Newsletter
TAX TREATMENT OF OVER-SEAS EMPLOYEE STOCK OP-TIONS
On 30 November 2004, the Ministry of Finance invited representatives of the ROC Chamber of Commerce, the Chinese National Federation of Industries, the Certified Public Accountants' Association of the ROC, and the American and European chambers of commerce, to discuss the tax treatment of employee stock options issued by foreign companies to their employees sta-tioned in Taiwan, and to the employees of their Taiwanese subsidiaries, branch offices, or rep-resentative offices. The conclusions of the meeting are summarized below.
Overseas-issued stock options received by em-ployees are to be treated as "remuneration for services rendered within the ROC" as referred to in Subparagraph 3 of Article 8 (income from ROC sources) of the Income Tax Act. But after employees leave employment or retire, they may still exercise subscription rights obtained while they were employed. Therefore under Article 14 of the Act (categories of personal income), such stock options should not fall into Category 3, "income from salaries and wages," but into Category 10, "other income."
The amount of income represented by stock op-tions is to be determined in the year in which they are exercised, on the basis of any amount by which the market price at that time exceeds the subscription price. The number of days the re-cipient was employed and providing services between the grant date and the vesting date of the options, and the number of days spent employed and resident within the ROC during the same period, are then used to calculate pro rata the proportion that should be treated as ROC-source taxable income, and the proportion attributable to provision of services outside the ROC, which is not taxable in Taiwan.
In the converse case, if a Taiwanese company issues employee stock warrants to employees of its overseas subsidiary, the number of days worked inside and outside Taiwan is likewise used to calculate the proportion of ROC-source taxable income to overseas-source non-taxable income.
The meeting left two issues unresolved. The first is the collection of tax-related data, and the date from which the above practices should take ef-fect. This will be decided by the Taxation Agency of the MOF after further consideration. The second issue is whether a Taiwanese sub-sidiary of a foreign company can declare as ex-penditures the fees it pays to its overseas parent to cover the cost of the parent's issuing employee stock options, and whether such fees, when re-ceived by the overseas parent from the subsidiary, are taxable income, and whether they should be subject to withholding tax. This too remains to be clarified.
The logic behind the meeting's conclusions is that it first affirmed that the reason for employ-ees' receiving stock options is related to the fact of their providing services, and on the basis of this relationship, concluded that such income should be categorized as remuneration for ser-vices, as referred to in Article 8 Subparagraph 3 of the Income Tax Act. However, in the case of personnel not directly employed by the foreign parent company, their receiving foreign stock options cannot be regarded as direct considera-tion for their services, and thus does not fit the definition of income from salaries and wages under Article 14 Category 3 of the Act, nor is it compatible with any of the other specific cate-gories, so that it can only be deemed as "other income." Furthermore, as "other income" of an individual located in Taiwan is not subject to withholding tax, assigning such income to this category avoids the issue of tax withholding.
From this we can see that the concept of remu-neration for services is broader than that of in-come from salaries and wages. In other words, income from salaries and wages is necessarily remuneration for services, but remuneration for services that is not received from the employer is not wages and salaries. Also, to determine whether income is remuneration for services, it is necessary to consider whether the factual causal relationship that results in the remuneration be-ing paid is related to the provision of services; but it is not necessary for an employment con-tract to exist between the payer and the recipient of the remuneration.
The conclusion regarding the calculation of taxable income and the year in which tax should be levied is in agreement with the principles set out in an interpretation issued by the MOF on 30 April 2004. However, said interpretation states: "When a company issues employee stock war-rants in accordance with the provisions of the Securities and Exchange Act or the Company Act, and an individual exercises such subscrip-tion rights in accordance with the subscription rules issued by the company, the income so arising is 'other income' as provided by Article 14 Paragraph 2 Category 10 of the Income Tax Act." It also categorizes stock warrants issued by an Taiwanese company to its own employees as not being income from salaries and wages. This would appear to be open to debate.
The above interpretation also does not indicate that under Article 8 of the Income Tax Act, such income should be deemed "remuneration for services." This is likely to lead to doubt as to whether it should be categorized under Sub-paragraph 11, as "other income." The conclu-sions clearly define such income as remuneration for services, and further hold that the source country of the income should be delimited ac-cording to the proportions of time worked inside and outside the ROC. This is a truly progressive interpretation.
As to the issue when the interpretation covering the above matters should take effect, a new in-terpretation should apply to outstanding previ-ously-filed tax cases if it is more advantageous to the taxpayer. In other words, less favorable provisions should not be applied retroactively to cases filed but not yet assessed when an inter-pretation is issued, and a more favorable inter-pretation should apply to cases already assessed but not yet confirmed.
The second outstanding issue is whether fees paid by a Taiwanese subsidiary to an overseas parent company to cover the cost of issuing stock warrants to employees may be declared as ex-penditures, whether such fees are taxable income, and whether they are subject to withholding tax. Until an interpretation is issued to clarify these points, the question may be dealt with pursuant to Articles 24 and 38 of the Income Tax Act, regarding the necessity and reasonableness of expenditures.
For example, it should be considered whether the benefit of services rendered by personnel is en-joyed by the Taiwanese company. As for the issues of taxable income and withholding tax, whether such receipts are income depends on whether the amount received by the overseas parent company exceeds the expenses it incurs in issuing the stock warrants. It would not be ap-propriate to limit such costs to the amount that the employees are required to declare as taxable ROC income. It will be worth watching what position the MOF ultimately adopts.