Should Your Global Equity Plan Include Recharge Arrangements?
September 13, 2022
Global equity award programs can be costly to the US parent corporation. One strategy to offset some of this expense can be to use recharge arrangements to transfer some of the cost to the local entities that award holders are employed by. This can produce a tax benefit at the local level that would not otherwise be available to the US parent.
To Recharge or Not to Recharge: That Is the Question
One of the primary benefits of requiring the local employer to bear the cost of the equity awards is that the employer may benefit from a local corporate tax deduction with respect to such cost. This is typically accomplished by having the issuer of the stock awards enter into a reimbursement (or "recharge") agreement with the local entity that employs the grantees, pursuant to which, the local entity agrees to pay the issuer the "cost" of the award.
The reimbursement of this cost generally becomes payable to the issuer at the time the shares are issued to the grantee (i.e., upon exercise of stock options or vesting of restricted stock units. Typically, the cost recharged to the local employer equals the ordinary income recognized by the employee, although in some circumstances it may be advisable for the issuer to instead charge the amount taken into account for financial statement purposes (or at least retain the flexibility to do so).
Although implementing a recharge arrangement and benefitting from a corporate tax deduction may seem like a no-brainer, there are a number of considerations to be evaluated before charging forward.
Will Recharging Award Costs Produce a Local Tax Benefit?
As a threshold matter, it is important to first evaluate which countries permit a local corporate tax deduction for this type of cost and, if so, whether a recharge agreement is required. The short answer is generally "yes," but there are exceptions.
For example, the UK permits a statutory corporate tax deduction for equity awards (subject to some exemptions) even if the local entity does not bear the cost (although for reasons beyond the scope of this blog post, it may still be advisable to implement a recharge arrangement even for the UK). Unfortunately, a company's vetting process for whether or not to implement a recharge program in a particular jurisdiction should not stop at whether a corporate tax deduction is available.
Below we highlight additional tax, regulatory and legal considerations that can come into play and make it either inadvisable or infeasible to implement a reimbursement arrangement in a particular country.
Ancillary Costs May Outweigh the Benefits of Recharge Arrangements
From a tax and social security perspective, one potentially significant downside from a recharge arrangement is that it may trigger social insurance contributions that are not otherwise due on the equity awards. For example, in Belgium, many companies historically have taken the position that social insurance contributions (which are uncapped and approximately 27% for the employer and 13% for the employee) are not due with respect to equity awards granted to employees of a Belgian subsidiary.
Although that position has been tested by recent Belgian court cases, there arguably still are grounds for taking the position that social taxes are not due. If, however, the equity plan costs are charged back to the Belgian entity, the position that social insurance contributions are not due likely is no longer tenable.
Similarly, by agreeing to bear the cost of the awards, the local employer in some countries may end up with a withholding and reporting obligation with respect to the equity income that would otherwise not exist. Thus, implementing a recharge program may require further coordination with a company's local payroll and stock administration teams to ensure that the withholding and reporting positions in each country reflect whether a recharge agreement is in place.
Finally, in a handful of countries, the implementation of a recharge arrangement will impact the taxation for the plan participants. An example is Indonesia, where typically equity awards are not subject to tax at vest or exercise, but only when the shares are sold. However, if the Indonesian employer bears the cost of the equity awards, the timing of the taxable event will accelerate to vesting (for RSUs) or exercise (for options) and a withholding and reporting obligation will be triggered for the local employer.
Be Wary of Regulatory Pitfalls
An issuer must also consider whether there are any regulatory impediments to implementing a recharge agreement in a country. Notably, there may be local exchange control restrictions that prohibit the remittance of the recharge payment by the local entity to the US issuer.
It should come as no surprise to those of you familiar with China's onerous State Administration of Foreign Exchange requirements, that SAFE has (at least so far) been reluctant to approve reimbursement arrangements in connection with equity plans. Even for countries that permit the remittance of reimbursement payments, there may be restrictions on the use of intercompany offsets in connection with these reimbursement agreements, so it is important to understand the applicable requirements in each country.
Recharging Award Costs Can Trigger Labor Law Considerations
An often-overlooked consequence of a recharge arrangement is the potential for increased labor law risks in certain countries. US issuers typically structure their global equity award programs to make clear that the program is offered by the US parent company and it is not part of the local employment relationship. If the local employer is required to bear the cost of the equity awards through a recharge arrangement, the lines are blurred and the equity award program starts to look much more like a local employment benefit.
The implications of this can be numerous, unwelcome, and quite costly. For example, the local employer may be required to include the value of the award in statutory severance payments or the employee may make a constructive termination claim if the US issuer decides to stop granting equity awards. Another common claim made by employees is that the equity awards are vested rights, such that the employee should have the right to continued vesting even after termination of employment. Unfortunately, some courts will be more inclined to agree this is the case where the local employer bears the cost of the award, notwithstanding any helpful language in a company's plan documentation designed to demonstrate that the plan is not a local employment benefit.
Companies historically have tended to implement recharge arrangements for stock options and RSUs, as the taxable benefit for those types of awards typically is larger than for ESPPs, thus leading to a bigger corporate tax deduction. That said, companies with generous employee stock purchase programs, such as those with a 15% discount and a lookback feature in a 24-month offering period, would be wise to evaluate whether also charging back the ESPP cost makes sense.
Finally, the decision on whether to rollout a recharge program is not a one-size-fits-all determination. It tends to be company-specific and will greatly depend on a company's global corporate tax strategy and the location of its workforce, among other factors. Thus, a company should ensure that its corporate tax department partners closely with its legal and stock teams when evaluating whether (and in what countries) a reimbursement program might result in meaningful cost savings or other benefits for the company.
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