Over the past year, there has been a marked increase in payroll queries on restricted stock units (“RSU”). Whether this is employers introducing new schemes or perhaps an increase in awards under existing schemes is unclear. However, what is clear are the difficulties that the RSU (and any share-related compensation) can present for payroll.
In this brief article, I set out an overview of RSU and also the steps that payroll should take when asked to process payments related to an RSU arrangement.
What are RSU?
This very question highlights the first challenge for payroll of any share incentive arrangement.
There are literally thousands of different shares schemes globally with different terms and conditions (normally set out in a share plan agreement or share plan rules document) and delivering different types of shares or sometimes cash.
For ease, people have ascribed generic names to the various schemes where they have certain characteristics (e.g. share options, restricted shares, conditions shares and RSU). However, whatever country you’re based in and whatever name you call the share scheme, the tax and social security (and therefore payroll) treatment of any share-related events are determined by the specific share plan rules.
This is an important point because, whilst RSU arrangements share certain characteristics (outlined below), they are not all the same and they are not all treated in the same way for tax, wherever you are based in the world.
The key elements that normally define a typical RSU arrangement are:
1. “Units” are awarded by the employer to the employee. Units are not anything physical or tangible but just an ‘on paper’ representation of potential future value. The ‘paper value’ of the unit at award is often tied to the value of the shares at award. So, for example, an employer may award an employee 100 units and each unit is equal to the value of one share in the employing company. So, if the value of the share is £1 then the employee will have been awarded £100 worth of units. However, there is normally no way for the employee to monetise the units at this stage. They are just, well, units!
2. Normally a ‘vesting period’ follows. After the vesting period has expired, the employee’s units are then often converted into actual shares in the employing company (which may be sold if there is a market and the scheme rules allow). So, if the employee’s 100 units vest, the employee acquires 100 shares in the company. It is normally at this point (though not always), across most countries, that an income tax charge (and often a payroll obligation) is triggered. Sometimes the vesting period is just a specified period of time or, sometimes, employers attach performance conditions whereby the units don’t vest until certain employment conditions have been met. Generally, like most share incentives, they are designed to support employee retention, motivation or both.
3. Sometimes RSUs don’t deliver shares at all and, instead of receiving shares after vesting, the employee simply receives a cash amount which is equivalent to the value of the company shares at the time of vest. Other schemes award shares at the vesting point but these shares may be restricted for a period of time (e.g. restriction on sale, restriction on transfer, restriction on the payment of dividends etc.).
A tax challenge
Whilst I have set out the key elements below I would normally see in an RSU scheme, there are a multitude of variations and additional terms that may be included in the scheme rules such as rules on forfeiture if the individual leaves employment, specific performance conditions, the option to acquire shares or receive cash following vest, additional restrictions on the shares acquired, vesting period tied to certain events (e.g. a company sale), restrictions on the circumstances in which the shares may be sold, rules around the circumstances in which the units may be cancelled, to name but a few. All of these variations can affect the tax and social security treatment of RSU, as well as the taxable amount.
What value should go through payroll?
Even where the tax, social security and payroll treatment is clear, the issue of valuation (i.e. what amount do you put through payroll where shares are received?) sometimes arises. In the case of shares listed on a stock exchange, this is normally straightforward because the share price is dictated by the market and is publicly available. However, if the company is a private company, the shares may need to be valued by a specialist to determine the taxable amount that should go through payroll.
In addition to this, where restrictions or other conditions are placed on the shares acquired, this can affect the value of the shares and so, again, specialist valuation input may be required.
Is payroll required?
As we have seen above, the tax and social security treatment needs to be determined based on the specific scheme rules and the legislation that applies to these rules in the country in which the RSU are subject to tax.
However, just because the acquisition of shares following the vest of an RSU is subject to income tax in a country, it does not necessarily mean that this should be reported via payroll in that country. Again, this will depend on the legislation in each country. For example, if the shares are not deemed to be ‘Readily Convertible Assets’ for UK tax purposes, then normally there would be no tax or social security (PAYE) withholding required.
So, therein lies an additional question to determine – is payroll required at all?
Globally mobile employees
Where employees relocate to work in a different county during the period from the award of RSU to their vest the tax and social security position can be even more complex. This is because both the ‘home country’ and the ‘host country’ may seek to tax at least part of the award. In these circumstances, payroll withholding may be required in more than one country.
Often, in such cases, the double tax treaty network can be used to apportion the ‘gains’ across the relevant countries for tax purposes and also enable foreign tax credits to be claimed where there is double tax.
Given this, payroll and RSU for globally mobile employees can be especially challenging.
What does this mean for payroll?
In summary, you can’t be certain of getting payroll right without first seeking instruction from specialists on exactly how the RSU should be treated for the relevant country.
Normally, for this purpose, external tax advisors should be engaged in the relevant country to:
1. review the RSU scheme rules and determine the tax and social security treatment;
2. determine whether any shares acquired on the vesting of an RSU should be taxed via payroll or where (for example) the employee should instead report any gain via their income tax return;
3. determine the position in respect of any globally mobile employees;
4. determine any additional employer reporting obligations in respect of the RSU; and
5. set out clear instructions for your payroll, based on the above.
So, when someone next asks you to run the RSU awards via payroll, you’ll hopefully have some questions to ask them before you do anything!
Author: Lee McIntyre-Hamilton
Lee has over 23 years of experience in international mobility, expatriate tax and employment tax. He works with a diverse range of international organisations, from small owner-managed businesses to large multi-national corporations and non-profit organisations. Lee delivers coordinated, joined-up global mobility tax, international social security and payroll advice across many territories globally. He is a published writer on international tax matters, notably the Tiley & Collinson UK Tax Guide.
Contact Lee: lee@globalpayrollassociation.com
Over the past year, there has been a marked increase in payroll queries on restricted stock units (“RSU”). Whether this is employers introducing new schemes or perhaps an increase in awards under existing schemes is unclear. However, what is clear are the difficulties that the RSU (and any share-related compensation) can present for payroll.
In this brief article, I set out an overview of RSU and also the steps that payroll should take when asked to process payments related to an RSU arrangement.
What are RSU?
This very question highlights the first challenge for payroll of any share incentive arrangement.
There are literally thousands of different shares schemes globally with different terms and conditions (normally set out in a share plan agreement or share plan rules document) and delivering different types of shares or sometimes cash.
For ease, people have ascribed generic names to the various schemes where they have certain characteristics (e.g. share options, restricted shares, conditions shares and RSU). However, whatever country you’re based in and whatever name you call the share scheme, the tax and social security (and therefore payroll) treatment of any share-related events are determined by the specific share plan rules.
This is an important point because, whilst RSU arrangements share certain characteristics (outlined below), they are not all the same and they are not all treated in the same way for tax, wherever you are based in the world.
The key elements that normally define a typical RSU arrangement are:
1. “Units” are awarded by the employer to the employee. Units are not anything physical or tangible but just an ‘on paper’ representation of potential future value. The ‘paper value’ of the unit at award is often tied to the value of the shares at award. So, for example, an employer may award an employee 100 units and each unit is equal to the value of one share in the employing company. So, if the value of the share is £1 then the employee will have been awarded £100 worth of units. However, there is normally no way for the employee to monetise the units at this stage. They are just, well, units!
2. Normally a ‘vesting period’ follows. After the vesting period has expired, the employee’s units are then often converted into actual shares in the employing company (which may be sold if there is a market and the scheme rules allow). So, if the employee’s 100 units vest, the employee acquires 100 shares in the company. It is normally at this point (though not always), across most countries, that an income tax charge (and often a payroll obligation) is triggered. Sometimes the vesting period is just a specified period of time or, sometimes, employers attach performance conditions whereby the units don’t vest until certain employment conditions have been met. Generally, like most share incentives, they are designed to support employee retention, motivation or both.
3. Sometimes RSUs don’t deliver shares at all and, instead of receiving shares after vesting, the employee simply receives a cash amount which is equivalent to the value of the company shares at the time of vest. Other schemes award shares at the vesting point but these shares may be restricted for a period of time (e.g. restriction on sale, restriction on transfer, restriction on the payment of dividends etc.).
A tax challenge
Whilst I have set out the key elements below I would normally see in an RSU scheme, there are a multitude of variations and additional terms that may be included in the scheme rules such as rules on forfeiture if the individual leaves employment, specific performance conditions, the option to acquire shares or receive cash following vest, additional restrictions on the shares acquired, vesting period tied to certain events (e.g. a company sale), restrictions on the circumstances in which the shares may be sold, rules around the circumstances in which the units may be cancelled, to name but a few. All of these variations can affect the tax and social security treatment of RSU, as well as the taxable amount.
What value should go through payroll?
Even where the tax, social security and payroll treatment is clear, the issue of valuation (i.e. what amount do you put through payroll where shares are received?) sometimes arises. In the case of shares listed on a stock exchange, this is normally straightforward because the share price is dictated by the market and is publicly available. However, if the company is a private company, the shares may need to be valued by a specialist to determine the taxable amount that should go through payroll.
In addition to this, where restrictions or other conditions are placed on the shares acquired, this can affect the value of the shares and so, again, specialist valuation input may be required.
Is payroll required?
As we have seen above, the tax and social security treatment needs to be determined based on the specific scheme rules and the legislation that applies to these rules in the country in which the RSU are subject to tax.
However, just because the acquisition of shares following the vest of an RSU is subject to income tax in a country, it does not necessarily mean that this should be reported via payroll in that country. Again, this will depend on the legislation in each country. For example, if the shares are not deemed to be ‘Readily Convertible Assets’ for UK tax purposes, then normally there would be no tax or social security (PAYE) withholding required.
So, therein lies an additional question to determine – is payroll required at all?
Globally mobile employees
Where employees relocate to work in a different county during the period from the award of RSU to their vest the tax and social security position can be even more complex. This is because both the ‘home country’ and the ‘host country’ may seek to tax at least part of the award. In these circumstances, payroll withholding may be required in more than one country.
Often, in such cases, the double tax treaty network can be used to apportion the ‘gains’ across the relevant countries for tax purposes and also enable foreign tax credits to be claimed where there is double tax.
Given this, payroll and RSU for globally mobile employees can be especially challenging.
What does this mean for payroll?
In summary, you can’t be certain of getting payroll right without first seeking instruction from specialists on exactly how the RSU should be treated for the relevant country.
Normally, for this purpose, external tax advisors should be engaged in the relevant country to:
1. review the RSU scheme rules and determine the tax and social security treatment;
2. determine whether any shares acquired on the vesting of an RSU should be taxed via payroll or where (for example) the employee should instead report any gain via their income tax return;
3. determine the position in respect of any globally mobile employees;
4. determine any additional employer reporting obligations in respect of the RSU; and
5. set out clear instructions for your payroll, based on the above.
So, when someone next asks you to run the RSU awards via payroll, you’ll hopefully have some questions to ask them before you do anything!
Author: Lee McIntyre-Hamilton
Lee has over 23 years of experience in international mobility, expatriate tax and employment tax. He works with a diverse range of international organisations, from small owner-managed businesses to large multi-national corporations and non-profit organisations. Lee delivers coordinated, joined-up global mobility tax, international social security and payroll advice across many territories globally. He is a published writer on international tax matters, notably the Tiley & Collinson UK Tax Guide.
Contact Lee: lee@globalpayrollassociation.com