Tax Articles

Taxability of Equity-based Compensation

By Atty. Rodel C. Unciano

As part of the compensation package of employees, some employers give equity-based compensation to their employees.

As defined, equity-based compensation includes all types of employee equity schemes in various forms such as stock options, restricted stock units, stock appreciation rights, and restricted share awards, which may or may not pertain to the share of stock of the grantor, but have the feature of being granted to existing employees of the grantor as a performance incentive for services rendered by the employees.

Under Revenue Memorandum Circular (RMC) No. 79-2014, the taxability of equity-based compensation would depend on the position of the employee, that is, whether the employee is rank-and-file or occupies a supervisory or managerial position. If the employee who exercises the option occupies a supervisory or managerial position, the difference of the book value/fair market value of the shares, whichever is higher, at the time of the exercise of the option and the price fixed on the grant date, shall be treated as fringe benefit subject to fringe benefit tax. However, if the employee is a rank-and-file employee, the benefit is treated as part of the regular income of the employee and is subjected to withholding tax on compensation.

Pursuant to the new rules laid down in Revenue Regulations (RR) No. 13-2022, the equity-based compensation granted to employees, whether holding rank-and-file or supervisory or managerial position, shall be considered as compensation which shall be subject to withholding tax on compensation. RR 13-2022 ratiocinated that Section 32 of the 1997 Tax Code, as amended, does not make a distinction for purposes of applying the tax implication on all forms of compensation, including equity-based compensation.

RMC 143-2022 clarified that the difference between the book value/fair market value of the shares, whichever is higher, at the time of the exercise of the equity-based compensation, and the price fixed on the grant date, shall be considered as additional compensation subject to income tax and to withholding tax on compensation. No capital gains tax (CGT) shall be imposed since there is no realized capital gain on the part of the employer-grantor. No documentary stamp tax (DST) shall likewise be imposed upon grant by employers of equity-based compensation to its employees. However, DST shall be imposed upon the actual issuance of shares to the employee-grantee in accordance with Sections 174 and 175 of the Tax Code.

Upon sale, barter or exchange by the employee-grantee of the equity-based compensation, the same is treated as sale, barter, or exchange of stocks not listed in the stock exchange subject to CGT under Section 24(C) of the Tax Code. If the equity-based compensation was granted for a price, the difference between the sales price and the option price shall be the basis of the CGT while if it was granted without a price, the cost for purposes of computing the CGT shall be zero. On the other hand, if the transfer is without consideration, the same shall be treated as donation of shares of stock subject to donor’s tax based on the fair market value at the time of the donation.

As employers are now preparing for the payment of employees’ 13th-month pay, the question to ask is - whether or not the equity-based compensation is included in the computation of 13th-month pay?

The rules implementing the 13th-month pay law defines 13th-month pay as one-twelfth (1/12) of the basic salary of an employee within the calendar year. The revised guidelines on the implementation of the 13th-month pay law defined basic salary to include all remunerations or earnings paid by the employer for services rendered, but does not include allowances and monetary benefits which are not considered or integrated as part of the regular or basic salary, such as the cash equivalent of unused vacation and sick leave credits, overtime, premium, night differential and holiday pay, and cost-of-living allowances. However, salary-related benefits should be included as part of the basic salary in the computation of the 13th month pay if by individual or collective agreement, company practice or policy, the same are treated as part of the basic salary of the employees.

Following the above definition, there is basis to include the equity-based compensation in the computation of 13th-month pay. But even if included, the same is subject to the tax-exempt ceiling of 13th-month pay and other benefits under Section 32 of the Tax Code.