Abdulateef Olatunji
Abdulrazaq
Director:
Tax Services
Nolands
Nigeria Professional Services
Lagos, Nigeria.
Introduction
An employee stock option (ESO) is a stock option granted
to specified employees of a company. ESOs offer the options holder the right to
buy a certain amount of company shares at a predetermined price for a specific
period of time. Many companies use employee stock options plans to compensate,
retain, and attract employees. These plans are contracts between a company and
its employees that give employees the right to buy a specific number of the
company’s shares at a fixed price within a certain period of time. The fixed
price is often called the grant or exercise price. Employees who are
granted stock options hope to profit by exercising their options to buy shares
at the exercise price when the shares are trading at a price that is higher
than the exercise price.
Employee stock
options give the employee the right, but not the obligation, to
purchase stock in the corporation at a fixed price on a specified date or
during a specified interval of time. When the options are granted, there are
usually restrictions as to when they can be exercised or when the acquired
stock can be sold or there may be a risk of forfeiture of the acquired stock
until the employee satisfies certain conditions, such as working for the
employer a certain number of years. When all restrictions or risk of forfeiture
are removed, then the options or the acquired stock are said to be vested,
meaning that the employee has an irrevocable right to the property.
An Employee Stock Option Plan (ESOP) is a
benefit plan for employees which make them owners of stocks in the company.
ESOPs have several features which make them unique compared to other employee
benefit plans. The employees can then be regarded as beneficial owners of
the company and thus indirectly entitled to participate in the wealth created
by their efforts. However, the profits are not distributed to the employees
immediately but are retained in the company on the assumptions that the
employer will be able to grow the profit fasters than if they were disbursed to
the employee. There is a further assumption that the employees will realise
that they are the owners, at least in part, of the company, and this should
reinforce their commitment to the growth to the growth of the company, and
thereby their own wealth creation. ESOPs have thus become a very potent
mechanism for hiring, retaining and rewarding a talented workforce.
Types of Employee Stock Options in Nigeria
Employee stock options have different names,
but are the same in substance. Various types of arrangements have evolved to
allow employees become shareholders in recognition of services rendered to the
company. The following are the different names/methods available for use in
Nigeria:
- Employee stock
option plans: Where the employee allows the employer to withhold a portion
of his or her monthly income, to acquire shares of the company at a
discount. Such acquisition of shares may happen each month. Alternatively,
the portion of the salary deducted may be accumulated to enable the
acquisition of the share at a future date.
- Employee stock
ownership plans: Where an employee of the company is given a choice to
acquire shares of the company at a pre-determined price after a certain
period. These shares may be acquired/allotted from the company directly or
indirectly through a trust.
- Employee stock
purchase schemes: Where the company offer shares to an employee as part of
a public issue or otherwise at a pre-determined price.
- Employee stock
option schemes: Where a company grants options to its employees to buy
specified number of shares at a specified price during a specific period.
- Stock
appreciation rights or plans: Where the employees are awarded stock
equivalents at a certain pre-determined value and after a certain minimum
stipulated period, the employees are allowed to such rights.
Uses of Employee Stock Options Plans in Nigeria
- An Employee
Stock Option Plan (ESOP) mechanism could be use for signing-up an
employee.
- It could be used
for remunerating technical and qualitative contributions by personnel.
- ESOPs could be
used for altering control over a company
- They can also be
used for remunerating employees but purely for cash-flow purposes.
Taxation of Employee Stock Options Plans in Nigeria
There are various stages in the implementation
of Employee Stock Option Plan (ESOP), which can be broadly categorised as:
- Grant of options
- Vesting of
options
- Exercise of
options and
- Sale of the
shares received on exercise of the options.
The question that needs to be addressed in
relation to an ESOP is at what stage the employee is said to have acquired such
a benefit or an amenity? Is it at the stage of grant, or at vesting, or exercise
of options or is it at the stage of the sales of shares received on the
exercise of the options. Various arguments could be advanced as to why the
benefit is taxable at any of the above stages only and not the other. The
variation in practices is also, in some measure, increased by government desire
to tax the benefits at the earliest point of time.
Below are some of the issues involved in the
taxation of the benefits of stock option plan at its various stages:
- Taxation of options at the time of grant
A grant
is a process by which an employee is given an option. The document outlining
the grant generally sets out the proposed contractual terms governing the
delivery of the options to the employee, including such matters as the numbers
of options given, the time of vesting and any special terms that might apply.
This is a transfer of an asset or property when the option is exercised and it
is taxable as a capital gain notwithstanding the employer-employee
relationship.
- Taxation at the time of vesting
Vesting
is the process by which the employee receives the right to apply for and be
issued shares of the company under the options granted. Until the vesting takes
place, the employee does not have a right to apply for the shares. Upon vesting,
the employee gets an unfettered right to apply for the issue of shares upon fulfillment
of the conditions. There is no tax liability until the conditions of the
vesting are fulfilled. The vesting is also not taxable until some benefit is received
and it is usually taxable as a capital gain unless the gains are paid
periodically as part of the salary in which it may become taxable as an income.
- Taxation of an option at the time of exercise
Exercise
of an option means that the employee applies to the company for the issue of
shares against options that have vested under Employee Stock Option Plan (ESOP).
An option may be seen as the opportunity to secure a future benefit. If so, its
exercise, where an employee receives shares, would be an event where the
expectation of profits is crystallized in the form of an asset being transferred
to an employee. The transaction would be akin to the sale of an asset to the
employee and taxable as a capital gain. If the asset were sold below the fair
market value, the benefit conveyed or transferred to an employee would be
regarded as a perquisite and taxable as an income.
- Taxation at the time of sale
The benefit
derived by an employee under Employee Stock Option Plan (ESOP) may also be
taxed at the time of sale. Such income is normally taxed s capital gains though
such gains arising from the sale of shares are exempt from tax in Nigeria. The
rationale is that, although the ownership of the asset has its origin in employment,
the asset is to be regarded separately and independently as capital.
- Taxation of Stock options given by a holding company
A
variation of the issues arising out of taxation of an Employee Stock Option
Plan (ESOP) is where stock options are given by the parent company to the
employees of the subsidiary. In some Jurisdictions, it could be arguable that
the stock options and the benefit they give do not flow from the employer. The
income, if any, could not then be categorized as salary. However, most countries
provide that an amount paid directly or indirectly by or on behalf of an
employer is to be taxed as salary, using a substance over form approach. Even
in this scenario, legal complications are bound to arise. It usually requires
specific legislation that caters for such indirect payments to be categorized as
salary.
Conclusion
Taxation of Employee Stock Option Plan (ESOPs)
raises issues is most jurisdictions that arise mainly from the determination of
how they are to the characterized for tax purposes, the time of taxation and
methods of granting relief from double taxation. The varying forms that ESOPs take,
often in response to the taxation law, further complicate the situation. These
problems are part of the policy arguments, including that ESOPs do not foster
horizontal equity, that they do not achieve the aim of extending general
employee ownership of the company, and that they are an instrument of tax
avoidance. Currently, there is no evidence of any attempt to converge and move
towards a uniform system. On an analysis of the reasons underlying these problems,
a few suggestions are possible in the international tax environment. For these
to succeed, they would need to come under the auspices of the OECD and/or UN
conventions.
Olatunji Abdulrazaq is Director, Tax Services at Nolands Nigeria Professional Services.
Email: olatunjia@nolands.ng, oabdulrazaq11@gmail.com
