Entrepreneurial Stock Option Scheme
Computation of Taxable Gains
The Dilemma
Entrepreneurial Stock Option Scheme
Following a recent ministerial statement by the minister of finance and an Inland Revenue Authority of Singapore (IRAS) administrative circular of May 22 2000, employees in Singapore can now enjoy a 50% income tax exemption on gains from exercising their stock options. This exemption, which is available only in relation to the acquisition of ordinary shares, will be granted up to a maximum of S$10 million in gains over a period of 10 years. Hailed as the 'entrepreneurial stock option scheme', an employee will enjoy the tax concession only if the company, the employee and the scheme itself satisfy certain eligibility requirements.
Vesting period requirements
First, the employee stock option plan (ESOP) must satisfy vesting period requirements prescribed by the Singapore Exchange. The option may not be exercised within one year from the grant of the option if the exercise price of the share is equivalent to its market value at the time the option was granted. Also, the option may not be exercised within two years from the grant of the option if the exercise price of the share is at a discount to the market value at the time the option was granted.
There is no requirement for the company to apply to the comptroller of income tax in order for the company's ESOP to be considered an entrepreneurial employer stock option scheme. All that is required is that the company have sufficient documentation to show, when required by the comptroller, that its ESOP satisfies the vesting period requirements.
Qualifying companies
In order for the company to qualify as one in which its employees are entitled to the tax exemption under this scheme, the company has to satisfy the following requirements:
- It must be incorporated in Singapore;
- It must carry out business activities in Singapore; and
- Its gross assets (whether the company is listed or unlisted) must be valued at less than S$100 million.
The same requirements must be satisfied if the stock options are granted by a parent company that is operating a group ESOP (ie, not by the subsidiary for which the employee works).
Employee eligibility
A qualifying employee is one who is granted options by a qualifying company under an ESOP that satisfies the Singapore Exchange's vesting requirements. In addition, the employee must satisfy the following requirements at the time the option is granted:
- He must be employed by and working for the company (or its subsidiary);
- The stock options must be granted to him on or after June 1 2000;
- He must work at least 30 hours a week or spend at least 75% of his total working time each week working for the company;
- He may not control 25% or more of company's voting rights; and
- He may not be a non-executive director.
The method for computing taxable gains for schemes that qualify under the new entrepreneurial stock option scheme and those which do not are similar. The new scheme does not change the current basis of determining when ESOP gains accrue to an employee and the amount that is taxable. The only difference is that a qualifying employee (as defined above) is entitled to a 50% exemption of the computed taxable amount over a period of 10 years, subject to the maximum ESOP gains of S$10 million.
Pursuant to Section 10(5) of the Singapore Income Tax Act, any gains or profits derived by any person by the exercise of any share option granted to him by reason of any office or employment is subject to tax. The taxable amount is the difference between the open market price at the time of exercise of the share option and the amount paid for the shares. However, where the open market price of the shares is not readily available or is impossible to determine, the net asset value of the shares will be used to determine the market price of the shares.
The taxability of gains or profits derived from the exercise of share options and the determination of the amount taxable are in most cases straightforward. However, the position is not as straightforward in a case where the share option is granted in one jurisdiction but exercised in another. These situations may arise where, for example (i) the share option is granted to a person by a non-Singapore company in respect of his employment in a jurisdiction outside Singapore, but exercised by him while he is in Singapore, or (ii) the share option is granted to a person when he is employed in Singapore but exercised by him while he is outside Singapore.
The previous position taken by the IRAS (Interpretation and Practice Note 25 of 1997) was that an employee would only be taxed on gains or profits derived from the exercise of his share option if he exercises it while he is in Singapore. For example, if a person is granted a share option by his non-Singapore employer before his posting to Singapore, but exercises the option in Singapore, he will be subject to tax in Singapore on the full amount of profits derived from the exercise of the option. Conversely, any gains or profits so derived when he exercises his option outside Singapore should not be considered income derived from Singapore, and so, should not be taxable. As a general rule, under Singapore's territorial basis of taxation, tax is only imposed on income that has a Singapore source (ie, the income is derived from or accrued from Singapore). Where its source is outside Singapore, income is taxable only if it is remitted into Singapore.
However, in recent dialogues between the IRAS and the Institute of Certified Public Accountants of Singapore, the IRAS has adopted a new administrative stance on the issue. The IRAS now takes the view that so long as the options are exercised while the employee is holding a Singapore employment or office, he will be taxed on the gains or profits. This is so regardless of where the individual is physically located at the time of exercise or where the option was granted. Although this new position appears to be contrary to the general territorial basis of taxation used in Singapore, it appears that this will be the position the IRAS takes until there are subsequent developments either on the ministerial, legislative or judicial front.
For further information on this topic please contact Mrs Teoh Lian Ee or Mrs Christina Ng at Drew & Napier by telephone (+65 535 0733/+65 531 2250) or by fax (+65 535 4864/+65 535 4864) or by e-mail ([email protected] or [email protected]). The Drew & Napier web site can be accessed at www.drewnapier.com.
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