Articles

Differences and what their increasing popularity means for your incentive plan

By Vince Alessi
Vice-President Sales

Restricted stock programs have been in existence for years and, at least initially, were primarily tied to the upper levels of management compensation. With the advent of forced stock option expensing in 2006, and with companies such as Microsoft changing their compensation mix to Restricted Stock Units (RSUs) from stock options, many companies have now started issuing both Restricted Stock and RSUs to entry level employees and lower levels of management.

Restricted stock and RSUs are very similar but have some basic differences between them. Restricted stock is an actual granting of shares to a participant while an RSU is the promise of issuing stock or cash at a specific lapse or vest date. The main distinction is that,an awardee is considered to own stock, has voting rights and is entitled to corporate dividend payments with a Restricted stock award. With RSUs, on the other hand, awardees do not own the shares, thus they do not have voting rights and they may or may not receive dividend payments, depending on the RSU structure.

Another major difference between Restricted stock and RSUs is that a Restricted stock holder can make a Section 83(b) tax election at the time of grant but an RSU holder cannot make such a selection. With a 'normal' Restricted stock award, the tax consequences are based on the fair market value (FMV) of the number of shares that lapse / vest. For example, if an awardee was given a Restricted stock award for 1,000 shares and the stock price at the time of grant was $20, that award would have an initial FMV of $20,000. If 25% of the award lapses or vests after one year, and the price of the stock has increased to $25, then the FMV of the lapsed / vested portion would be $6,250 (25% of 1,000 shares X $25).

The 83(b) election (which needs to be made within 30 days of the grant) allows the awardee to pay for applicable taxes based on the then fair market value at the time of the grant. In the above example, the awardee would pay taxes on taxable compensation of $20,000, but then would have no further tax consequences as the later lapsings / vestings occur.

There is some risk / reward with doing an 83(b) election, however. If the company stock decreases in price, the awardee would have paid too much tax and the overpayment is not refundable. Likewise, if the awardee leaves the company for whatever reason and the Restricted stock award is forfeited / cancelled, then any previously paid tax from the 83(b) election is not refunded. For the above reasons, many awardees are somewhat hesitant to undergo an 83(b) election unless the stock price is extremely low.

An additional difference with RSUs is that RSUs can have a tax-deferral feature attached to them which can make them much more attractive to certain groups of awardees. With a Restricted stock award, this deferral feature is not an alternative.

Furthermore, in the case of issuing awards outside of the United States, depending on the specific country tax regulations, RSUs can be advantageous over Restricted stock because some countries tax Restricted stock awards at the time of grant, not at the time of lapse / vesting. RSUs can get around this hurdle and are primarily taxed at time of lapsing / vesting.

Companies are also looking to grant more and more performance awards and it is fairly easy to hook these performance awards into an RSU structure. No actual company shares are issued with an RSU grant and it is easy to cancel the RSU if performance criteria is not met. These types of performance-based RSU awards are becoming much more common.

One of the areas that Restricted stock and RSUs are almost identical on is the procedures setup to handle tax liability payments. When a Restricted stock or RSU lapses / vests, a taxable event occurs. Companies can be very prescriptive in how their awardees take care of their tax liability but most companies offer a few alternatives for their awardees.

Many companies will allow their awardees to pay for their tax liability by either:

1. cutting a check to the company for the amount of the tax liability
2. selling enough shares to cover the tax liability (sell-to-cover); or
3. doing a 'net share holdback' whereby a calculation takes place to determine the tax liability and how many shares are required to be 'held back' to cover that tax liability and the remaining shares are delivered to the awardee.

With each of the above alternatives, there are issues that companies should be aware of. With the cash payment alternative, the tax portion could be substantial and you may put an undue financial burden on those who have a weak cash flow if no other alternatives are offered.

In the 'sell-to-cover' methodology, companies need to be cognizant of their trading volume and the potential repercussions to their stock price if a sizable amount of shares hits the market at one time. A large sale of an illiquid or poorly traded stock could put downward pressure on the stock price and force even more shares to be sold to cover tax liabilities.

The 'net share holdback' is a very popular alternative as there is no cash out of pocket from the awardees and they simply receive the 'remaining shares'. This alternative may not fit all companies, however, as the company is basically holding back shares but then the company needs to have cash on hand to make the tax payments on behalf of their awardees.

Whatever alternatives are offered to awardees to pay for their taxes, it is extremely important that awardees have these methods clearly explained to them and all are aware of what their responsibilities are and their timelines. A good administrator will assist in making sure this communication is done properly and in a timely manner

Based on empirical evidence from our client base, we are seeing slightly more RSU grants than Restricted stock grants but, as described above, there are definite reasons why companies choose one over the other and we see many companies that offer both types of awards. If you have any questions relating to Restricted stock awards or RSUs, please do not hesitate to contact Solium Capital at 877-380-7793 and we will be more than happy to assist you.

Changes to the reporting requirements of ESPPs and ISOs

The IRS has recently released proposed changes relating to the regulations for the reporting of the transfer of stock related to Employee Stock Purchase Plans (ESPPs) and incentive stock options (ISOs). There has always been the requirement for corporations to provide written statements to employees for such transfers and in 2006 additional amendments to the Internal Revenue Code (the Code) required submission of this information to the IRS as well. However, the IRS did not have the established processes and forms needed to effectively file this information.

As of July 16th, 2008 the proposed regulations for these statutory filings have been published along with anticipated new forms and procedures needed in order to file. These new forms (Form 3921 for the Exercise of an Incentive Stock Option and Form 3922 for the Transfer of Stock Acquired Through an ESPP) are not yet available via the IRS website but are scheduled for a fall release. Due to this, the requirement to file has been waved for 2007 and 2008 but will be required for any transfers that occur in 2009 with an information and form submission deadline of January 31, 2010. This is to be conducted in a manner similar to the current 1099 and W-2 forms, with simultaneous distribution to both the employee and IRS.

As for the actual information that is to be reported for ISOs, the most significant change is that the aggregate exercise price and exercise date fair market value is to now be reported on a per share basis. Reporting on a per share basis is a requirement for ESPP reporting as well, but this is in addition to the need to report the method for the calculation of the discounted purchase price for employees (e.g. if a 15% discount is offered on the lower stock price between the beginning and end of a purchase period).

The proposed rules can be reviewed at http://edocket.access.gpo.gov/2008/pdf/E8-16177.pdf. The deadline for comments on the proposed rules is October 15, 2008.

New regulations for ESPPs

On July 29, 2008 the IRS released a proposal for changes to the regulations in Section 423 of the Code relating to employee stock purchase plans. While certain sections of the new proposals simply clarify and update previous regulations, there are some dramatic alterations that may have a pronounce impact on certain company's ESPP plans. These regulations can be relied on for any option under an ESPP granted on or after July 28th and are expected to become effective on January 1, 2010. The IRS has requested submission of all comments relating to the proposed changes be submitted by October 27, 2008.

1. Equal rights and privileges of participants
2. Exclusion of employee subsets
3. Defining the date of grant
4. The annual $25,000 limitation
5. Shareholder approval for subsidiary grants

1. Equal rights and privileges of participants

The proposed changes in Section 423(b)(5) stipulate that all employees under the Plan receive the same rights and privileges and these apply equally to both the parent company and any subsidiaries, even those that are foreign corporate or subsidiary entities. This includes:

1. Payroll deductions and direct payment by the employee. If any employee, domestic or foreign is permitted to contribute to the ESPP plan through payroll deductions or direct payment then all employees of the plan must be permitted to via the same method as well.
2. Carryover of unused amounts. If carryover of unused amounts are permitted for one employee, then all other employees must be allowed the same privilege. In the case of employees that are new participants in the ESPP, they must be allowed the opportunity to make a direct payment to the plan up to the maximum amount carried over by any other employee.

Limited exceptions to the proposed equal rights and privileges exist where terms may vary for foreign employees in conjunction with foreign laws, as long as the terms result in a condition where the benefits are less favorable for foreign employees than domestic employees.

2. Narrowing the ability for exclusion of employee subsets

The exclusion of particular subsets of employees from participation in an ESPP plan has been permitted for employees who:

• have been employed for less than two years
• work 20 or less hours per week
• work five or less months per year; or
• are highly compensated (as defined in Section 414(q) of the Code)

The proposed regulations clarify that the category of excluded employees can be based on lesser criteria than those listed above but that the standard must apply equally to all employees. This can be an issue for certain plans where, for example, a corporation wishes to exclude the highly compensated executives of the parent company but include the highly compensated employees of a subsidiary, or, exclude part-time employees in the US but include European part-time employees in order to comply with nondiscriminatory practices.

http://europa.eu/scadplus/leg/en/cha/c10416.htm

3. Defining the date of grant

The proposed regulations define the date of grant of an ESPP as the first day the ESPP is offered, as long as a calculation has been done to determine the maximum number of shares that will be made available to an employee during the purchase period. The minimum price does not have to be determined at that time but the number of possible shares awarded does. If the maximum shares available for purchase has not been determined, then the date of grant will be considered to be the exercise date. This is important in establishing the holding period for disqualifying dispositions.

4. The annual $25,000 limitation

The proposed regulation changes in 423(b)(8) address the current limitation that an ESPP may not grant an employee an option to purchase shares above $25,000 of fair market value (determined at the time of grant) in the calendar year the options are outstanding. The new regulation allows this limit to be calculated using the rules (to the extent possible) that apply to the $100,000 limit of incentive stock options (ISOs), where the limit applies only over years where the option is both outstanding and exercisable.

5. Shareholder approval for subsidiary grants

Under the proposed regulations, if a subsidiary or recently acquired company is granted stock options of the parent company's stock, the approval of the shareholders of the parent company is no longer required. Shareholder approval is required for a change in the granting corporation or if there is a change in which options are issued. The proposed regulations apply to both ISOs and ESPPs.

Written comments in response to these proposals must be submitted to the IRS by October 27th, 2008. The document of proposed regulations can be obtained and reviewed at http://edocket.access.gpo.gov/2008/pdf/E8-17255.pdf

Part 2 of 2 - Click here to view Part 1 from the previous issue of KnowledgeWorks

6. Guarantee accurate record access across departments and locations
   Companies that are leaders in employee equity plan management have made the shift to centralized data management, for employee equity plans, to ensure secure access to reliable records and reports for different users and departments such as HR, Payroll, Finance, and the Corporate Secretary. As regulations and compliance requirements evolve, multiple stakeholders require specialized information for their unique administration and reporting purposes. Historically, different stakeholders may have created and maintained records in their own set of independent reports. These data "silos" seemed workable until data discrepancies crept in and monthly or annual data reconciliation efforts were needed. Stakeholders were left without absolute certainty in record accuracy at the same time compliance pressures were increasing. Leveraging technology to centralize accurate plan records, providing access, and maintaining security and privacy across all groups has become a necessary practice of organizations that want to be effective, efficient, and compliant.
7. Provide comprehensive reporting tools for audit, control, reporting and compliance
   Best in class governance requires compliance with evolving legislation such as:
   • Sarbanes-Oxley
   • SAS-70
   • Option expensing requirements
   • Exchange requirements
   • Privacy legislation
   For expensing stock options, completing monthly securities filings, and meeting Board and Shareholder governance expectations, access to accurate, on-demand reporting tools are essential for today's equity incentive management. Online reporting tools offering search driven reporting functionality as well as standardized reports offer users the best of both worlds. Users become more efficient by leveraging the standard report templates required for ongoing reporting requirements and monthly filings. Additional functionalities, such as easy export to MS Excel® and complete data history, become important, yet simple tools, which create additional flexibility to manipulate these standardized templates. The next level of reporting functionality allows users to create, and produce their own reports by selecting required data fields and report formats. This functionality effectively allows administrators with unlimited reporting functionality and arms them with tools for any inquiry that may develop in the future.
8. Control data integrity through system integration
   Integrating employee equity plan data management with existing systems minimizes manual processes and creates efficient plan management that allows organizations to analyze and move information around the enterprise and to external vendors. Companies that utilize direct links to HRIS, payroll and treasury systems are able to support distributed payrolls, multiple currencies, global participants and expats. Automating the withholding process to withhold in local currency, direct the withholdings to a designated corporate bank account and ensure settlement of company proceeds directly to their designated account enable seamless execution through all systems. Leveraging technology to create direct interfaces between all systems that track and manage this type of information creates a highly efficient back office.
9. Manage global plans and participants within one system
   Global organizations managing plans and participants in international jurisdictions must be capable of managing multiple payrolls, currencies, exchanges, languages and tax implications. These global requirements create complicated procedures and increase workloads in providing transaction ability, tracking activity, converting funds, communicating in appropriate languages, and producing reports that comply with the regulations of specific countries. From a front office perspective, leveraging online banking functionality such as electronic fund transfers (EFTs) and wire transfers are effective tools that allow organizations to provide best in class employee services for global plan participation.
10. Consider outsourcing
    Implementation of equity based employee incentive plans can be a daunting thought. Best practices in plan management extend beyond ongoing management to include the initial planning, transitioning and implementing new or existing plans, tracking and managing new option grants, managing and executing stock splits and granting dividends. In reviewing and planning for these events, factors such as the key points discussed above need to be carefully considered and partners with experience, proven results, global capabilities, and technical adaptability become integral in ensuring success. Organizations setting the standard in employee equity plan management are choosing partners that are focused and specialized in the plan management industry to enable the organization to make their own internal decision while leveraging specialized expertise to ensure best in class equity programs.

An opportunity to increase employee participation and enrollment in a new type of Employee Savings Plan and encourage employee ownership of your company's stock, at minimal cost to your corporation.

Right now is a perfect opportunity to review the new TFSAs and include this tax-sheltered instrument in your 2009 corporate employee compensation plans.

By Lori Landage
Senior Account Manager

As we enter the second half of the year, planning for 2009 is ramping up and it's a perfect time to review a new savings alternative available to your employees. On February 26, 2008, the Canadian Federal Budget Summary was delivered and it included a very significant change with respect to personal finance, and the potential for a new incentive plan that will benefit your corporation and your Canadian employees. Namely this was the introduction (for 2009 and subsequent years) of a Tax-Free Savings Account ("TFSA"), described by the government as the most important savings vehicle since the introduction of the Canadian Registered Retirement Savings Plan ("RRSP") in 1957.

(TFSAs are) the single most important personal savings vehicle since the introduction of the RRSP.

- Canadian Government Statement

In the 2006 election campaign, one of the more significant campaign promises made by the Tory government was to introduce a mechanism through which people would be able to defer capital gains taxes, provided that the proceeds giving rise to such capital gains were reinvested within a certain time period. As predicted by many in the tax community, the actual creation of such a capital gains deferral mechanism has proven to be a challenge. Although the TFSA is presented as fulfilling this election promise, it is actually a very different and more limited vehicle. The most notable advantage of the TFSA is that all income, rather than just capital gains, earned within the TFSA will be free from tax, offering great tax benefits to Canadian employees.

TFSA quick facts:

• Canadian-resident individuals 18 or older will be entitled to contribute up to C$5,000 per year to a TFSA with the contribution limit being indexed to inflation rounded to the nearest $500
• Income and capital gains within the TFSA will not be subject to income taxes, however, losses within the TFSA will not be deductible from other capital gains that occur outside the TFSA
• Contributions will not be tax-deductible to the individual, but unused contribution room may be carried forward without limitation indefinitely
• Spousal contributions will be permitted and income earned or gains realized in a spouse's TFSA will not be subject to the existing attribution rules. Contributions to a spousal TFSA are subject to the spouse's TFSA available contribution room
• Investment earnings and withdrawals will be tax-free
• Withdrawals may be made at any time, and for any reason., The amounts withdrawn will be added to the individual's contribution room and can be replaced
• Neither the amount in a TFSA nor any amounts withdrawn from it will affect eligibility for federal income tested benefits and credits. Furthermore, withdrawals from a TFSA will not be taken into account in determining an individual's eligibility for government means-tested benefits such as Old Age Security and the Guaranteed Income Supplement. Financial institutions currently eligible to offer Registered Retirement Savings Plans (RRSPs) will be able to offer TFSAs.
• The TFSA will be of interest to employers seeking to supplement their current registered or unregistered savings plan arrangements. The TFSA is also good news for employees with little or no RRSP contribution room

Similarities to RRSPs:

• Interest on amounts borrowed for contribution to a TFSA will not be deductible
• Excess contributions will be subject to a penalty tax of one per cent per month
• Contribution room will be determined by the Canada Revenue Agency (CRA) and reported to eligible individuals who file an annual tax return
• Assets can be transferred to the TFSA of a spouse on death
• The account can be divided on marriage breakdown. Amounts transferred in these circumstances to the TFSA of the former spouse will not be counted against the contribution room of the transferee. The transferor will not have contribution room reinstated to reflect the amount of the transfer
• The same types of investment options permitted under RRSPs will generally be eligible for TFSAs

Differences from RRSPs:

• TFSAs will not have a maximum age for making contributions or closing the account
• TFSA assets can be used as collateral for loans
• the annual TFSA contribution amount/limit of $5,000 per year is fixed regardless of income

Remaining questions

• It remains to be seen whether the provinces will also exempt TFSA assets or withdrawals from consideration for provincial income-tested benefits or TFSA investment income from income tax generally
• The Federal Government has not announced the details of the administration responsibilities for financial institutions that are eligible to offer TFSAs
• As with RRSPs, the Federal Government has not announced the guidelines, registration instruction, forms and agreements that have been outlined for the roles and requirements of Trustees, Agents and Plan Sponsors
• As with Group RRSPs, the Federal Government has not announced if there will be guidelines to Group TFSAs, particularly when plan transfers, plan splits and bulk transfers occur (change in provider/institution)
• There will likely be new Tax Summary Filings and Tax Slips requirements introduced for TFSAs, particularly for tracking book values related to contributions and withdrawals (which can be moved in and out of TFSA accounts)

Despite the many unanswered questions with respect to TFSAs it is anticipated that this will be a widely accepted program with high levels of individual and employee participation. The ability to make tax-free withdrawals coupled with the conversion of any amount withdrawn into an equal amount of contribution capacity provides the TFSA with a distinct advantages over RRSPs.. Even the often critical Canadian Taxpayers Federation has touted TFSAs as "an excellent policy proposal". It is likely that, in time, TFSAs will be commonplace for Canadians and we recommend that it may be an opportune time for companies to review their employee incentive programs to consider the inclusion of a TFSA.

Starting in January, your employees will be able to participate in this tax advantaged savings plan via Shareworks, by investing regularly in your corporation's stock via payroll deductions, similar to a traditional Employee Share Purchase Program.

Contact Solium Capital today for more information about this attractive, new employee incentive savings plan, and the related benefits to your corporation.

Regular Features

IBM Settles Stock Option Expensing Suit
June 3, 2008 - IBM agreed to settle to the amount of $20mil in a securities class action lawsuit for claims that it misrepresented its stock option expenses for the first quarter of 2005 . Those that invested in IBM from April 5-14, 2005, claimed that omissions and misrepresentations in an release on April 5th gave misleading information regarding anticipated financial results relating to the option expensing of Q1 2005. The initial presentation estimated the negative impact of stock options on first quarter earnings would be $0.10/share but the announcement on the 14th stated actual expenses of $0.14.share. That, in addition to announcing decreased earnings of $0.90 to $0.85/share, caused a 8% drop in IBM's stock value.

The SEC Hit List

New Precedent Set: The First Compensation Consultant Fined for Backdating

Typically when fines for stock option backdating are announced, eyes turn to the usual suspects such as the CEO, CFO, General Council, VP Human Resources or other executives. However, with fines being levied in June against Harvey Benenson, CEO of the of Lyon, Benenson & Co., the scope has now widened for those who can be punished. For the first time, a compensation consultant has been tagged with a fine and one worth a $2 million out of a total of $34.4 million for a settlement to a derivative lawsuit against Cablevision Systems. They stated in its Form 10-Q of September 21, 2006 that backdating occurred SARs and stock options between 1997 and 2002.

404(b) Compliance Delayed for Small Businesses

A year extension was granted to the requirement for small businesses (defined as those with a market cap under $75mil to comply to Section 404(b) of the Sarbanes-Oxley Act. Attestation reports will now be required in annual reports for these companies with fiscal years ending on or after December 15, 2009. The Section requires an auditor to attest to management's assessment of the company's internal controls over financial reporting.

US Finance Executives warming up to IFRS

According to a Deloitte poll of 200 companies' executives, 30% are considering adoption of IFRS. This is up from 20% from a similar poll conducted 6 months ago.

"As more companies outside the U.S. report using IFRS there will likely be increasing pressure on U.S. companies to do the same in order to stay competitive in increasingly global capital markets." - D.J. Gannon, Deloitte & Touche IFRS Solutions Center.

Status briefing on Transitioning GAAP to IFRS

Tentative Dates set by the SEC
On Wed. August 27, 2008 the SEC finally gave some solid direction as to the timeline anticipated to transition US companies to IFRS. The roadmap, which is up for a 60-day comment period, is as follows:

2009 - Approximately 110 large firms will be given the option to start using IFRS standards for financial reporting

2011 - The SEC will review and analyze the use of IFRS and determine whether or not all US companies will be required to adopt it and, if so, a schedule for milestones and deadlines for certain companies will be determined,dependant on size.

If adopted in 2011:

2012 - the initial companies will now be required to report their financial results using IFRS

2014 - large accelerated filers begin using IFRS

2015 - accelerated filers begin using IFRS

2016 - all public companies will be mandated to report their financial results using IFRS

SEC Full After One Year

It had been 49 weeks since all five of the commissioner positions of the SEC were spoken for. After Luis Aguilar and Troy Paredes were sworn in as commissioners on July 31st and Aug 1st respectively, all seats are finally filled. This should help Chairman Cox move forward with initiatives like IFRS implementation.

Timing the award of long term incentives such as stock options and RSUs is crucial for Human Resources professionals in order to retain, attract and motivate employees. The timing and type of event that triggers employees receiving these incentives can vary from company to company. Below is a breakdown of the typical events that lead to determining when an employee receives an incentive grant:

Stock options were once the standard for awarding long term equity incentives to employees but in the wake of the accounting scandals of the 90's and the more recent fall out from backdating option scandals, expensing requirements have become stricter and companies are looking to other programs for awarding employee incentives. The prevalence of restricted stock and performance-based awards are gaining ground on stock options and year-to-year are getting closer to becoming more popular.

From 1999 to 2005 a CEO's mix of incentives have gone from 8% restricted stock to 27% while the percentage of stock options in that mix has decreased from 78% to 52%.