Key Takeaways
1. Granting stock options to foreign employees is increasingly an important compensation component for attracting the best overseas talent.
2. ‘Equity compensation’ covers various possibilities which relate to stock or shares in the company in question. Stock options is perhaps the most popular form of equity compensation.
3. It is possible to issue stock options to foreign employees, though there can be tax complications.
4. It may be possible to issue stock options through a PEO, Employer of Record, or outsourcing solution depending on which country’s laws are involved.
It is becoming increasingly common for businesses to attract new employees with equity compensation in the form of shares, stock, stock options and other financial securities.
Below, we explain the key things you need to know about granting stock options to foreign employees.
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What Are Stock Options and Equity Compensation?
Equity compensation, or ‘equity-based compensation’, is a form of remuneration for employees that relates to stock or shares, or some other form of security or financial product.
It can be a useful component of compensation in a variety of situations, including:
- Startup hiring. Often startups are low on liquidity which hampers their ability to provide generous cash compensation. Equity compensation (especially stock options) can be a useful mechanism for attracting new employees while keeping expenditure low in the early years;
- Executive or specialist hiring. Even with well-established companies, it can be important to have equity as part of the compensation package for attracting executives or technical talent such as software developers. By analogy, consider the way in which new partners in law firms receive/purchase an ownership interest in the firm;
- Workers co-operatives. In these cases, staff generally become equity holders as as the corporation is owned entirely by staff members.
Common forms of equity compensation include:
- Stock or shares
- These terms are generally used interchangeably to refer to a fractional ownership interest in a company or corporation. ‘Common stock’ is an ordinary ownership interest in a corporation. ‘Preferred stock’, unlike common stock, usually doesn’t carry voting rights, but comes with increased dividends, and a preference over common stockholders in cases of distress/insolvency.
- In most cases, when granting stock options to foreign employees, it is common stock that is granted, with preferred stock being primarily for investors.
- In the case of ‘restricted stock’, also known as ‘restricted stock units’ or ‘RSUs’, the stock is only vested in the individual when certain conditions are met. In the case of ‘shadow stock’ or ‘phantom stock’, the employee receives a product which follows the exact price movements of stock, but is not actually company stock.
- Employee stock options
- When an employee is given a stock option, they enter into a contract to buy a stock at a certain fixed price (the ‘exercise price’. After a certain vesting period, they are able to ‘exercise’ that option and buy the stock.
- The goal for the employee is for the exercise price to be lower than the market price of the stock when the employee is permitted to purchase it. The difference is then profit for that employee.
- Employee stock options can take several different forms in the United States. An incentive stock option (ISO), is a statutory stock option available to employees in the US which provides specific tax benefits to employees of US companies (more on this below). In the UK, a very similar form of employee benefit is known as an ‘enterprise management incentive‘.
- A non-qualified stock option (NSO) is a stock option that does not qualify for the tax breaks of an ISO (more on this below).
- Employee stock purchase plans
- An employee stock purchase plan (ESPP) is a program administered by a company which allows participating employees to purchase stock at a discount.
- Contributions to the plan occur through payroll deductions. On the purchase date, the company purchases the stock on behalf of all contributing employees.
- Unlike stock options, participation in an ESPP is usually considered an employee benefit, rather than part of their compensation.
- Confusingly, a similar plan is known as an ‘Employee stock option plan‘ in India.
- Employee ownership trusts
- In an employee ownership trust (‘EOT’), the company’s owners invest in a trust. The new owner of those shares, the trustee then purchases shares in the company. Employees then become beneficiaries of that trust.
- The employees receive distributions from the trust at the discretion of the trustees, and in accordance with the trust deed that established the trust. Usually, this income will reflect dividends from the shares owned by the trustees.
- EOTs exist in the US, but are much more common in the UK, Australia and New Zealand (where trusts in general are a more common legal form).
- They are a more flexible form of compensation than ESOPs which are strictly regulated under US law, which specifies which employees are eligible to participate.
How employee stock options work
What Are the Benefits of Granting Stock Options to Foreign Employees?
When hiring employees overseas, it is reasonable to ask whether it is best to grant stock options to employees, or whether some other form of equity-related compensation may be more appropriate. Some of the benefits of granting stock options to foreign employees, compared to the other possibilities, include:
- Retaining owner control
- Issuing common stock to employees means that employees immediately acquire voting rights and hence a degree of control over the company, diluting the power of existing stockholders. Similarly, ESPPs and EOTs can allow significant indirect control through the trustee’s ownership of stock.
- By contrast, stock options mean that the existing stockholders retain control up until the point where the stock option is vested.
- Incentivizing retention
- As the vesting, and vesting schedule, is usually linked to the individual’s tenure at the company, it can be an excellent incentive for the individual to stay with the company and help it grow over time.
- By contrast, owning common stock provides no such incentive to the employee.
- Tax benefits
- The granting of stock options can have tax benefits to employees. In some cases, such as ISO in the US, the exercising of the option is not subject to income tax. The employee simply pays capital gains tax when any acquired shares are eventually sold. This results in a substantially lessened tax bill. By contrast, with a non-qualified stock option (NSO), tax is due both on the exercising of the option, and the eventual sale of the stock.
Granting Stock Options to Foreign Employees
Once you have decided that granting stock options to foreign employees is a good idea, how do you go about doing it?
Generally speaking (it depends on the country), an overseas employee of a US company will not receive the tax benefit of an ISO, as most countries tax stock options when exercised.
For this reason, US companies are more likely to issue NSOs to foreign employees. NSOs also have the benefit of being available for non-employees, such as consultants and contractors.
There is a tax complication for companies issuing NSOs overseas. Generally speaking, when the US parent company issues the NSO, the foreign subsidiary cannot deduct that cost as a cost of labor. The reason being that it is an expense of another company (the US parent, rather than the foreign subsidiary).
It is common to get around this issue with a ‘recharge agreement’. In this agreement, the subsidiary pays back the US parent for the cost of the stock option. This payment is then tax-deductible for the subsidiary.
As the payment received by the US parent is for equity, it is generally tax-free.
Method 1: Granting Stock Options to Foreign Employees with a Global PEO
A global Professional Employer Organization (global PEO), or international employer of record, hires employees on behalf of a client business in another country. This is a common mechanism for expanding overseas or hiring foreign employees in a cost-effective and compliant manner.
Where a US company is granting stock options to foreign employees, it is usually under rule 701 of the Securities Act 1983 (for privately held stock) or Form S-8 (for publicly listed stock). These regulatory provisions permit companies to issue options (a financial product) without being a registered security provider.
These provisions provide that the stock may be issued to ’employees’ or ‘consultants’. Depending on the employment contracts issued by the global PEO, there is an argument that the employees may be ‘common law employees’ of the client company, permitting them to receive equity under the plan.
Note, for some types of stock option this will not be permitted. For example, the Enterprise Management Incentive scheme in the UK is not eligible to employees of a PEO.
Method 2: Granting Stock Options to Foreign Employees by Outsourcing Payroll and Benefits Administration
As noted above, in some cases, issuing stock options to overseas employees via a PEO or employer of record can pose a compliance risk.
There is a viable workaround in many cases however. PEO agreements between global PEOs and client companies are flexible documents. It is often possible for the client company to outsource the processing of payroll, withholding of employee taxes and administration of stock options and other benefits, while still remaining the legal employer of staff. This is usually done by opening a foreign subsidiary in the country of expansion to be the formal employer of workers, while the PEO carries out the practical employer tasks delegated to it.
To read more about outsourcing benefits administration in general check out What is Benefits Administration?
Horizons Can Help With Granting Stock Options to Foreign Employees
Stock options can be a useful element of employee compensation, anywhere in the world. Horizons are experts in international benefits administration and can ensure your foreign employees receive this compensation in full compliance with local laws.
Get in touch with us today to find out how to grant stock options to your foreign employee through global PEO or outsourcing solutions.
Frequently asked questions
Yes. However incentive stock options (ISOs) are generally only available to employees. For non-employees, such as directors and consultants, non-qualified stock options (NSO) are available.
Yes, as long as the individual is an employee of the qualifying US company. Note, however, that individuals based overseas will often lose out on many of the tax benefits of an incentive stock option (ISO).
The United States can tax any and all income on its citizens, regardless of whether the income come from local or foreign sources.
U.S. citizens must fill out IRS Form 8938 if they hold foreign stocks or securities that pass the reporting threshold (specified foreign assets valued at minimum USD $200,000 on the last day of the tax year OR USD $300,000 at any point of the year for unmarried taxpayers; specified foreign assets valued at minimum USD $400,000 on the last day of the tax year OR USD $600,000 at any point of the year for married taxpayers).
U.S. taxation on foreign stock options should be taken seriously. We recommend to consult a tax professional if there is any question of whether to report financial assets.
