ESOP or employee stock option scheme is very popular in the industry and especially in the start-up ecosystem. This is because it helps to attract employee without putting much burden on the cash flow of the entity. Singapore being a vibrant economy attracting talents from all over the world finds good use of ESOP as a tool of compensation. In this blog we shall thus try to decode the various facets of ESOP and explain how to issue ESOP in Singapore.
Regulatory Authority of ESOP in Singapore
Like in India, in Singapore also the concept of ESOP is regulated by multiple Statues out there which include:
i) Singapore Companies Act,
ii) Listing manual of Stock Exchanges of Singapore,
iii) Taxation laws of Singapore
Major Benefits of ESOP
Attracting and Retaining Employees
Employees will have to wait for a certain period (usually range between 3-4 years), also called a vesting period, before they can exercise their right to purchase the shares. The vesting period is an important advantage since it ensures that the employee stays with the company for a certain period. If the employee leaves before the period ends, the ESOPs are lapsed and they might not get any benefit. This helps ESOP helps Start-up to retain their employees.
Lessen the Financial Burden on the Company
The Financial Burden on the company will be reduced as the money will be paid in kind i.e. ESOP and thus the compensation would not affect the immediate cash-flow of the company. Payment through stock option helps to effectively manage the finance of the entity.
In an age where innovation culture is hyped, it can be easy to forget that starting and running a business is difficult. With ESOPs, employees will feel a sense of ownership of the company since they will be part owners of the company, and not just employees. The logic is that employees will give their all to create value for the company since they will benefit directly if the valuation of the company increases and hence will take equal amount of responsibilities for the start-up.
Why Singapore is preferred destination for issuance of ESOP-
1) Process and Paper work are much less in Singapore. Hence it saves time and compliance burden for companies.
2) Valuation Report from a Registered Valuer is not required during creation of ESOP Pool by the Start-up
3) Singapore attracts global talents and hence it is a good place to attract talent by offering ESOPS
4) Singapore is one of the few developed countries of the world where tax rates are comparatively much less
5) Singapore has tax treaties with most countries and hence one can avoid paying double tax on ESOPs.
Brief idea on how to implement ESOP in Singapore
As an employer, you will need to take note of the following:
- The company should decide on the percentage and number of shares in the ESOP pool.
- One should also draw a cap table. Cap table is a form of showing a start-up’s shareholding structure in a table format on a fully diluted basis. You may want to inform future investors about the ESOP pool in place, so this table comes handy.
- Once you have the ESOP pool in place, have an ESOP Agreement executed. One should take help of someone who is proficient over here as this agreement has major implications on the overall objective of the company while implementing ESOP.
- After drafting a ESOP Agreement, pass a Board Resolution in the Board Meeting to authorise its directors to sign the ESOP Agreement.
- Once the ESOP agreement is signed and adopted, constitute the ESOP committee.
- The ESOP Committee will then record the proceedings of the ESOP meeting and keep the directors informed of any grant, issuance etc made to its employees.
- If the ESOP has been issued to any employees, necessary returns are filed with ACRA informing them about the addition of the shareholders. It is to be noted that the return is filed only when the ESOPs are issued and not at the time of formation or grant.
- Update the ‘Register of Members’ with the details of the new shareholders.
Restriction with regard to ESOP
There are certain restrictions with regard to ESOPs in Singapore for e.g.:
- Employees who are substantial shareholders (with more than 5 percent share ownership of the company) are not allowed to participate in the plan.
- The number of shares that can be issued under each plan must not exceed five percent of the total issued share capital for main board-listed companies and must not exceed 15 percent for the smaller firms listed on the SES Dealing and Automated Quotation (SESDAQ) system.
- The number of shares issued to directors, chief executive officers, general managers, and officers of equivalent rank is restricted to 50 percent of the total number of available shares under the plan.
- The maximum entitlement of each participant is 25 percent of the total number of shares available in the ESOP.
However, all these restrictions, regulations and statutory obligation are associated with the ESOP plan that involves the equity shares of the company and not in case of cash-based incentive plans
A detail and easy explanation is given as under-
Profits from ESOP plans in Singapore are taxed regardless of where the ESOP is exercised. This is relevant for expat workers (foreign workers) in Singapore because taxation of ESOP gains will be connected to employment in Singapore and the profits will be taxable even when the ESOP is exercised after employment in Singapore has been terminated and the employee has been posted overseas.
It must be noted that, if an employee is granted ESOP during overseas employment, any gains derived is not regarded as income derived in Singapore and will not be taxed in Singapore.
Gains from ESOP plans without selling restrictions is computed based on the open market price of the shares on the relevant date less any amount paid for them are taxable in the year when the ESOP is exercised by the employee and gains from ESOP plans with selling restrictions is computed based on the open market price of the shares on the date the selling restriction is lifted less Exercise price of the shares. Where the open market price of the shares is not readily available, the net asset value of the shares will be used to determine the market price of the shares.
Also, double taxation avoidance agreement between Singapore and the other country should be referred while calculating the Tax of any foreign citizen incurring taxable income in Singapore.
Tax treatment on stock gains derived by foreign employees upon cessation of employment in Singapore – “Deemed Exercise” rule and “Tracking Option”
The “deemed exercise” rule applies to any ESOPs or ESOW plans granted on or after 1 Jan 2003 to foreign employees while exercising employment in Singapore. When a foreign employee ceases employment in Singapore, he may have some unexercised ESOPs or unvested ESOW plans. The gains from these unexercised ESOPs or unvested ESOWs are subject to tax on a “deemed exercise” basis.
Under, deemed exercise rule the foreign employee is deemed to have derived a final gain from the following when he ceases employment in Singapore:
a) Unexercised ESOPs;
b) restricted ESOPs where the moratorium has not been lifted;
c) shares under ESOW plan with vesting imposed where the beneficial interest from the ownership of the shares has not yet vested; and
d) restricted shares under ESOW plans where the moratorium has not been lifted.
Under the rule, the final gains from unexercised ESOPs are deemed to be income derived by the individual one month before the date of cessation of employment or the date the right or benefit is granted, whichever is the later.
The “Tracking option” is an alternative to the “deemed exercise” rule. Under this scheme, it allows employer to track when the “income realization event” of the foreign employee occurs and report the gains to CIT then.
The “income realization event” refers to the following:-
a) When the foreign employee exercises options that were unexercised; or
b) When the shares acquired under any ESOP plan are no longer subject to any restriction; or
c) When the shares under any ESOW plan that were unvested or restricted at the time he ceases employment in Singapore become vested or are no longer subject to any restriction.
The “deemed exercise” rule will not be applied if the employer has been approved to adopt the Tracking Option. However, cases where “deemed exercise” rule has been applied and assessment has been already finalized will not be eligible for the Tracking Option.
ESOP can be used successfully by any organization and it has various positive affect both on the Employer as well as employees. However, one should be careful both in the compliances as well as tax -perspective to get the maximum benefit out of it.