding due from the employee who in the worst case scenario may no longer be with the company.

What have companies done in the past? In the past, faced with the timing issue, employee location data availability issues and calculation difficulty, many companies have applied domestic rules to the calculations, operated withholding on a piecemeal basis or in some cases ignored the problem altogether. The issues arising have forced organizations to address this significant compliance issue.

Understanding the issue

SummaryCross-border withholding calculations are:

Complicated ►Time critical ►Require a knowledge of the employee’s ►work location history

The issue is rising up the agenda of a number of international revenue authorities and companies are increasingly realizing that it needs to be managed better than it has been in the past if they are to avoid heavy penalties.


Tax factors to consider

Varying taxation methodsDifferent countries calculate the taxable value of “equity gains” using varying methods. Some countries will tie the taxation point to times other than grant, vest or exercise adding a further level of complexity.

Additionally, country recharge arrangements may alter the tax liability. For example, some locations will apportion the gain based on the number of days an individual was resident in the country between grant and exercise. On the other hand, most other countries source the gain between grant and vest. This difference in treatment may lead to an element of double taxation.

Double taxationWhere tax is due in two or more locations an element of double taxation may result. The application of treaty relief will often remove any duplication but this is not always the case and may not apply at withholding level. In particular, where a capital tax is payable the overlap with income taxes may still remain. This is often the case where a tax approved plan has no special tax status in the assignment location.

While the OECD Treaty model supports stock option apportionment between grant and vest, some treaties such as those between the UK and the United States and the United States and Japan retain grant to exercise sourcing. In addition, some countries such as Egypt and Thailand source entirely based on where the participant was at the date of exercise, which may be incompatible with the assignment jurisdiction’s version of sourcing. This can result in situations of double tax or no tax at all.

Foreign tax creditsForeign tax credits may be available to reduce final tax liabilities either under domestic law or by way of a provision in a Double Tax Treaty. The application of foreign tax credits for withholding purposes is a matter of some debate and practice varies by employer and by country.

Tax equalizationThis is a common feature of many assignment policies whereby an individual will be asked to pay a hypothetical amount of tax with any excess real tax due to the tax authorities in the assignment location(s) being paid by the employer (or any shortfall being retained). This “excess” amount is a benefit in the hands of the employee and therefore it may in itself be taxable. Consequently, there must be a gross up calculation to ensure the right amount of tax is paid in each country. Increasingly some employers are questioning the way in which the tax equalization policy and the income apportionment of equity awards interact and this issue may need to be considered in the withholding calculation.

Tax factors summaryVarying taxation methods, double taxation and foreign tax credits and tax equalization policy all need to be considered along with a clear understanding of the practical ramifications.

Ernst & Young’s Stock and Mobility Group has extensive experience in this area.


Processing factors to consider

Required dataIn order to allocate the equity income between the relevant countries and states and determine the withholding obligations, calculations require consideration of the share event details (e.g., grant, exercise and/or vest), assignment/moving pattern and basic employment details for each participant.

Transaction data is usually provided by the share plan administrator or internal stock administration team(s), however the employee demographic data may come from a number of sources. Typically these are:

The company ►A third-party assignment services provider ►The employee in cases where good historic ►data is missing

Processing speedCalculating the amount due quickly is often vital as there is only a short window of opportunity to collect withholding amounts while cash sums are held by share plan administrators.

If the actual withholding amounts are not known and collected, the problem of recovering withholding from the employee becomes that of the company.

In some circumstances, in the absence of good processes, withholding recovery may become difficult or impossible, for example where an employee has been terminated. In such cases the company may find itself paying over the withholding on the employee’s behalf and accounting for gross up tax on the withholding paid.

Finding the right withholdingThe starting point for withholding compliance is usually a review of the information held within the organization and the way it is stored.

Available data along with the expected frequency of future transactions, the country coverage and the plan types will generally help to shape the type of approach adopted.

Processing factors summaryWhile in some cases a manual process is the right answer, for most organizations, technology is central to the delivery of cross-border withholding instructions within the required time-frames.


Stock and Mobility Service

Ernst & Young’s Stock and Mobility Service (EYSMS) is the market leader in the field of cross-border calculations based upon the number of transactions processed, the scale of implementations managed and the corresponding experience available within the team.Our tried and tested service utilizes a web-enabled tax calculator to apportion the taxable income on an “equity gain” across each jurisdiction taking into account company specific stock plan rules, tax treaties, social security agreements, processing assumptions (agreed with the corporate user) and individual employee residency history.

This data is then used to enable withholding tax calculations to be completed and fast, accurate withholding instructions to be passed through to international payrolls for processing.

Automated calculationsThe vast majority of calculations are processed automatically, with particularly complex or client specified cases for intervention diverted for manual review by our global network of tax professionals.

ScalabilityEYSMS can be scaled from a manual service for a company with a few transactions, to a fully automated systems integrated service, processing thousands of transactions within a client agreed time frame (typically two days from processing event) for our clients with higher transaction volume.

Integration optionsFull implementation of EYSMS in an integrated and automated way allows the company, the plan administrator and service provider to

work together seamlessly and enables all the necessary information to flow between the parties within the agreed critical time frames without manual intervention.

Demographic databaseEYSMS also includes a stand-alone web-based Assignee Tracking Database to store demographic information and a web-based survey tool which participants can use to validate their work history data.

Data requirementsIn order to allocate the equity income between the relevant countries and states and determine the withholding obligations, EYSMS broadly requires share incentive event details (e.g., grant, exercise and/or vest), assignment history/moving pattern and basic employment details for each participant.

Employee demographic data typically comes from the client or assignment management services provider while the transaction data usually comes from the share plan administrator.

Combining demographic data with transaction dataThe transaction and demographic data can be brought together and loaded into EYSMS as part of calculation processing. Alternatively, the demographic information may be stored in the Assignee Tracking Database to be pulled into the calculation when the transaction data arrives from the share plan administrator. Storing demographic data in this way may be useful where company databases do not have the necessary tracking potential or interface capability. Our clients have found this flexibility particularly useful, with several larger implementations using this capability.

EYSMS provides:Fast, accurate and multi-jurisdictional ►withholding calculations for equity income

Defendable “ready to go” generic tax ►positions for over 85 countries

Calculations for 20 employees and ►above with no upper limit

Flexibility to fully align calculations with ►company policy

The option of full automation and ►system integration


Moving forward with EYSMSOur experience suggests that clients often need a tailored service rather than one that you take “out of the box.” We also appreciate that there is usually a need for EYSMS to integrate smoothly with existing well-working internal processes and technology.

Many clients approach us with significant underlying time pressures and as a result we sometimes find that an out-of-the-box start-up is appropriate, with integration and fully automated data feeds following on at a later date.

While large engagements typically involve automated data feeds and system integration, a cost effective in-house bureau processing model is available for smaller engagements.

Country coverageEYSMS automatic coverage spans 85 countries making it one of the broadest and efficient systems on the market. This number is constantly rising to allow us to provide optimal service to our existing client base.

Providing a complete serviceWhere required we can provide a complete service incorporating process design, tax position mapping, system setup and the customization of our tax calculator to meet client specific share plan features and administration processes.

Share plan administratorsEYSMS is the longest standing product on the market and based on client demand, we have established EYSMS data exchange communications with more share plan administrators than any of our competitors.

FlexibilityEYSMS is a highly flexible service offering. The system itself can be configured so that the output for clients and share plan administrators is in a format that works best with their existing processes.

EYSMS can be easily configured to accommodate company tax positions, tax equalization, foreign tax credits methodology and company recharge policy.

EYSMS is flexible and can be tailored to meet client specific requirements.


Features of EYSMS EYSMS helps supply fast and accurate withholding tax data, providing a number of benefits:

Increased protection for the company by ►using marginal withholding rates

Fast, automated processing based on tax ►positions and treaty interactions between over 85 countries ensuring withholding is determined within the settlement period

US state-to-state automated ►tax calculations

Reportable income amounts by country ►and region

Both company and assignee estimated final ►liability, based on the projected tax return income figures

Accurate allocations of income on which ►withholding tax and social security is to be applied (federal and state/provincial)

FlexibilityFlexible multiple country/region/state ►withholding calculation output reports arranged by employee, region, regional hub or business line/entity

Share plan administrator ►data requirements

Demographic data storage in the Assignee ►Tracking Database

Quality controlProcessing rules such as sending all high ►level employees or transactions over a set value for manual review

Automated local payroll ►system notifications

Automated output report distribution ►An experienced technical support team ►to resolve complex calculations or those involving out of scope locations

TechnologyManual web page input or data file upload ►Automatic data feeds from client and ►administrators back-end applications via XML-based web services

Secure internet hosting infrastructure ►with 128 bit encrypted secure sockets layer (HTTPS)

Process integration ranging from manual ►input through to full automation

Tax technicalA high level of flexibility in terms of configuration for:

Company specific plan rule configuration: ►Hypothetical tax calculation ►Equalization gross ups ►Company agreed tax rulings ►Tax protection policy ►Broker fee deduction (where allowable) ►Local tax and social security rates ►

Supported plan types: ►Stock options ►Restricted stock units (RSUs) ►Restricted stock ►Cash settled LTIPs ►

Treaty relief, exemptions and foreign tax ►credit calculations

Residence and social security country ►determination based on agreed programmable assumptions

Individual tax elections ►Leaver processing rates ►Alternative market value calculations, e.g., ►German lowest market value of the day and Italian norm value

EYSMS provides clarity on a company’s cross-border withholding and reporting obligations

Key feature summaryInstantaneous automated calculations ►Continually expanding country ►coverage with over 85 countries currently supportedFlexible tax engine to meet your local ►regulatory requirements and specific tax policiesReady to use linkage with a wide ►number of share plan administratorsSupport for all key equity plan types ►Capacity to process very high ►transaction volumesRobust regulatory reporting and ►withholding instructions


Stock and Mobility Advisory

Withholding calculation advisory areas

Reviewcountry tax

positions

Businessprocessreviews

Establishcross-bordertax positions

Reviewrechargesand theirimpact

Review datasources and

integrity

Equitywithholdingcompliance

Withholding calculation advisory areas

Assessing the availability and ►integrity of required data for tax withholding calculations

Setting the cross-border country tax ►positions for each equity plan

Agreement of the company tax policy ►and positions attached to equity processing events

A review of tax recharge policy and its ►impact on the tax withholding positions

A review of the end-to-end business ►processes required for the compliant operation and payment of international tax withholding on equity incentives

Equity withholding process There are a number of advisory areas which normally sit alongside the implementation process for EYSMS. That said, the experience gained in resolving compliance gaps and spotting opportunities for process efficiency is valuable to companies who wish to better manage equity withholding but are inclined to maintain internal or manual processes.

SummaryWithholding calculation advisory areas include:

Domestic tax positions ►Cross-border tax positions ►Data availability and integrity ►Recharge policy ►Tax policy ►Processing and information flows ►


Long-term incentive compensationThe unison of our Global Equity and Stock and Mobility teams provides our clients with end-to-end support in the design, implementation and ongoing management of their international incentive programs.

Ernst & Young can check whether equity-based compensation plans support business objectives that reward corporate performance, attract and retain employees and align the interests of employees with the financial interests of all stakeholders.

Withholding compliance issuesTax authority disclosure. ►Internal governance controls, e.g., UK ►senior accounting officer sign-off

Review of current tax compliance ►readiness identification of statutory tax reporting or withholding obligations by country

Risk reviews related to past share plan ►tax compliance

Current share plan operational reviews ►and process re-engineering support

Corporate recharge and transfer ►pricing assessment and setting

Output process recommendations ►including payroll and treasury guidance

SummaryThe Stock and Mobility Group provides support and advice on all aspects of cross-border tax withholding relating to equity income.

Equity withholding compliance issuesIn respect of the ongoing compliance aspects of international equity plan withholding, we provide a review service for current withholding practice, assessment of tax risk and assessment of process risk, and help manage issues with revenue authorities.


Summary

Ernst & Young’s Stock and Mobility Group can deal with all aspects of cross-border payroll withholding on long-term incentives.Stock plan withholding is particularly complex when internationally mobile employees are involved, however we have a proven track record of working with major international businesses and as a result we have a wealth of experience we can apply to help companies in this area.

Our market leading EYSMS service provides instantaneous multiple country tax withholding and income reporting instructions.

With a background of rising international revenue authority cooperation, rising focus on equity withholding and large penalties being awarded, companies that have not managed this area properly in the past are now beginning to see a strong incentive for a change in direction.

Allow us to make the connection with you and improve your organization’s stock plan processes and risk management.


For more informationPlease contact:

Giles Capon Tel: +44 (0)11 7981 2073 Email: [email protected]

Dan Sullivan Tel: +44 (0)20 7951 2962 Email: [email protected]

Michael Bussa Tel: +1 212 773 7510 Email: [email protected]

Ernst & Young

Assurance | Tax | Transactions | Advisory

About Ernst & YoungErnst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 144,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

For more information, please visit www.ey.com.

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

The Ernst & Young organization is divided into five geographic areas and firms may be members of the following entities: Ernst & Young Americas LLC, Ernst & Young EMEIA Limited, Ernst & Young Far East Limited and Ernst & Young Oceania Limited. These entities do not provide services clients to clients.

EYG no. DN0172

© 2010 EYGM Limited. All Rights Reserved.

In line with Ernst & Young’s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content.

This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

0901015.indd (UK) 02/2010. Creative Services Group.

Managing equity withholding risk - Ernst & Young · Managing equity withholding risk Stock and...

Documents

Transcript of Managing equity withholding risk - Ernst & Young · Managing equity withholding risk Stock and...