We understand that payroll is complex and high risk. Payroll is a “Cinderella” function which is taken for granted until something goes wrong, this is especially relevant for equity and share plans. In most countries there are payroll withholding obligations in respect of at least some equity awards. Global companies often struggle with equity payroll, especially for expatriates.
We work with companies around the world to help them ensure that payroll is robust, compliant and cost effective. We have put together our key 12 areas where payroll teams struggle with equity and where we can use our experience to help — how many sound familiar in your company?
- BDO has developed a number of tools and expertise to help clients. Our Global Equity Mobility Solution can automate the payroll process, cover multiple award types and source income for expatriates
- Take a look at our Global Mobility Toolkit: we can advise on payroll and reporting process and work closely with our Global Outsourcing team to support accurate and robust payroll
- Download BDO Global Equity Rewards Matrix, our free app covering the tax treatment of equity in 30 key countries
1. Lack of local visibility and control
Most local payrolls pay salary/bonus to employees and have the opportunity to operate payroll on the cash. With equity there is a disconnect between the party providing the shares (the HQ or broker) and the local payroll. In many cases local payroll have little or no visibility on equity awards or vesting. Equity plans are often run at the HQ level and involve other parties such as the broker, international mobility and company secretarial team. Another layer of risk is awards to senior individuals which are often dealt with by a separate HQ based team.
Ideally the local payroll team is able to calculate how much tax to withhold based on YTD earnings but this needs a robust system and rapid transfer of data. The optimum is a one to three day period between a taxable event and a YTD payroll calculation used to inform the broker how many shares to sell. What is the period and timescale in your company?
If companies don’t withhold from proceeds on the sale of shares and instead try to deduct from salary sometimes employees have negative pay and owe the company money. This leads to employee relation issues and stress for the payroll team.
2. “Fire and forget”
Equity awards often have a vesting period (i.e. are earned) of three years or longer. Awards such as options are typically valid for ten years. Once vested options can be exercised by the employee at any time (subject to plan rules and share dealing codes). Individuals may have moved country or even left the company before they exercise and acquire shares, these time gaps can lead to local payrolls being unaware of payroll and reporting obligations. In our experience payroll issues normally include expatriates and ex-employees. In most countries payroll has to be operated in respect of ex-employees. Robust systems are therefore needed to track individuals with outstanding awards and ensure that local payroll is correct and risk minimised.
Equity can involve small numbers of high value transactions which often involve senior employees with complex fact patterns. A common issue is to provide equity to a “new in country” team or senior expatriate without considering payroll exposure. The local team is often unaware of these awards or how long individuals have been working in country.
Employee payroll is typically funded by selling shares within a few days of exercise or vest. Companies which fail to do so are often exposed to settlement, interest and penalties. Many plan rules require payroll to be withheld on exercise or vest and once shares are delivered to the employee the company can become solely responsible for unpaid tax or face legal obstacles to reclaiming (especially where ex-employees are involved).
Coordination with brokers is key, they typically sell shares to cover payroll withholding within a few days of transactions. Changing brokers and key personnel often disrupts this process and has to be handled very carefully.
Taxable events involving former employees are a major risk, in many jurisdictions the equity gains they make should be subject to payroll. A leaver may correspond with the HQ/broker to exercise a share option or acquire shares but without local payroll involvement there are corporate risks, especially for employees who moved to a different country and subsequently left. Failing to deduct the correct amounts from leavers typically means that the company funds the payroll plus interest and penalties. Nearly all plans have withholding clauses but enforcing them against leavers is at best problematic.
5. Unique reporting obligations
There are often specific equity reporting obligations such as in Australia, Japan and UK. Payroll may be expected to comply with these but lack clear visibility or the information required. We increasingly see tax authorities use reporting as the entry point for equity payroll audits.
6. Different information sources
As well as having to take account of forex, share values and dealing costs equity payroll has to recognise that key information is often provided via a third party broker. Many companies operate multiple equity plans which may have different payroll treatments. Combining different data sources and using them consistently for payroll, reporting and employee communication is key.
Companies typically know when a bonus is paid and usually have a gross amount from which they can deduct payroll. Not so for equity — employees can often exercise options whenever they want and trigger an immediate payroll liability. Whilst the trend towards Restricted Share Units (RSU) helps, many companies still operate option plans. With equity there is no cash – the company typically needs to instruct the broker to sell sufficient shares to cover the employee payroll costs. Failing to do so often means that the employee receives 100% of the gain and the company has to cover all tax (often on a grossed up basis) and is subject to penalties and interest.
8. Expatriates and trailing liabilities
Probably the largest hidden issue. As internationally mobile employees spend time working in different countries they leave trailing liabilities where part of the final equity gain has to be taxed, typically via payroll, in each country. An employee could be granted an option with a three year vesting period and spend 18 months of this on secondment in Country A, five years later the employee could exercise the option and make a gain – 50% of the gain may well be taxable in Country A. Some countries such as Israel and Singapore impose an exit charge when an individual changes residence.
This also applies to taxable events for former employees, tax equalisation adds to the complexity. Covid-19 and the rise of home working means that we are seeing more employees who are employed in one country and seeking to work in another. Global mobility is one of the key areas where we are seeing authorities review compliance and where robust systems are needed.
9. Asymmetry with local payroll cycle
Payrolls work with local cut off dates. Equity events later in the payroll month or near year end can cause compliance issues. Payrolls often need additional payroll runs and payslips. This can be especially problematic when awards vest close to tax year ends but are processed in the following year. Late payment of tax may lead to interest and penalties.
10. Local expertise
Running payroll is already difficult and adding equity is a big ask. Local teams may not be aware of the complex and fast changing rules around equity. The rules may change in countries between grant and vest/exercise, particularly where the taxable events are years later. Employee often have questions around equity which often only surface on vesting/exercise – these are often directed at the local payroll team.
11. One size fits all approach
This is often used, where the approach is to subject all equity awards to full payroll deduction it may reduce overall risk. However, this approach will always lead to risk and losses. For example some countries such as Australia, Japan and Sweden do not typically payroll equity gains and there may be local exemptions/allowance to consider and overwithholding may create risk issues with the employee just as underwithholding may create risk issues with the tax authority. This approach should be moderated by a local payroll reconciliation, adding to the workload. It is usually better to ensure that the correct amount is deducted at source.
The “One size” approach is often based on the practice in the HQ country, if so it is highly risky — for instance we see US headquartered companies incorrectly treating ESPP gains as non-taxable outside the US. The “One size” will not be appropriate where a global companies has a mix of non-qualifying plans subject to income tax and qualifying plans subject to capital gains tax.
12. Equity allowances and tax optimisation
Some countries have allowances or exemptions which specifically apply to equity. In some cases there are country specific plans with a different tax treatment which can save tax and social security. Typically local payroll needs to be involved to ensure these rules are correctly applied. Many countries operate social security caps or limits — ignoring them leads to overpayments at both employee and employer level. We are aware of cases where HQ has implemented tax approved plans in jurisdictions and not informed payroll which meant payroll was incorrectly calculated. There must be effective communication between all parties to effectively manage payroll for equity.
Equity is unique because the employer can unilaterally take action to change the tax and social security treatment — often to reduce the tax cost for participants and the company. As well as qualifying plans which may exempt certain amounts from income tax or social security there are inter-company recharges (where the HQ charges local companies for the value provided through equity). Recharges can generate useful local corporation tax deductions but in some countries mean that income tax and or social security is then due via payroll. In the UK employers social security can be transferred to employees, this saves money for the company but requires a bespoke payroll approach.
Local payroll teams need to be aware of these points, work with HQ teams and access robust technical support.
Source BDO United Kingdom