Taxation of equity-based compensation

In today’s dynamic labor market, companies must have a competitive compensation package to retain high-performing employees, attract new talents, and align the interests of the employees with the strategic goals of the company. This is why equity-based compensation is an integral part of the remuneration model of many companies.

Having a compensation structure that offers various types of equity-based compensation creates complex transactions, and companies must understand the tax implications and properly comply with the applicable tax regulations. This is especially true nowadays when tax authorities worldwide apply more stringent tax rules in relation to equity-based compensation.

Revenue Regulations 13-2022

The Bureau of Internal Revenue (BIR) released Revenue Regulations (RR) 13-2022, entitled Income Tax Treatment of Equity-Based Compensation, dated Oct. 7, 2022. The RR listed and defined the most common types of equity-based compensation, such as stock options, restricted stock units, stock appreciation rights, and restricted share awards. All these have a feature of being granted to existing employees on the basis of performance, outstanding business achievements, and exemplary organizational, technical or business accomplishments.

The RR is very straightforward. It provides that equity-based compensation of any kind is considered as taxable compensation regardless of the employment status of the recipient who could either be rank-and-file or occupy a supervisory or managerial position.

The RR expressly mentioned that the provisions of Revenue Memorandum Circular (RMC) 79-2014 and any regulations, rulings or orders, circulars, or portions thereof which are inconsistent with the provisions of the RR are hereby revoked, repealed or amended accordingly. This clearly means that equity-based compensation, including those provided to employees holding supervisory or managerial positions, should now be subject to withholding tax on compensation.

Revenue Memorandum Circular 79-2014

With the release of this RR, the BIR took a full U-turn on its treatment of equity compensation. RMC 79-2014 provides that stock option and other option plans should be taxed depending on the employment status of the employee who is exercising the option. If exercised by a rank-and-file employee, it should be considered as an additional compensation subject to income tax while for employees holding a supervisory or managerial position, it should be considered as fringe benefit subject to Fringe Benefit Tax (FBT). Although RMC 79-2014 did not expressly mention its applicability to other equity-based compensation, the BIR had a history of applying the same tax treatment to stock options and other types of equity-based compensation.

Now claimable as a foreign tax credit

One of the issues when RMC 79-2014 took effect was that double taxation cannot be avoided in cases where the equity-based compensation provided to employees holding a supervisory or managerial role is also subject to tax in another jurisdiction. Most countries consider equity-based compensation as additional compensation subject to income tax rather than a fringe benefit subject to FBT. As a result, FBT paid in the Philippines cannot be claimed as a tax credit in the taxpayer’s foreign income tax return because it is under a different tax regime. The good news is that with RR 13-2022, the income tax paid in the Philippines can be used as a creditable tax in another jurisdiction.

Shift of tax liability

For employees holding a supervisory or managerial role, shifting from FBT to withholding tax on compensation means that the liability to pay the taxes is also shifted from the employer to the employee. Also, the tax rate from zero to 35 percent shall apply based on the total taxable income, as opposed to the FBT rate fixed at 35 percent based on the grossed-up income. Companies can explore different options on how they can provide tax support to their employees and refer to the RR in further designing their stock plans.

Timing of applicability

Now that there is clear confirmation on how equity-based compensation should be taxed, companies must comply accordingly. The question is: starting when? This RR will take effect 15 days following its publication in the Official Gazette or in a newspaper of general circulation, whichever comes first. Will income tax reporting begin in the month of November or will the RR apply retrospectively? The BIR needs to provide further guidelines and clarifications through an RMC on how to handle the transition and shift in reporting to help taxpayers comply with the change.

Jan Kent Q. Viray is a senior manager from the Global Mobility Services (GMS) under the tax group of KPMG R.G. Manabat & Co. (RGM&Co.), the Philippine member firm of KPMG International. The firm has been recognized in 2022 as a Tier 1 in Transfer Pricing Practice and in General Corporate Tax Practice by the International Tax Review.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity. The views and opinions expressed herein are those of the author and do not necessarily represent KPMG International or KPMG RGM&Co.

For questions and inquiries, feel free to send a message through social media or [email protected].