Sunday, July 31, 2011

Latest Malaysian Tax Scheme for ESPP is Stupid

If you do not know what ESPP is, you may skip this article.  Basically, ESPP stands for employee stock purchase plan. ESPP is one of the company’s compensation which allows you to purchase the company share with discount (e.g. 15%). Your company may or may not have this benefit and every company has slightly different way to implement this ESPP.

How this ESPP works is you can enroll this ESPP program for about let’s say 6 months. During this 6 months window, your company will deduct up to maximum certain percentage (e.g. 10%) of your salary every month and use this money to purchase the company share at the 6th month - the closing window (e.g. June 30) based on the “Subscription Value” with discount (e.g. 15%).

Let’s assume number of shares you have purchased with this ESPP is 50 shares and see the following example to illustrate the previous and the latest tax scheme for ESPP:

Subscription value                       = $30
Purchase price at 15% discount   = $30 X 0.85% = $25.5
Stock price on June 30 (highest)  = $51
Stock price on June 30 (lowest)   = $49
Stock price on June 30 (average) = $50
No. of shares purchased              = 50

Previous Tax Scheme for ESPP

Based on the previous tax scheme for ESPP, the taxable gain  is based on the discount (e.g. 15%) the company gives you.  In this example, the taxable gain will be $225 -  see the calculation below. This tax scheme makes a lot of sense because if the company doesn't offer you the discount, you will still need to purchase the share price at $30 not at $25.5  Because of the 15% discount, $225 is the extra money your company gives to you. Thus,  $225 to be considered as taxable income makes a lot of sense.

The taxable gain calculation based on previous tax scheme:
   = ($30 – $25.5) X 50 or ($30 X 15%) X 50
   = $225

Latest Tax Scheme for ESPP

However based on the latest tax scheme for ESPP, the taxable gain is no longer based on the 15% discount. but based on the average price of the last day of your ESPP closing window (e.g. 30 June). In this example, the average price on June 30 is $50. So it is automatically assumed that you gain $50-$25.5 = $24.5 although you didn't sell the share at June 30. Huh, what a crap?

The taxable gain calculation based on latest tax scheme:
   = ($50 – $25.5) X 50
   = $1225

So technically speaking, if you sell your ESPP share later at price lower than $50, you're actually being taxed more. Well, you may argue that what if you sell higher, then you're getting taxed less. Isn't that a good thing?Well, don't you know that capital gain in Malaysia is not taxable? If it is not taxable, why I sell higher, then I need to be taxed more? Think again!


Honestly if you ask me, there is something wrong with the latest Malaysian tax scheme for ESPP. The previous tax scheme is  reasonable but definitely not the latest. Although similar tax scheme is being applied to the restricted stock units (RSU) and stock options, I'm still okay with that because we do not fork out our own money. It is just like you're getting less compensation, not really that a big deal. However for ESPP, we basically fork out our OWN money to purchase the shares and now you simply tax me. This is not acceptable!

Well, what can you do? You can protest to the government or  just be alert of the price at the ESPP closing window (e.g. June 30) and if the price is high, you may want to consider a quick sell rather than keep it. I know this is suck...

[Update: 19 August 2011]: Let's look at the comment in this post from "HS Ooi". He gave a very good explanation why market gain is classified as the compensation instead of capital gain. Thus, it should be taxed. What do you think?

P/S: By the way, please don't confuse that you can claim back your money if your sell your ESPP share at lower price. I"m talking about taxable gain here and not the tax deduction in your monthly payslip. If there is extra tax deduction, you can only claim them back but this is not the case. The $1225 is reported as a taxable income in your EA form and it is part of your income.


LCF said...

Hi ChampDog...interesting post; when was the Malaysian ta scheme for ESPP changed? Where you get this info?

Allow me to share my experience on this at MNC A:

Previously, the subscription price (in 2008/2009)takes the lowest price within the 6 months window, and minus 15% from it. I was in ESPP in 2008/2009 but no more now. Now, the subscription price follows the closing price on the last trading day for the 6 months window. My colleague tried to pulled out from the money accumulated but not able to because it needs to be done 3 days before the last trading day. He ended up buying the shares at 52 weeks high, minus 15%. I am not aware of the rationale behind this change in my company before but after reading what you shared, this could be the reason perhaps?

Because like you said, it is not reasonable for you to be taxed (screw the tax system!) based on the average price of the share at the last trading day if your subscription price is equivalent to the lowest stock price within the 6 months period. However, to 'cater for' the Malaysian tax system, company change its ESPP system so the tax system does not look stupid but we still at the losing side for both cases.

Taking into your example, say, you accumulated $1275 from the 6 months salary deduction, which following the previous system, I can buy 50 shares at fair price of S25.5. Now, in the new system I described above, with average share price of $50 on last trading day, I can now only buy ($1275/$42.5) = 30 shares after 15% discount. So, my taxable amount now is, $7.50 x 30 = $225.

Therefore I end up having the same taxable amount, but I paid a higher price per share.

ChampDog said...

I thought you're another LCF! :) Anyway, thanks a lot for the comment.

I'm not exactly sure when the tax scheme for ESPP has been changed. I think it was started quite some time ago. It should be in 2008 if I remember correctly. In the past (for my case), the the average of the high & low market price on the day the shares are purchased is quite low. So, I don't really see the huge impact. :D However for this round, I have higher impact because the stock price in the closing window is pretty high. Now the stock price is drop about 20%, so if I sell now I"m basically getting taxed more which I"m not supposed to. All the while, I thought this is only applicable to stock options and RSUs. I can still close one eye but when this applies to ESPP as well, I think this is too much. :(

I get this information from the payroll of my company when I tried to figure out why ESPP taxable income is a lot more higher than the 15% discount. You can check with either your HR or the payroll to understand this more.

I think every company implement the subscription price differently. Specifically, my company has 1 year window with 2 6-months enrollments and the subscription is based on whatever the lowest between "first day of offering period" and the "last day of the purchased period". It is not just the last day of the purchase period but that is only for my company. Hopefully they don't plan to change that soon.

I think I get your point now especially after looking at your example. The company purposely does this so that the difference is not huge between the "purchase price" vs the stock price at the ESPP closing period. Wow, this is really a nice trick. You hide a problem without people realizing it!!! At the end of the day, it is just taxed $225 as per your example which appears to be like previous tax scheme!

Speechless... but your company seems like pretty smart too.

Alvin Lim said...

:O :O this is not what our company told us for ESPP =_= maybe our company got it wrong? need to check with them :T

ChampDog said...

Do check it out and let me know. :)

HS Ooi, CFP® said...

Well, this is not "stupid" but getting "smarter". The government is finally catching up with the loop hole of ESPP. It shows that how much lost revenue the government had suffered in the past!

In the past, when the government was taxing the "profit" of 15% subscription price discount enjoyed by employees, the government treated the discount as benefits received by employees. However, they forgot to take into consideration of "market gain" enjoyed by employees. You may argue that the market gain is a capital appreciation which shouldn't be taxed by the government. However, who is actually giving the employees the "market gain"? Is it truly market gain or employees compensation in the form of market gain?

If a company is giving out ESPP at a lower price of the offering window, in an upward market, the company is actually have to "compensate" employees for the gain. You haven't actually owned the stocks yet but you are able to buy the stocks at a lower price (plus 15% discount). The company is selling you the stocks at lower price when market price is higher at closing of the offering window. So, by definition, you are receiving "extra benefits" from the company. You are not getting capital appreciation from the stocks you owned. By taxing you based on the average price on the window closing day, the government is maximizing their tax revenue, which is a smart move by them. :-)

From company standpoint, a company will save more by using the average window closing price because they only need to pay you the 15% discount of market price. Of course, when a company is using the lower window price, most probably the company will buy some call options to make sure that in case the market is going up very high(hence the call options are in-the-money) their ESPP cost is still fixed. But this also means that the company have to pay additional premium for the options position they are taking. In a downward market when the call options are out-of-money, they will lose all the premium of the call options position. I think companies will have to spend more if they choose to use the lower window subscription price instead of window closing price. You will probably see more and more companies change to window closing price. So, enjoy the extra benefits while you still can :-)

It is a win-win for company and government to use the window closing average price instead of lowest price of the windows. This move make smart sense for them, though it is not good for employees.

As for employees, it is a less attractive benefit and like you said, employees have to be careful when executing their ESPP strategy. It is not always to the employees benefits because the tax may eat into the 15% discount the employees enjoy, unless it is in an upward market.

ChampDog said...

This is an awesome explanation especially when you're able to look at the bigger picture not only from an employee perspective. Thanks for the comments.

I've never thought of the market gain is classified as the compensation but you made a point that the company in fact compensates employees for the gain. Well, my question is does a company really folk out the money physically to compensate the employee? Is that somehow done in the accounting? It looks like the answer if yes from your explanation, then I would only consider that as compensation.

As you said, it doesn’t favor employees. I don’t like the idea being taxed that I don’t physically earn the money. Although the company does compensate but we don’t get the physical money until we sell it. So it seems like if you know your closing window price is higher than your subscriptions value, you should seriously consider to do a short selling.

Okay, looks like it is going to happen – more and more companies will change to window closing price instead of using the lowest price of the windows. Well, hopefully it won’t happen to my company that soon.

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