Global Equity Services
Securing a Tax Deduction Globally
for Equity Awards
Originally published in The Journal of Corporate Taxation (WG&L), November/December 2014
Author: T. SCOTT McMILLEN
T. SCOTT McMILLEN is an associate in the Chicago office of
Baker & McKenzie LLP.
The general rule under the Internal Revenue Code is that a U.S.
corporation cannot take a tax deduction for equity awards granted to
employees of a non-U.S. subsidiary.1 Some companies do not review this
issue further-making the assumption that a tax deduction is not available
or that the foreign affiliate is already taking a local tax deduction.
Nevertheless, in the majority of cases, it is possible to take a corporate tax
deduction for the value of the equity awards granted to employees of a
non-U.S. subsidiary. The purpose of this article is to help readers
understand the requirements for obtaining a corporate tax deduction
outside of the United States and to describe the country-specific
considerations that must be addressed prior to taking the tax deduction.
To obtain a local corporate tax deduction, the foreign affiliate generally
needs to reimburse the parent company for the value of the equity awards
through an agreement with the issuing parent company. Reimbursement
can result in a local tax deduction and potentially increase a company’s
earnings per share by lowering the consolidated company’s effective tax
rate. Obtaining a tax deduction at the foreign affiliate level carries over to
the parent company’s earnings by having the equity award expense count
as a deferred tax asset, creating a tax benefit under the principles of FASB
(Financial Accounting Standards Board) ASC 718 (the tax benefit will
ultimately be recognized upon issuance of shares).2 In short, a tax
deduction may increase the parent company’s earnings by reducing the
taxes payable-creating additional cash flow for the company and
shareholders. Of course, the benefit depends on the amount of the tax
deduction, the effects of the tax deduction, and the ability to acquire the
tax deduction-in addition to accounting and transfer pricing
One common impediment is the foreign affiliate’s hostility to using the
affiliate’s cash to pay the parent company for the cost of the equity
awards.4 The hesitancy is often for a variety of reasons. One reason is that
a decrease in cash at the affiliate level could lead to a diminished profit
sharing plan contribution locally or affect the financial planning of the
foreign affiliate. Nevertheless, foreign affiliates that have sufficient cash
may benefit from using the money to obtain a local tax deduction.5 To avoid
cash concerns, some companies may prefer to use cash-netting or
intercompany transfers-where the expense is recognized on the books of
the foreign affiliate, but an actual cash transfer is not required since the
amount to be reimbursed is offset by other amounts payable to the foreign
affiliate. While this works in some jurisdictions, this also raises foreign
exchange control issues in others (for example, Argentina, Brazil, China,
India, and Thailand).
An additional advantage of reimbursement is the tax-free repatriation of
cash from foreign operations.6 Generally, the transfer of funds from the
foreign affiliate to the parent company will be construed as a dividend
subject to corporate income tax at rates as high as 35%. However, Section
1032(a) allows a company to repatriate funds and apply nonrecognition
treatment to the receipt of cash in the context of a transfer of stock. Cash
received from the foreign affiliate’s reimbursement should avoid creating
a taxable event pursuant to Section 1032(a) and create a helpful benefit for
the parent company.
With the benefits of reimbursement in mind, the goal of this article is to
provide an overview of the considerations and practicalities of
implementing reimbursement agreements to secure a local tax deduction
and allow for the tax-free repatriation of foreign cash.7
Basics of obtaining a corporate tax deduction globally
As discussed, a U.S. company cannot take a tax deduction for
compensation expenses related to its foreign affiliates’ employees. Since
the compensation expense is attributable to the foreign affiliate and not
the parent company, a deduction for equity awards granted globally is
available only at the foreign affiliate level (if available at all).8 For a foreign
affiliate to obtain a local tax deduction, the affiliate will generally need to
reimburse the parent company for the cost of the equity awards pursuant
to a written reimbursement agreement.9 The amount of the
reimbursement can be contractually altered in some jurisdictions, but is
generally the value of the award upon grant, purchase, or settlement.10
A written reimbursement agreement is not essential in all jurisdictions
(for example, the United States and United Kingdom), but is advisable to
evidence the terms of the reimbursement in the event of a tax audit.
Common language in reimbursement agreements includes (1) details
regarding the timing of the reimbursement; (2) the contents of the invoice
from the parent company; (3) and provisions required by local law (a more
detailed list of pertinent provisions is discussed below). In addition to
having a written agreement, it is also imperative to know each
jurisdiction’s requirements to secure a local tax deduction, including when
the reimbursement agreement must be in place to secure the deduction
(that is, the timing of legal effectiveness). For example, in some
jurisdictions the agreement must be in place before the grant of the equity
award to obtain a local tax deduction; however, in other jurisdictions the
agreement can be implemented any time before the taxable event (for
example, settlement for restricted stock units).
In some jurisdictions the process is more complicated. For example,
shareholder approval may be required or regulatory approval may be
mandatory or recommended. Yet, in a few jurisdictions it is not possible to
secure a local tax deduction or it is not wise due to foreign exchange
control restrictions or otherwise (for example, China). These are just a few
of the concerns that should be addressed when drafting/implementing a
reimbursement agreement. Below is a broader discussion of these
matters, followed by country-specific considerations and issues.
Considerations for obtaining a tax deduction globally
Before deciding to set up a reimbursement agreement in a particular
jurisdiction a company should fully understand the consequences of
reimbursement-including any filing requirements that may result. The
following are short descriptions of common scenarios that companies
should consider before implementing a reimbursement agreement.
Withholding and reporting consequences.
In more than a handful of jurisdictions (for example, Brazil and Mexico)
reimbursement by the foreign affiliate will create an income tax and
employer social insurance withholding and reporting obligation. This will
increase the cost of offering equity awards if an employer tax or
burdensome reporting obligations are triggered.11 Brazil is an example of
a jurisdiction where reimbursement may not be cost effective or
desirable-demonstrating that prior review of each jurisdiction’s
consequences is a prudent exercise. Specifically, in Brazil, reimbursement
may trigger an employer social insurance withholding obligation of 35%
(uncapped) on the taxable value of the equity awards-an expense that
would not have been created but for the reimbursement agreement.
Tax deduction limitations.
Reimbursement of equity award expenses is not always feasible for an
entire population of grantees. In some jurisdictions, it is not permissible to
take a deduction for the cost of equity awards granted to certain executive
level participants. For example, in Brazil, a local tax deduction is generally
not permissible for equity awards attributable to directors or board
members. As a result of this limitation, a company may want to
specifically tailor the reimbursement agreement to either exclude the
value of equity awards attributable to any special class of participant or
seek repatriation only of the value associated with this special class of
Labor law consequences.
In European and Latin American jurisdictions in particular, reimbursement
will often result in a heightened risk that equity awards are vested rights and
cannot be discontinued at the discretion of the parent company (for example,
Belgium and Brazil). By reimbursing the parent for the cost of the awards, the
foreign affiliate is considered to be funding the equity program and the
awards appear to be an additional form of local salary. Likewise, there is a
risk in these jurisdictions that the value of any equity awards will be included
in severance when an employee terminates employment. While this result
can be muted with proper planning and robust award agreement language, it
is a central risk when reimbursing in jurisdictions with stringent labor laws.
Exchange control considerations.
Reimbursement may be complicated by a requirement to seek foreign
exchange control permission from a jurisdiction’s central bank or other
exchange control authority. Thus, a company may need to determine if there
is an exemption or allowance on which the company may rely or whether
approval from the relevant regulatory body is unconditionally required. For
example, in Brazil, a company may need to engage a Brazilian commercial
bank to effectuate reimbursement and the commercial bank may need to
consult with the Central Bank of Brazil for approval. Jurisdictions like Brazil
(and others) discourage and generally prohibit the use of cash netting or
intercompany transfers of the reimbursed amount (for transparency
reasons among other concerns) and have put in place a means of
monitoring the reimbursement or transfer of funds.
Shifting of taxable event.
One other consequence of reimbursement is that it can result in a
different point of taxation for certain types of equity awards (for example,
instead of tax upon sale, the taxable event may be upon exercise). This is
most often the case for stock options or in the context of an employee
stock purchase plan.
Sticking with Brazil, reimbursement may move the taxable event of stock
options from the time of sale to the time of exercise. This shift in taxation
is commonly seen in Latin American jurisdictions, where reimbursement
may also change the nature of the equity award from “other income” to
“employment income” subject to withholding and reporting obligations.
Corporate governance issues.
Reimbursement may trigger corporate governance concerns and
shareholder approval requirements. For example, if a company wants to
implement a reimbursement agreement in Ireland, several hurdles must
be overcome. The foreign affiliate may need to amend its articles of
association to authorize the reimbursement. Further, the Irish affiliate’s
board of directors will need to approve the reimbursement agreement in
accordance with section 60 of the Companies Act 1963.
Type of shares issued.
The type of shares issued upon vesting or exercise can be decisive in
determining whether a local tax deduction is available. The use of treasury
shares or newly issued shares may be adequate in one jurisdiction to
obtain a tax deduction, but not in another. For example, in France and
Singapore, awards may be required to be settled in treasury shares to
obtain a local tax deduction (however, a tax deduction is generally
available only for the cost of the treasury shares as purchased, less any
amount paid by the participant). Likewise, tax advisors in Germany
commonly recommend settlement in treasury shares to bolster the
argument of a compensatory tax deduction for equity awards.
Timing of implementation.
When and how a reimbursement agreement is implemented may dictate
the availability of a local tax deduction. If the reimbursement agreement is
implemented following the grant of equity awards, some jurisdictions will
not allow a tax deduction. Alternatively, some jurisdictions will allow a tax
deduction only in the tax year in which the invoice is received by the local
affiliate. As a result, understanding the timing of implementation and the
affect this will have on the local tax deduction is important. For example,
in Switzerland, a local tax deduction is available in the year the invoice is
received by the foreign affiliate and the charge is recorded on the books.
The amount a company can seek reimbursement for is controlled by the
applicable accounting standard or local regulation(s) (for example, U.S./
U.K. generally accepted accounting principles (“GAAP”), International
Financial Reporting Standards (“IFRS”), IFRS 101, IFRS 102). A company
which is a tax resident of the United Kingdom may be limited to
reimbursing for the Black Scholes value of a long-term incentive award.
Any value in excess of the Black Scholes value may result in the
recognition of income/profit for the U.K. parent company. The amount that
a company may reimburse for may even vary from the amount that can be
taken as a tax deduction. Nevertheless, the amount a company
reimburses for is generally the full value of the awards; however, it is
recommended that a company determine whether any limitations exist
and what the appropriate chargeback limitation is in that jurisdiction or
according to the specific accounting standard.
Besides the general considerations discussed above, there are also
country-specific considerations that need to be addressed before deciding
to implement a reimbursement agreement. Set forth below is a sample of
the various considerations and themes that need to be analyzed in
implementing a reimbursement agreement:
Generally, a tax deduction is available only for cash-settled awards and not
for share-settled awards.12 However, a reimbursement agreement may
still be advantageous for cash repatriation purposes.
China’s State Administration of Taxation has issued guidance (Bulletin 18,
5/23/12), providing that a tax deduction is available in China for the cost of
equity awards borne by a Chinese company. However, it is uncertain if
Bulletin 18 and the ability to take a tax deduction apply to non-Chinese
multinational corporations (for example, U.S. multinational companies)
with local Chinese entities. As a result, while it appears possible to take a
tax deduction in China, the practical ability of a non-Chinese multinational
company may be limited. Another hurdle to obtaining a tax deduction in
China is the State Administration of Foreign Exchange (“SAFE”), which
controls the inbound and outbound remittances of currency in China. The
SAFE will want to approve any reimbursement of equity award costs to the
extent the reimbursement is more than $100,000 in the aggregate. Only in
limited circumstances has the SAFE granted permission for a company to
receive a recharge payment from its local Chinese affiliate.
Irish law requires shareholder approval by the local affiliate’s board of
directors and several other corporate procedures to properly implement a
reimbursement agreement and obtain a local tax deduction. Ireland is not
the only jurisdiction that has a shareholder approval requirement. Thus,
implementing a reimbursement agreement to obtain a tax deduction in
Ireland and a handful of other jurisdictions requires adequate planning
and it not something that can be done in a short window.
In addition to the prerequisite of using treasury shares to obtain a tax
deduction in France, the 2014 Finance Bill includes a 50% employer-paid
tax on employee compensation in excess of €1 million. In general, the
employer-paid tax applies only (for non-French multinational companies)
where the local French affiliate reimburses the parent company for the
cost of the equity awards. As a result, reimbursement in France will
re-characterize the equity awards as local compensation-triggering the
employer-paid tax. When combined with already expensive French social
insurance taxes, this employer-paid tax could effectively push the local
affiliate’s tax liability to 75% on compensation paid in excess of €1
million.13 While the employee would be subject to lower social insurance
rates and income tax rates, the employer would effectively be paying close
to double for awards over €1 million. All the same, this will apply only if
the local affiliate has highly compensated employees in France and
reimburses for the cost of the equity awards.
It may be possible to claim a tax deduction in Japan; however, costs
associated with director or officer equity awards are generally not tax
deductible. Nevertheless, in Japan, if the award is structured as a
performance award or other type of remuneration, it may be possible to
take a local tax deduction for director/officer compensation.
Claiming a tax deduction in South Africa requires approval from the
Financial Surveillance Department (“FSD”) of the South African Reserve
Bank. Like China, discussed above, the FSD is not likely to grant approval
for reimbursement. Rather, it has informally stated that it prefers that
plan participants exhaust their foreign investment allowance rather than
having a foreign affiliate bear the cost of the equity awards on behalf of
Reimbursement agreement best practices
For most companies, preparing a reimbursement agreement should start
with drafting a global base agreement (that is, one form of reimbursement
agreement to be used in the majority of jurisdictions). On the other hand,
specific country regulatory requirements may create the need to prepare a
country-specific reimbursement agreement. Nevertheless, with the idea
of a global base document as the foundation, the following could be
considered best practices in developing reimbursement agreements:
• Spell out detailed invoicing parameters related to timing, format,
value-added tax, withholding taxes, etc.;
• Include the legal name of the local affiliate in every reimbursement
• Have the agreement signed-off by the appropriate parties and
signatories at the company;
• Determine if the agreement should be governed by U.S. or foreign law;
• Determine the amount that is available to charge-back in a particular
• Include language referencing Section 1032 for tax-free repatriation;
• Include a successor clause for situations involving mergers,
acquisitions, and other corporation transactions; and
• Assess the impact of the global reimbursement agreement on overall
transfer pricing and global tax strategy.
Of course, the above list is merely a sample of common best practice
steps and provisions. Some of the practices above may not be applicable
or necessary, depending on the circumstances and facts.
Depending on the available benefit, a company may not want to establish a
reimbursement agreement in the majority of jurisdictions where it offers
equity awards or a stock purchase plan. It is important to carefully select
each jurisdiction and perform the necessary due diligence before
implementing a reimbursement agreement (for example, surveying each
reimbursement jurisdiction). Yet, a reimbursement agreement may result
in tangible benefits to a company’s effective tax rate and an increase in
earnings per share-or at the very least-become a cost-saver for
1 Section 83(h) .
2 The accounting treatment and related principles under ASC 718 are
outside the scope of this article.
3 A company should consider the effects of the tax deduction from a
transfer pricing perspective and whether the reimbursement
agreement will fall in line with the company’s overall transfer pricing
strategy. In general, reimbursement may not be beneficial for costplus
4 Of course, this concern is not present if the reimbursement is
accomplished via an intercompany transfer or book expense.
5 This may not always be the case if the company is more concerned with
cash accumulation than earnings. For example, if the company is
worried about its debt covenants or is trying to avoid a
6 See Section 1032(a) and Reg. 1.1032-3 . Also, for further detail see
Burmeister, “Income Tax Issues With Equity Grants to Employees of
Foreign Subsidiaries,” 38 Corp. Tax’n 25 (May/June 2011) [jct05201105].
7 This article does not consider any of the transfer pricing considerations
that may be applicable to reimbursing for the cost of equity awards
globally. However, if the local affiliate operates on a cost-plus basis,
reimbursement may not be desirable.
8 See Columbian Rope Co., 42 TC 800 (1964).
9 This is often required internationally and also helps to establish a
tax-free repatriation of foreign cash pursuant to Section 1032(a) .
10 Further limitations may be imposed by International Financial
Reporting Standards (“IFRS”) or the relevant governing
11 In some cases, reimbursement will substantially increase the tax
burden of the local affiliate. This is the case in South Korea where
reimbursement will trigger social insurance obligations that are
uncapped and will generally be assessed at aggregate rates
12 Granting cash-settled awards in Canada may result in unintended
consequences which could result in the award being subject to tax
upon grant and not vesting under the Salary Deferral Arrangement
rules in Canada.
13 This depends on the applicable social insurance thresholds and the
individual’s personal circumstances, among other considerations.
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