For tax purposes, employment stock options refer to the employee’s right to receive or acquire the company’s shares based on their employment relationship and on a certain kind of contract or commitment, such as a stock option. An employment stock option also creates taxable benefit for the employee if the option allows him or her to register the share at a lower price than fair value. In determining the benefit amount, the total price paid by the employee for both the share and option is deducted from the share’s fair value at the time of registration.
All discount received through exercising employment stock options is considered earned income of the employee regardless of the size of the discount or whether stock options are offered to the majority of staff. Tax is not paid on the benefit until the year in which the employment stock options are exercised, i.e., the employee receives or acquires shares under the option or surrenders the option. In the latter case, the value of the benefit is considered to be the selling price minus the possible price of the option.
Donating or surrendering the option to a related party is not considered exercising the option – in this case, tax will only be payable when the transferee exercises the option. Even in this case, the benefit is the original recipient’s earned income, not the transferee’s, and income tax cannot therefore be avoided, for example, by donating options to a family member.
In the case of employment stock options, fair value for listed companies is considered to be the average rate on the day the share was registered, not the date the option was received or acquired. The fair value of non-listed companies’ shares is determined in the same manner as in personnel issue. In practice, the difference between receiving a share based on an employment relationship and a stock option arises from the fact that the increase in value following receipt of a share becomes taxable as capital income at the time of transfer, whereas the increase in share value that follows receipt of an option becomes taxable as earned income at the time of registration.