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The tax treatment of equity-based compensation

With just a couple of months before the end of the year, most employers have started planning for the year-end annualization of their employees’ income. The purpose of the annualization is to determine the annual income tax due based on the total compensation earned by the employee, including those from previous employer/s. One of the things that employers review during the annualization is the tax treatment of compensation income, which may be paid in money or in any medium other than cash, such as shares of stock, bonds, or other forms of property.

On Oct. 7, the Bureau of Internal Revenue (BIR) issued Revenue Regulations (RR) No. 13-2022 to lay down more definitive guidelines, procedures and requirements for the income tax treatment of equity-based compensation of any kind.

As defined in the regulations, equity-based compensation covers all types of employee equity schemes such as stock options, restricted stock units, stock appreciation rights, and restricted share awards, and which may or may not pertain to the shares of stock of the grantor itself. They are granted to employees of the grantor as an incentive for services rendered and are typically dependent on performance, outstanding business achievements, and exemplary organizational, technical or business accomplishments.

According to RR No. 13-2022, the equity grants under the applicable equity schemes of the grantor will give rise to a realized benefit on the part of the grantee-employees. Moreover, once exercised or availed of by the grantee-employees, such equity grants are considered compensation to be taxed as such under Section 32 of the National Internal Revenue Code (NIRC) of 1997 and implemented by RR No. 2-98 (otherwise known as the Withholding Tax Regulations). This withholding tax treatment applies regardless of the employment status of the grantee-employee, who could either be rank-and-file or occupying a supervisory or managerial position because Section 32 of the NIRC and all applicable issuances do not make a distinction for purposes of taxing compensation, including equity-based compensation.

Before RR No. 13-2022, such equity awards were subject to two possible tax treatments, depending on the recipient. If the recipient was a rank-and-file employee, equity awards were subject to Withholding Tax on Compensation (WTC). However, equity awards were subject to Fringe Benefit Tax (FBT) if the recipient was a managerial or supervisory employee pursuant to Revenue Memorandum Circular (RMC) No. 79-2014.

As stated in RR No. 13-2022, any provision of RMC No. 79-2014, any regulations, rulings, orders and circulars or portions thereof which are inconsistent with the provisions of the more recent Regulations are revoked, repealed or amended accordingly. All matters and other tax treatments that are consistent with the pronouncements made in the recent Regulations, on the other hand, are maintained and/or adopted accordingly.

The RR will take effect on Oct. 29, or 15 days after its publication. It is possible there have been equity grants that vested and were exercised by employees between Oct. 1 and 29 (prior to the effectivity of the regulation), and there may be a concern from taxpayers whether this income is still subject to FBT or if WTC shall apply.

Another concern is the impact of this new RR on employees. In particular, for those holding supervisory or managerial positions, this may result in lower take home pay because they will now be shouldering the tax related to this equity-based income, unlike FBT which is borne by the employer.  It may significantly impact the cash flow of employees as they will receive a lower amount as compared with the salary package that they agreed to. Thus, employers may need to take into account whether they will continue to shoulder the tax. 

It is also important to note, however, that before RMC No. 79-2014, regardless of employment status, all equity awards were subject to WTC.

As the year draws to a close, I hope that the BIR will clarify whether the employer should begin reporting equity awards in October or November as income subject to WTC. By doing so, it will reduce the worries on the part of employers as to their duty as withholding agents. It will also give ample time to employers to manage expectations and properly communicate the new tax treatment of equity-based compensation and its impact on employees’ after-tax pay.

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only and should not be used as a substitute for specific advice.

Maybellyn O. Pinpin-Malayao is a senior manager with the Client Accounting Services group of Isla Lipana & Co., the Philippine member firm of the PwC network.

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