Share-based income: Compensation, fringe benefit, or what?

As a continuation to my Sept. 28, 2006 article, "Option income: Compensation or fringe benefit?", this article intends to provide an update on the BIR’s position on the issue of the tax treatment of option income. This time, however, I deemed it best not to limit the discussion on stock option income alone, but rather, to include the broader topic on share-based compensation, in general.

Share-based compensation, in recent days, has become more attractive than cash compensation since it gives the employees the opportunity to become part-owners of the company instead of being mere salaried employees. In fact, due to its increasing popularity especially in the Philippines, the trend has leaned toward wide-based programs which cover not only top executives and managerial employees but all rank-and-file employees.

However, despite its popularity in the Philippines, there remains no specific and clear-cut guidelines on tax implications. Thus, the treatment is generally determined with reference to existing revenue regulations on income taxation, specifically those that relate to payments in kind to employees as well as on the BIR’s interpretation, as embodied in tax rulings.

Unfortunately, existing interpretations offer taxpayers conflicting opinions. Hence, instead of providing clarification, they often create further confusion.
For example, in BIR Rulings 027-95, 135-97 and Delegated Authority (DA) Ruling DA-181-01, the BIR has consistently ruled that share income (arising from various share-based compensation schemes) is compensation income subject to withholding tax on compensation (WTC).

However, in Ruling DA-255-2005, the BIR unexpectedly ruled that option income derived by managerial employees is taxable as a fringe benefit subject to fringe benefits tax (FBT) and not WTC.

This change in position created quite a stir among taxpayers and also among tax practitioners particularly because there had been no revocation of the earlier rulings on the compensation treatment of the share income. Thus, the BIR is effectively allowing alternative tax treatments to the option income. This is quite evident in the following rulings which upheld both the compensation and fringe benefit treatment of share income:

"It is clear from your representations that the executives of xxx who are qualified under your Restricted Stock Unit Plan (RSUP) receive benefits either in xxx shares or its cash equivalent which clearly constitute a fringe benefit xxx. Such being the case, the benefits under your RSUP are subject to the fringe benefit tax xxx.

xxx being the employer, it is liable to pay a final tax of 32% based on the grossed-up value of the benefit granted, xxx. Accordingly, the 32% tax is payable upon the delivery of the shares of stock or its cash equivalent." (DA-152-2007 dated March 14, 2007)

"However, the discount provided under the SPP is a realized benefit actually received by the employee-participants upon exercise or purchase of the xxx common stock. If the employee-participants bought the shares at market, they would have been made to pay for the shares at prevailing market price. Consequently, the discount is considered compensation xxx. That the discount is a realized benefit considered as additional compensation for the services of employee-participants becomes more evident by the fact that xxx it expensed out the discount." (DA-353-2007 dated July 2, 2007)

Moreover, as if two different tax treatments of the same income type are not confusing enough, the BIR further issued two rulings which favored a tax exemption.
In DA ITAD Ruling 020-06 dated March 13, 2006, the BIR ruled that employees exercising their stock options are not required to pay income tax on the difference between the acquisition cost and market value at the time of exercising the stock option or the purchase of the shares.

The reason is because in the exercise of their stock options, employees will be using the money or fund they had saved under the program which is considered capital and therefore no income or flow of wealth shall be actually or constructively realised or received despite the grant of a discount.

Similarly, in BIR Ruling 003-200 dated Jan. 29, 2007, the 15% reduction on premium relative to the subscription of employees participating in the program was not considered income forming part of their compensation since the reduction is not given as a remuneration for services performed by the employees under the employer-employee relationship, but rather, it is based on a mutual contractual relationship arising from the subscription by the employees to the authorised capital stock.

With all these apparently conflicting opinions, would the BIR admit to a "lapse in judgment?" Talking about lapses in judgment, I can’t help but be reminded of the infamous "I am sorry" speech delivered by President Arroyo on June 27, 2005 where she apologised for her "lapse in judgment" in calling a Comelec official at the height of the election canvassing process during the May 2004 elections.

I personally would like to believe that the BIR has judiciously evaluated these rulings. However, without any clear and specific guidelines or yardsticks against which these rulings were measured/evaluated, a different message is communicated to the readers-taxpayers, i.e., the tax administrators cannot seem to get their acts together.

On the other hand, if the BIR indeed had a lapse in judgment, I hope that the words uttered by the President would reverberate within the walls of the BIR offices and send the message that while it is human nature to err, it is likewise in our nature, as intelligent beings with conscience, to recognise our mistakes and make amends, no matter how late the realization may be.

Taxpayers, however, need more than just to hear the words "I am sorry." More precise and consistent rulings are preferred to come from the BIR for better and more effective tax compliance.