Exercise of stock options: Compensation or a fringe benefit?

Just as the annualization of withholding tax is about to begin, the Commissioner of Internal Revenue (CIR) issued Revenue Memorandum Circular No. (RMC) 88-2012 dated December 27, 2012, to clarify the tax implications of income or gain from the exercise of stock option plans.  In BIR Ruling No. 119-2012 dated February 22, 2012 it was ruled that any income or gain derived by an employee from the exercise of stock option is considered as additional compensation subject to income tax and consequently, to withholding tax on compensation (WTC).   However, in RMC 88-2012, the CIR clarified that notwithstanding the aforementioned ruling in BIR Ruling No. 119-2012, any income or gain derived from stock option plans granted to managerial and supervisory employees which qualify as fringe benefits is subject to fringe benefits tax (FBT).

As worded, RMC 88-2012 can be taken to mean that income or gain derived by the employee for the exercise of stock option is subject to WTC; or to FBT, if the stock option qualifies as a fringe benefit.  Unfortunately, the RMC does not provide guidelines or criteria for the classification of the gain from the exercise of stock option as fringe benefit or as compensation income.

Under Revenue Regulations No. 3-98, the term “FRINGE BENEFIT” means any good, service, or other benefit furnished or granted by an employer in cash or in kind, in addition to basic salaries, to an individual employee (except rank and file) such as, but not limited to the following:

1. Housing;

2. Expense account;

3. Vehicle of any kind;

4. Household personnel, such as maid, driver and others;

Interest on loan at less than market rate to the extent of the difference between the market rate and actual rate granted;

6. Membership fees, dues and other expenses borne by the employer for the employee in social and athletic clubs or other similar organizations;

7. Expenses for foreign travel;

8. Holiday and vacation expenses;

9. Educational assistance to the employee or his dependents; and

10. Life or health insurance and other non-life insurance premiums or similar amounts in excess of what the law allows.

Based on the above definition, the gain in the exercise of a stock option plan would qualify as a fringe benefit.  Does it follow that the gain from the exercise of stock option of managerial and supervisory employees is subject to FBT, and not to withholding tax on compensation?

As illustrated below, whether the gain in the exercise of stock option is subject to FBT or to WTC, the same amount of taxes will be remitted to the Bureau of Internal Revenue (BIR).

1. Under a stock option plan where the employer will shoulder the taxes, the tax base for FBT and WTC would be the grossed up amount of the gain from the exercise of stock option; hence, the amount of tax that will be remitted to the BIR would be generally the same under the FBT or WTC scenario.

2. Under a stock option plan where the employer will not shoulder the taxes on the gain from the exercise of stock option, it can adopt a policy to include the tax cost (FBT or WTC) in the total stock option gain of the employee.  Thus, the tax that will be remitted to the BIR will still be the same under either tax scenario.

From the standpoint of tax collection, there is thus no compelling reason to require taxpayers to treat the gain from the exercise of stock option as subject to FBT.  As shown above, under the WTC or FBT regime, the BIR stands to collect the same amount of taxes.

RMC 88-2012 was supposedly issued to clarify the taxation of gain from the exercise of stock option.  Unfortunately, it has instead created confusion among taxpayers.  Some quarters fear that the RMC will be used as basis to assess deficiency FBT even against taxpayers reporting the gain on the exercise of stock option as compensation income subject to WTC.  If the intention is to revoke BIR Ruling No. 119-2012 and to subject to FBT the gain from the exercise of stock option, so be it.  But please make the pronouncement clear and unequivocal.

Cecille Fernando is an assistant manager from the tax group of Manabat Sanagustin & Co. (MS&Co.), the Philippine member firm of KPMG International.

This article is for general information purposes only and should not be considered as professional advice to a specific issue or entity.

The view and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG International or MS&Co. For comments or inquiries, please email [email protected] or [email protected].