OECD Recommends New Rules Governing Tax Treatment Of Employee Stock Options

by Robert Lee, Tax-News.com, London

07 September 2004

The OECD has issued a series of recommendations designed to achieve a common interpretation of how tax treaties apply with respect to employees or directors who receive stock-options as part of their remuneration.

As a first step, following discussions in its Committee on Fiscal Affairs, the OECD is making changes to the Commentary on its Model Tax Convention, recommending that:

• relief from double taxation should be granted by the residence country even if it taxes the employment benefit derived from stock-options in a year that is different from the source country ;
• the moment of exercise of an employee stock-option should constitute the dividing line between the employment benefit and any capital gain related to the stock-option ;
• the employment services to which a stock-option relates should be determined on the basis of the facts and circumstances of each case, in line with specified guidelines ;
• when employment services are provided in more than one State, the employment benefit derived from a specific country should be determined on the basis of the number of days during which employment has been exercised in that country ;
• the above rules should also generally apply to stock-options granted to members of a board of directors.

The OECD’s Commentary, which is non-binding, provides the basis for negotiation, application and interpretation of the global network of bilateral tax treaties that govern taxation of cross-border income and capital.

The OECD has also addressed the transfer pricing issues which may arise as a result of the use of employee stock options, basing its approach on the ‘arms-length’ principle whereby intra-company transactions are measured against those which would have taken place between independent parties.

The OECD analysis focuses on three main areas:

• The granting of stock-options to employees of an associated enterprise resident in another tax jurisdiction: where this should give rise to a charge by the issuing (parent) company on the employers of the beneficiaries, three possible approaches to measuring the charge are identified.
• The impact of provision of a stock-option plan on other intra-group transactions where the transfer pricing method to be applied to these other transactions is sensitive to employee remuneration, and the impact of stock-options on comparability where employee remuneration of either the taxpayer or third party comparables is materially impacted by stock-options.
• The impact of employee stock-options on Cost Contribution Arrangements within a multinational enterprise: based on an example, the study contains a discussion of whether and under what circumstances employee stock-options must be taken into account in the valuation of the participants’ contributions to a CCA, as well as a discussion of the valuation principles that may be applicable and circumstances in which employee stock-options may be omitted from the determination.

Comments on national taxation issues will be contained in a study on domestic tax issues to be released, along with the first two studies, in an OECD publication later this year.

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