An Introduction to the Employee Treasury Stock System

For companies considering employee stock incentive plans, besides the familiar employee profit sharing and employee stock option (ESO) schemes, they may also want to consider using employee treasury stock as an alternative reward scheme. This article discusses regulations and procedures related to employee treasury stock in the hope that this will improve understanding of such plans among corporate units.

Taiwan’s Employee Treasury Stock System

When Taiwan’s Company Law was amended on 12 November 2001, language was added under Article 167-1 regarding the employee treasury stock system. The original reason for drafting these provisions was because “Companies do often issue new shares (for employees participating in share subscriptions). Hence, having consulted legislative examples in other countries, it is stipulated that a company may use undistributed accumulated surpluses to purchase a certain proportion of their shares to be used as incentives for excellent employees and, by acquiring such shares, generating in them stronger bonds with the company and promoting the company’s development.”

The article provides that, “Except where otherwise stipulated by law, a company may purchase up to 5% of its total outstanding shares upon a resolution of the board of directors approved by a majority of the directors in attendance and with two-thirds of the directors attending. However, the total amount paid to buy back such shares shall not exceed the sum of its accumulated surplus plus realized capital reserve.” Concerning this later limitation, Ministry of Economic Affairs Letter Ching-Shang-9102298480, dated 23 December 2002, provides that “The amount paid to purchase employee treasury stock is based on the amount recorded in the company’s financial statement as of the date of the special resolution of the board of directors.” Article 167-1 also states that “Treasury stock purchased by a company may not enjoy shareholders’ rights.” Furthermore, employee treasury shares “must be transferred to employees within three years; those not transferred in that period shall be deemed to be unissued shares, and a change of registration to that effect shall be made.” Treasury stock operations by both public and non-public share-issuing companies are subject to Company Law regulations.

Publicly listed companies that use employee treasury stock are likewise subject to the provisions of Article 28-2 of the Securities and Exchange Law, under which a public company may buy back its shares on a stock exchange or over-the-counter market, or from securities brokers, and transfer the shares to employees. The proportion of shares bought back may not exceed 10% of the total shares outstanding. The total amount of the shares bought back shall not be more than the amount of retained earnings plus premium on capital stock plus realized capital reserve. The shares bought back shall be transferred to employees within three years from the date of buyback. The shares not transferred within that time limit shall be deemed as unissued by the company, and a change of registration to that effect shall be made. The shares bought back by a company in accordance with Paragraph 1 shall not be pledged, and shareholders’ rights shall not be enjoyed before transfer.

Employee Treasury Stock Procedures

According to Article 58 of “Criteria Governing the Offering and Issuance of Securities”, a company may issue employee stock options either by issuance of new shares or delivery of an exchange-listed or OTC-listed company’s previously issued shares (treasury stock). However, for emerging stocks, unlisted stocks, or stocks not traded in the business places of securities firms, performance of (option) contracts shall be by issuance of new shares. Therefore, an exchange- or OTC-listed company’s employee treasury stock may be handled jointly with employee stock option issuing procedures. In practice, however, when companies issue employee stock options, they commonly choose to perform the contracts by issuing new shares, viewing employee treasury stock as a separate incentive scheme.

When companies issue employee stock options, they must do so upon a resolution of a board meeting approved by a majority of the directors in attendance, with at least two-thirds of the directors attending. Under Article 10 of “Regulations Governing Share Repurchase by Listed and OTC Companies”, before buying back stock and conferring it upon employees, a company must first adopt Rules for Transfer of Shares. At a minimum, the following particulars must be clearly stated in the Rules: (1) the type, rights, and restrictions on rights of shares to be transferred; (2) the transfer period; (3) qualifications of transferees; (4) transfer procedures; (5) the arranged price per share for the transfer (which may not be less than the closing price of the shares on the day that the Rules for Transfer of Shares were adopted); (6) rights and obligations after the transfer; and (7) other matters related to the rights and obligations of the company and its employees. Ordinarily, the Rules will also spell out limits on the number of shares to be bought back, the total amount of money for buying stock and the stock purchase price range, so as to help the company in the course of its work.

Comparing the use of treasury stock versus issuing new shares, the main difference is in the direction that funds flow. A new share issue can increase needed operating capital, but if a company buys back shares for treasury stock, it must spend company funds. In addition, newly established companies may find it hard to use treasury stock because the total amount paid to buy back shares cannot exceed its accumulated surplus earnings plus capital reserve. Companies with a certain amount of history under their belts are more likely to conform to such a rule.

The Tax Consequences of Employee Treasury Stock

Except for where they are handled in conjunction with ESOs, the Ministry of Finance has so far not specified how employee treasury stock is to be taxed. However, the nature of treasury stock transfers is similar to that of employee stock options. Judging from the Taxation Agency’s firm attitude towards such options, employee treasury stock may be taxed along the same lines.

As interpreted by MOF Letter Tai-Tsai-Shui-930451436 dated 30 April 2004, if employee treasury stock is handled in conjunction with ESOs, then, where a company issues ESOs under Securities and Exchange Law or Company Law regulations, and individuals exercise their option rights in accordance with the subscription rules adopted by the company, the income earned from the current price of the underlying stock on the exercise date exceeding the option strike price falls under “other income” (category 10 in Paragraph 1, Article 14 of the Income Tax Act). It must be recorded as income of the year in which the options are exercised and by law is subject to income tax. The “current price” for an exchange-listed or OTC-traded company is “the closing price of the underlying stock on the option exercise date”. For emerging companies, unlisted companies, share-issuing companies whose shares are not traded at the placed of business of securities firms, or companies without publicly issued stock, it is “the net value per share given in the CPA-audited and certified financial statement for the most recent period.” As to the difference between the stock’s ultimate selling price and its current price on the exercise date, it constitutes a gain/loss on a securities transaction. At present, the securities transaction tax has been suspended, so losses on securities transactions may not be deducted from taxable income.