How Mobile Employees Are Taxed on Cashouts and Award Assumptions

What is the correct tax treatment of a stock award for a mobile employee when the original equity award is assumed or converted into cash?

By assumed (assumption), I mean that the award is adjusted so that the underlying shares are replaced by shares in the new company with no additional benefits or increases in value to the participant.

By converted (conversion), I mean that the award is changed so that it is settled in cash either immediately, or, more likely, over the vesting schedule of the legacy award.

Assumption of Stock Awards on a Merger or Acquisition

Consider the case of Cathy, a California-based employee, who was granted RSUs that cliff-vest on the fourth anniversary of the grant. Two years after grant, Cathy moved to New York. On the third anniversary of grant, her employer was acquired by ACME and her RSUs were assumed to be RSUs over shares in ACME. The original vesting schedule was retained. On the fourth anniversary of grant, the RSUs vest and Cathy receives shares of ACME. Does California have a right to tax any of the income from these RSUs?

The tax laws of many countries and states do not get to this level of detail and, therefore, companies should rely on general tax principles instead. It is a common mistake to think that the trailing tax liability should apply only from the assumption date, and many tax authorities are unlikely to share that viewpoint.

Cathy would not have received the assumed awards in ACME but for the RSUs she was originally granted. Services provided in California contributed to the acquisition of ACME shares. Therefore, a portion of Cathy’s RSU income should be sourced to California using workdays from the legacy grant date to the vest date. In general, assumed awards inherit the trailing tax liability of the legacy award.

However, if the vesting schedule restarted at the date of the assumption, there may be a case for considering mobility only after the assumption date to determine the income allocation.

Conversions into Cash

The same principles apply when an award is converted into cash; namely, time spent in the location at grant of the original award should generally be considered for income allocation. However, the situation can often be more complicated for a cash conversion. Cash payments often have different payroll requirements as well as different income sourcing rules than stock awards.

In my last NASPP Blog, “How to Source Equity Comp Income for Mobile Employees,” I discussed that many countries (and US states) have adopted the OECD’s guidance for sourcing equity awards using workdays from grant to vest. However, there is no similar widescale approach for cash-based awards, although some countries apply a similar sourcing approach to cash-based payments.

Ireland is a good example where the difference between share-settlement and cash conversion can result in a large difference in tax treatment. If an employee resident in Ireland is granted stock-settled RSUs and then moves to another country, breaking Irish residency before the RSUs vest, Ireland will not tax the income from those RSUs. Note, the same tax treatment does not apply to stock options or cash awards. What happens if the RSUs of an Ireland mobile employee are subsequently converted into cash? If the employee had already broken Irish residency upon the conversion, it would make sense under general tax principles, to not subject that award to Irish taxes. However, if the award is converted into cash and then the employee leaves Ireland, there will likely be a trailing tax liability as the sourcing rule for cash payments is different.

Other Considerations

Withholding and Reporting Requirements for Cash vs. Stock: Some countries apply payroll withholding and reporting for cash payments even though stock-settled equity awards are exempt from similar treatment. For example, cash payments made to Australian employees require tax withholding even though equity awards are not subject to withholding if the employee has provided their Tax File Number. When employer social tax costs are considered, the conversion of RSUs into cash can become much more expensive for the company.

Logistics of the Cash Payment: Sometimes stock awards are exempt from payroll reporting and withholding as the local subsidiary is not involved in the granting or settlement of the award. However, if the cash payment is made through local payroll, then reporting and tax withholding may be required. Japan is an example of a country that falls into this category.

Furthermore, the employee may have changed bank accounts or closed accounts in a prior country and may not be able to receive a cash payment made through a prior payroll. For this reason, some companies only report income and remit taxes through the prior payroll; the current payroll becomes the main distributor of the funds. Close cooperation between multiple payroll teams is required in these situations.

Taxation of Assumptions and Conversions: Companies should seek advice as the assumption or conversion of awards may be taxable in some countries. Particular attention should be paid to awards that were granted under a locally tax qualifying plan. Tax authority rulings may be required.

Global Filings: Companies should remember to indicate the award assumption or conversion as well as the related mobile employee sourcing in any global filing, such as U.K. annual online reporting.

Conclusion

Companies that are being acquired or cashing out their stock awards should not assume that the mobile employee allocation period is reset from the award assumption or conversion date. Specific advice should be sought based on the circumstances including mobile employee profiles.