This article is relevant for candidates preparing for P6 (MYS), Advanced Taxation, and is based on prevailing laws as at 31 March 2015.
The purpose of this article is to discuss the Malaysian income tax implications arising from the provision of employee share schemes. The focus of this article will be on Employee Share Option Schemes and Employee Share Purchase Plans. Candidates should be able to analyse the tax implications of these schemes from both the perspective of the employer and the employee.
Introduction to fundamental concepts
Employees are an important asset to any organisation. To ensure continuous growth and development, businesses realise the need to gain employee loyalty and to retain them. In this respect, employee share schemes are often used as a tool to retain and motivate employees. The grant of shares to employees recognises the role of employees in the organisation by inculcating a sense of belonging in that the employees now have ownership rights in the company through the shares.
There are various ways in which employee share schemes can be implemented. The employees can be offered shares in the company in which they are employed or shares in the employer’s holding company. Some of the commonly used employee share schemes include the following:
- Employee Share Option Schemes (‘ESOS’) –the employees are given the option(s) to purchase shares at a certain price, normally referred to as the offer price, over a specified period of time.
- Employee Share Purchase Plan (‘ESPP’) – the employees are allowed to purchase the shares, normally at a discount, at certain intervals over a specified period of time.
- Share Award Schemes – the employees are given free shares in the company.
Apart from the above schemes, which all offer rights to actual shares in the company, employers may also offer a cash equivalent to the value or appreciation in value of shares without undertaking a transfer of ownership of shares – for example, share appreciation rights (‘SAR’) schemes, etc.
Each employee share scheme is likely to be different depending on the objectives of the organisation and the specific rules governing the share schemes. These rules are normally set out in the scheme’s by-laws and constitutions.
In the past, there were no specific provisions under the Income Tax Act, 1967 (‘the Act’) that addressed the taxability and deductibility of such schemes. However, as the Government realised that more organisations were launching employees share schemes, they also recognised the need to provide clarity on the tax treatment of such schemes. The Government first introduced provisions governing the taxability of such schemes in the hands of the employees in the year of assessment (‘YA’) 2006 and, subsequently, rules relating to the tax deductibility of employee share schemes for the employer were introduced in the YA 2013.
The tax implications of employee share schemes are also discussed in detail in Public Ruling 11/2012 Employee Share Scheme Benefit as well as Public Ruling 9/2013 Special Deduction for Expenditure on Treasury Shares.
In understanding the tax implications of employee share schemes, there are a few common features of the schemes which need to be understood.
Firstly, being a retention tool, most schemes would incorporate a vesting period before the shares can be acquired / the options can be exercised. A share scheme offers the right, but not the obligation, to an employee to purchase a specific number of shares at a specified price and at specific time. Before an employee can purchase the shares (or exercise their options under a share scheme) they need the option to purchase. In order to earn the right to purchase these shares, the employee needs to have a vested right to acquire these shares. Normally shares are considered vested upon fulfilment of the conditions imposed under the scheme which must be fulfilled by the employee in order to have the right to purchase or exercise the option to acquire the shares.
Examples of such conditions would include the continuation of employment for a period of time or the achievement of certain performance measures.
Example 1
Cerise Bhd (‘Cerise’) launched an ESOS on 1 April 2014 whereby all eligible employees were given the option to purchase 10,000 shares in the company at an offer price of RM1.50. The employees can only exercise their options to purchase the shares after 1 April 2015 (the vesting date) if the company achieves an annual turnover of RM100m and the employee continues to be employed by Cerise during the vesting period.
The employees are given until 31 March 2017 to exercise their options. For the financial year ended 31 March 2015, the company achieved a turnover of RM120m.
Based on the above example, whilst the scheme was launched on 1 April 2014, the option to acquire the shares was only vested on 1 April 2015 upon the fulfilment of the conditions imposed under the scheme – that is, achievement of the required turnover level and the employee remaining in employment with the company.
The other key concept is the date of exercise and the exercisable period. Being offered an option to a share scheme does not require the employee to exercise the option (purchase the shares) immediately. Share schemes normally have a specified exercisable period during which an employee can exercise the right to a share scheme. The exercisable period is the period from the first date the employee can exercise the right to the share scheme (the vesting date) to the final date the share scheme can be exercised. An employee is considered to have exercised an option to a share scheme when they have taken steps to purchase the relevant shares.
Based on Example 1, the exercisable period of the scheme would be from 1 April 2015 to 31 March 2017. The employee can exercise the option at any time during this period.
Employee’s perspective: Taxability of employee share scheme
With effect from the YA 2006, Section 25(1A) of the Act provides that –
'The gross income from an employment in respect of any right to acquire shares in a company of the kind to which paragraph 13(1)(a) applies, shall where the right is exercised, assigned, released or acquired in the relevant period be treated as gross income of the relevant person for that relevant period'.
In other words, a benefit derived from a share scheme is considered to be part of gross employment income in the relevant period in which the rights are exercised.
The basis of computing the taxable benefit of a share scheme is provided under Section 32(1A) of the Act. It provides that:
'Where in the relevant period a relevant person acquired any right to acquire shares in a company of the kind to which paragraph 13(1)(a) applies, under his name or in the name of his nominee or agent, the amount in respect thereof to be included in his gross income from the employment shall be -
(i) the market value of the shares where the right shall be exercised, assigned, released or acquired on a specified date or where the right shall be exercised, assigned, released or acquired within a specified period, the first day of that period; or
(ii) the market value of the shares on the date of the exercise, assignment, release or acquisition of the right, whichever is the lower less the amount paid for the shares'.
The calculation of the taxable benefit can be summarised in the table below: