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We are excited to publish the first monthly newsletter of the Global Compensation practice group at Manatt, Phelps & Phillips. We hope that you find the information in the newsletter helpful; and welcome any comments and suggestions that you may have.
Manatt’s Global Compensation practice group is led by Craig Tanner and John Heber. Craig is a partner at Manatt, where he specializes in the design, implementation, and administration of global equity-based compensation programs, such as restricted stock, stock options, stock purchase rights, and stock appreciation rights; as well as base salary and cash bonus programs. Prior to joining Manatt, Craig was a member of the global compensation teams at White & Case and Baker & McKenzie.
John is a partner at Manatt with expertise in executive compensation and global equity-based compensation plans. With John’s tax, legal and accounting backgrounds, he is able to advise on both the technical and strategic implications of executive compensation and equity compensation. John comes to Manatt from the San Francisco office of KPMG, where he served as National Director/Practice Leader of the Global Compensation Services Group. In that capacity, John headed the global equity compensation practice for the West Region and the executive compensation practice for Northern California.
Below, we have summarized new developments in a number of countries that may impact your global compensation programs.
France – New Legislation For Employee No-Cost Share Plans
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New legislation under the 2005 French Finance Bill, effective January 1, 2005, provides for preferential tax treatment on no-cost shares granted to employees and certain members of the French-company’s management (including the chairman of the board). These no-cost share awards include typical restricted stock grants with vesting requirements.
Similar to French-qualified stock option awards, a four-year holding period on the sale of the shares is imposed. The structure of the holding period, however, is different from French-qualified stock option awards in that the vesting restrictions on the no-cost shares may not be removed for two years from the grant date and the employees may not sell the no-cost shares for an additional two years.
If the four-year holding period is met, the taxable event is deferred until the shares are sold. Upon sale, the employee will be taxed as follows:
- 41% tax rate on the difference between the fair market value of the no-cost shares at the time of vesting and at the time of grant; and
- 27% tax rate on the difference between the proceeds from the sale of the no-cost shares and the fair market value of the no-cost shares at the time of vesting.
The full amount of the benefit received by the employees will be exempt from social insurance.
Final guideline concerning the valuation of the no-cost shares and additional conditions placed on the shares of foreign companies are not yet available.
Netherlands – Stock Option Tax Update
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The Dutch 2005 Tax Plan, effective January 1, 2005, provides that the benefits from stock options should be taxed when the option rights are exercised or sold. Accordingly, the current regime that allows an employee to elect taxation when his or her right to exercise the stock option becomes unconditional (typically upon vesting), or to be taxed at the time of exercise, will be abolished.
While not yet adopted by the Dutch authorities, the current version of the 2005 Tax Plan is not expected to be significantly modified. The amendment to the stock option tax regime will bring the Dutch in line with international practice, since most other countries tax stock options at the time of exercise. This amendment to the Dutch tax law will result in easier administration for issuing companies because (i) tax deferral elections will not longer be necessary, and (ii) withholding will not be required when each portion of the stock option vests. However, the amendment will eliminate the employee’s opportunity to receive untaxed (or partly untaxed) option gains. This is so because income tax will be due on the actual gain, not on the expected gain as allowed under the current tax regime.
For stock options that vest in whole or in part prior to January 1, 2005, the current tax regime will apply.
UK – Implementation of the EU Prospectus Directive
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This past October, the UK’s HM Treasury published a consultation document on its proposed implementation of the Prospectus Directive. The consultation document sets forth the ways the UK intends to modify its current securities legislation in order to comply with the provisions of the EU Prospectus Directive. Two significant modifications to the current UK securities legislation that will impact employee stock plans are: (i) the determination of a public offering; and (ii) the expansion of exemptions from the prospectus requirement for small or limited public offerings.
Determination of a Public Offering. Under the current securities legislation, awards of stock options, purchase rights, and restricted stock to employees of the issuing company or its subsidiaries are not considered public offers. Accordingly, these awards are not currently subject to the UK prospectus requirement. With the proposed legislation, the broader definition of a public offer set forth in the Prospectus Directive will be adopted. The broader definition includes as a public offer any communication to an individual that provides material information about an offer and the underlying securities. It has been widely interpreted that awards under employee stock plans fall within the Prospectus Directive definition of public offer. Thus, employee stock plan awards that are not currently regulated in the UK would become regulated and subject to the prospectus requirement.
Exemptions to the Prospectus Requirement for Small or Limited Public Offers. The current securities legislation allows an exemption from the prospectus requirements for public offers valued at less than £100,000 (US$188,000). Under the proposed legislation, a much higher exemption threshold of €2,500,000 (US$3,300,000) over a 12-month period would apply. With the increased threshold, a greater percentage of public offers would qualify for the exemption to the prospectus requirement.
If the proposed securities legislation is implemented, employee stock plan awards regulated in the UK would be subject to the filing of a prospectus. Issuers may qualify for an exemption to the prospectus requirement if the total value of the awards is less than €2,500,000 over a 12-month period.
The Prospectus Directive was published on December 31, 2003 by the European Parliament; and is scheduled to go into effect for all Member States on July 1, 2005. Each of the Member States is expected to amend its existing legislation to implement the Prospectus Directive before the effective date.
US – FASB Issues Its Final Statement On Equity Compensation Accounting
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On December 16, 2004, the Financial Accounting Standards Board (FASB) issued its final statement on accounting for equity compensation, referred to as “Statement 123(R), Share-Based Payment.”
For public companies (including subsidiaries of public companies), Statement 123(R) becomes effective on a “modified prospective” basis for the first interim or annual reporting period that begins after June 15, 2005 (December 15, 2005 for “small business issuers”). Earlier application of the new rules is encouraged if feasible, and companies are permitted to “retrospectively restate” the initial year of adoption or all reporting periods presented (based on previously estimated grant-date fair values and attribution methods used for recognition or pro forma footnote disclosures under Statement 123).
For nonpublic companies not previously adopting the fair value provisions of Statement 123, Statement 123(R) becomes effective on a “prospective” basis for fiscal years beginning after December 15, 2005. The final statement provides several special measurement provisions for nonpublic companies designed to ease implementation, such as the ability to use stock price volatility of an appropriate industry sector index and intrinsic value rather than fair value to measure compensation cost for “liability” awards.
The final statement is substantively similar to the Exposure Draft issued earlier this year, with compensation cost for equity awards generally recognized net-of-tax over the requisite service/vesting period for non-forfeited awards based on “modified grant-date fair value” methodology.
It is expected that Statement 123(R) will substantially impact the equity compensation practices of many companies. Since stock options are no longer afforded the favorable accounting treatment under APB 25, it is likely that other equity compensation strategies will be explored (e.g., restricted stock, restricted stock units, performance vesting, stock settled stock appreciation rights (SARs), etc.).
US –- IRS Publishes Nonqualified Deferred Compensation Guidance
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On December 20, 2004, the IRS issued Notice 2005-1 providing initial interpretive guidance on Section 409A. The guidance includes definitions of persons and plans covered by the law, transition rules to address immediate concerns, some substantive guidance, guidance on W-2 reporting requirements and indications of additional rules to come.
For employee stock plans, the IRS has allowed important exemptions to the application of Section 409A. Generally, Section 409A will not apply to the following:
- statutory stock options (ISOs);
- nonstatutory stock options (NQSOs) with an exercise price of not less than fair market value on the date of grant; and
- stock appreciation rights (SARs) that may be settled only in the company’s publicly traded stock and that have a strike price not less than fair market value on the date of grant.
However, Section 409A will apply to SARs granted by nonpublic companies and SARs that may be settled in cash.
The IRS has allowed for some transition time to make decisions about current deferred compensation arrangements. Employees may be given the opportunity through March 15, 2005 to elect to defer 2005 compensation under existing plans. Additionally, employees may be given the opportunity through December 31, 2005 to change payment elections for amounts deferred in previous years and to cancel 2005 deferral elections. Companies operating their plans in good faith compliance with Section 409A have until December 31, 2005 to amend their plan documents. Companies may terminate existing plans and pay out all deferred amounts through December 31, 2005, as well.
Section 409A was introduced under the American Jobs Creation Act of 2004; and significantly impacts nonqualified deferred compensation arrangements. Section 409A broadly defines the types of arrangements covered by the new rules and dramatically changes the conditions under which deferred compensation is not subject to immediate taxation. Effective for compensation deferrals after December 31, 2004 and to modifications made after October 3, 2004 to previously deferred compensation, Section 409A imposes restrictions on:
- Timing of initial deferral elections - generally before the beginning of the year in which earned, with special rules for first year of eligibility and annual or longer-term bonuses;
- Events upon which deferred payments may be made - separation from service (for key employees six months after), disability, death, change in control, unforeseeable emergency or time specified in deferral election;
- Changes to payment elections - 12 months before effective and 5 year delay in commencement; and
- Rabbi trust provisions.
Failure to comply results in affected employees having immediate taxation of all deferred compensation with interest and a 20% excise tax.
US – Disclosure of Maximum Number of Shares Under Final ISO Regulations
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We have confirmed with the IRS that, under the final ISO regulations, issuing companies are not required to set specific share limits for ISO grants in an omnibus stock plan. The setting of the aggregate number of shares that may be offered under the omnibus stock plan through all awards satisfies the IRS’s requirements.
As you may already know, the IRS issued final regulations concerning ISOs in August. One of the unexpected provisions in the final ISO regulations is the apparent requirement for an issuing company to set the number of shares that may be granted through ISOs in the stock plan. While it is common for the issuing company to set the actual number of shares that may be granted under a stock plan through all allowable awards (i.e., ISOs, NQSOs, restricted stock, RSUs, and SARs), it is not common for the issuing company to separately set the number of shares that may be granted under ISOs. If effected, this change would require issuing companies to modify stock plans to set the specific ISO share limits.
Through conversations with the IRS, we have learned that separately setting share limits for ISOs granted under an omnibus plan was not intended. So long as the stock plan sets the maximum number of shares that may be granted under all awards, the IRS regulations will be satisfied.
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