Wading through the muck of what is, and is not, income
It seems to be that stock-option time of year again, and so this week's column looks at the latest issues for confusion and uncertainty in this area. Those of you who have followed the column for a number of years know that this is one of my favorite subjects, as the technical issues are quite complicated. Polish law has no special rules governing stock options, so we end up having to fit this into the framework of what income is and is not, and when it is realized.
As more companies introduce stock options for their employees, and not just for expatriates, then this issue becomes increasingly important. The Ferrigno in-tray has had no fewer than four of such questions come in just this week from various other Arthur Andersen offices as our global share-plan gurus implement global share plans globally for global companies.
We give our comments on the taxation and reporting obligations, and these are passed on to the company that is granting the options to its worldwide employees.
However, the political argument over tax rates has meant that one of the changes proposed for the income tax law concerning stock options was not made.
If you get the option to acquire shares at a discount by virtue of your employment, that discounted purchase price is a benefit in kind, and so the discount would constitute taxable income at the time the shares are acquired.
Separately, at the time you sell the shares, the amount paid can be deducted from the proceeds of the sale, to calculate the capital gain. So if you buy for 100 when the market price is 200, you have a discount of 100 that is taxable. If you then sell for 300, the effective income is 100 (as you have been taxed on the discount), but the taxable gain is 200 (300 received less the 100 actually paid), with no relief for that tax paid already.
Last year, an ordinance of the Ministry of Finance relieved this potential double taxation by abandoning collection of the tax at exercise, shifting taxation only to the gain on ultimate sale, meaning that tax was paid once on the total economic income received, and at the time cash was received to pay the tax with. This specifically only applied to newly issued shares, where the issue was approved by shareholders. Therefore in many cases, this is not applicable, as it is unlikely that a global plan would be redesigned just to take this into account for a couple of staff in Poland, as the formalities of issuing a few new shares for a global multinational may not be cost-effective.
This was a one-year ordinance, that expired on Dec. 31, 1999, on the expectation that the change would be passed directly into the law from Jan. 1, 2000. The ordinance duly expired at the end of its intended life, and as the personal income tax law changes were not passed, we now have double taxation reinstated. This is generally not a good thing, as with people who have stock options typically being in the 40% tax bracket, that makes the tax rate 80% on the discount.
Of course, we have various ways around it if you want to exercise the option and sell the shares immediately. Alternatively, as many option plans typically provide for a three to five-year period before you can sell your shares, then that also means there's no point in panicking about it yet, as the law could say anything by then.
The other aspect that gives some concern is what happens when you sell shares, and in particular whether the exemption from tax on the sale of quoted shares applies or not. The personal income tax law gives a temporary exemption (until Dec. 31, 2000) from taxation of gains on the sale of shares purchased on the stock exchange or similar regulated market. This means that if you buy shares on the exchange, then their subsequent sale is tax free if you make a gain (and any loss is conversely not tax deductible). Most stock option plans involve the stock being obtained through a brokerage agent acting on behalf of the company.
As the stock is acquired other than through the market (as the market price is by definition not being paid if the shares are being bought at a discount), then this will also arguably not apply to most option plans.
Also, if you'd like to confuse things even more, if your employee exercises the option, it is increasingly popular to try and charge the cost back to the Polish subsidiary, to obtain a corporate income tax deduction for the cost. Then the Polish company will be responsible for withholding PIT on the income, and potentially ZUS as well. Separately, if the individual has exercised the option from the foreign parent company, then he should be reporting the income and paying the tax on it. Therefore, if the recharge takes place separate from the exercise, then both parties could have a reporting and tax payment obligation on the same amount triple taxation!
So where do we go with these things? Of course we'd like to see the ordinance reinstated, as that will avoid the double taxation. Also, it would be helpful to have some clarification of the capital gains tax position. If it is considered a good thing fiscally to encourage people to own shares in quoted companies, it seems anomalous to have stocks in the company that you are employed by comparatively "disincentivized" compared to those that you have no involvement with. In most countries, it is the other way around, as special tax treatments are typically given for employee stock options, to encourage employees to align their work performance with the objectives of the company.
Also, the withholding rules in the PIT law are fine if the company is a Polish employer paying cash in Poland, but the withholding obligation on this sort of recharge needs to be clarified, to ensure that companies are not in technical breach of the law by not reporting something when the individual has already reported the income in their own right. Some obligation for employers to look at worldwide employee income with related parties would however be very messy and unpopular I'm sure, so the ability to waive withholding if the individual certifies that he has already reported the income tax would be easier.
One thing that is increasingly certain however is that, absent a big dive in global stock markets, stock option plans will not go away. Therefore adapting the law to keep pace with these developments will become increasingly important over time, as the current potential double taxation may in certain cases tempt people who receive this income abroad to suffer selective amnesia at tax reporting time, which is not the right solution for the country or the individual.
Peter Ferrigno is a tax manager in the Warsaw office of Arthur Andersen.
