How an Equity Plan Team Can Add Value in a Recession
October 06, 2022
It's easy to read current financial headlines and understand that it's possible the US and other countries may be headed into or are currently already in an economic recession. Either way it doesn't hurt to start preparing for a potential downturn. In such a downturn, it's quite possible that corporate budgets will tighten and companies will be tasked with finding ways to stretch each dollar further than the quarter before.
Equity stock plan administrators tasked with overseeing a company's equity programs have the ability to add significant organizational value by considering a few tactics that might assist their organization in securing cost savings. This blog post will detail some of the more significant strategies for approaching a recession and adding value to your organization's goal of reducing costs, while still maintaining the goal of operating a robust stock program.
One of the most obvious and overlooked ways to obtain equity award cost-savings is the implementation of recharge (also called reimbursement or chargeback) arrangements to secure local tax deductions for the cost of equity awards.
If a US parent company grants equity awards to employees of non-US subsidiaries, these entities typically do not automatically qualify for a tax deduction for the award cost. [One notable exception is the United Kingdom where a local tax deduction is generally available even if the local entity is not charged for the award cost.]
If, however, the local entity is charged for the cost of the awards by way of a written recharge agreement with the parent company, such tax deductions often become available. By doing an analysis of your jurisdictional footprint, headcount and aggregate award value, it can quickly become apparent where a tax deduction can result in significant cost savings.
Of course, there are a number of considerations when implementing a recharge arrangement, including transfer pricing consequences, labor law considerations and important tax withholding and reporting consequences. For example, by implementing a recharge arrangement in Mexico, you may trigger withholding and reporting requirements that will result in additional social insurance and administrative costs to your organization. Likewise, in certain jurisdictions the implementation of a recharge arrangement may substantially increase the probability of the equity award income being considered an acquired right or subject to termination indemnities. Thus, it's important to carefully select in which jurisdictions a recharge arrangement may be implemented to obtain a local tax deduction, avoiding the trap of triggering additional costs in certain countries.
In addition to the potential benefit of a tax deduction, recharge arrangements come with an added benefit of tax-free repatriation of cash. Stated differently, the cash transferred back to the parent company from the overseas entity will not be subject to taxation as a dividend but can qualify for tax-free treatment in the US. In a recession, this can provide additional operating cash to the parent company, available for corporate investment and maintenance purposes—this is especially beneficial to organizations that derive a significant chunk of their revenue from overseas operations.
Before proceeding with implementing a recharge arrangement, it is recommended that you broach the topic with all relevant stakeholders (e.g., treasury, transfer pricing, tax and accounting teams) to discuss the implications and timing of such a project. With the correct line of attack, significant savings should be possible for your company.
Tax Benefits and Exemptions
In several jurisdictions, it's possible to realize savings if equity awards are structured to take advantage of certain tax exemptions. For instance, in Estonia, if you grant equity awards that do not vest/are not exercisable for a period of three years, you can avoid a substantial employer-paid fringe benefits tax (of 60+%) that is otherwise due on the equity award income. In the United Kingdom, it is possible to transfer employer social security contributions (due at a rate of currently 15.05%, uncapped) to employees. Tax-qualified awards in France likewise can help reduce the cost of employer-paid social insurance contributions.
Of course, some tax-qualified programs may actually cost more to operate than nonqualified programs, depending on the number of employees and the aggregate value of awards. This must be considered in the cost-benefit analysis.
Conversely, you may want to re-examine tax-qualified programs or exemptions that you are currently utilizing for employee tax savings to assess whether you receive a significant benefit from these programs. If not, consider whether the cost of maintaining this benefit is desirable. For instance, if you are offering a tax-qualified program in Ireland, consider whether this program's benefits are achieving the desired goals compared to the cost of operating the program for employees. Likewise, if you offer Section 7P awards in Denmark, there is not an employer benefit (only an employee benefit) and significant administrative resources have to be utilized for tracking purposes.
Audit of Jurisdictional Resources
The next topic ties into the point just made about reviewing tax-qualified programs to ensure the benefit gained under the program justifies the cost. More broadly, companies may want to undertake a detailed review of which jurisdictions are causing the most significant use of resources and budget.
For instance, if you grant awards in Malaysia to only a handful of individuals and are constantly having to make securities and tax filings, it may be worth considering an alternative approach. Likewise, if you offer an ESPP to employees in Japan and are required to make very onerous (and frequent) securities filings, it may be worth analyzing whether operating the ESPP in Japan makes sense and perhaps offer only RSUs to employees (which are not subject to securities filings). By taking stock of the headcount and relative spend in each jurisdiction, you may be able to locate potential cost savings by deciding to curtail awards, re-design awards or pull back from awards in a jurisdiction.
Altering or Terminating an ESPP
This is an unpopular suggestion and one that will not be right for every organization (in fact arguably not right for the vast majority of organizations): consider the alteration or termination of an employee stock purchase program.
The nuclear approach, terminating an ESPP, could be advisable if the ESPP requires significant ongoing legal costs and there is only low participation.
More justifiable could be a less aggressive approach, such as reducing the length of offering periods (e.g., from 24 months to six months), prohibiting increases of contributions during an offering period, decreasing the discount, etc. All of these measures will result in a reduction in the accounting expense for the ESPP and, therefore, cost savings. Assuming the ESPP is drafted broadly, it should be relatively easy to implement such changes, and also to roll them back in the future, when the economic situation improves. However, even with less aggressive measures, there are significant arguments against this strategy, including the impairment of employee morale and the investment in the long-term health of the organization post-recession (i.e., not overreacting to short-term pessimism at the expense of long-term gain). Finally, consideration will need to be given to entitlement and acquired rights issues.
A plethora of alternatives are available for a stock plan team to add value to a mission aimed at cost savings, while also delivering the stated goal of motivating and compensating a global workforce. Keep the above strategies and considerations in mind if necessary for your organization.
Global Equity Services