Why employee stock options are a bad idea in our tax environment
In this dawn of double taxation in Uganda, it is not only the mighty corporations, but also employees that feel the pain hence the latter should be careful.
Properly understood, an employee stock option is that which grants specified company employees the right to buy a certain amount of company shares at a predetermined price for a specific period.
An employee stock option differs slightly from an exchange-traded option because it is not traded between investors on an exchange.
I have just read the recently released Uganda Securities Exchange (USE) brochure titled “listing on the stock exchange.” It is rather interesting that as one of the advantages for listing on the stock exchange, it stipulates that listing provides “Stock options and employee share purchase programmes that are a good mechanism for compensating your employees.”
Employee stock options are a very bad idea in such a tax environment because of the inconsiderate taxman Uganda Revenue Authority (URA). Employee stock options rely solely on appreciation of value of the share price, which under the new tax regime, is taxable.
Should the share price increase, the taxman will claim a tax for appreciation in value. Adding insult to injury, there will be a double taxation of a capital gains tax should you transfer those shares at a profit as a retirement plan. You will be subjected to a fairly heavy capital gains tax of 30 per cent, so much so that your employee stock option would be worthless.
Instead, with this new tax regime promulgated in 2018, Uganda should have emulated the progressive taxation and company laws regime implemented around the world such as in the United States or Kenya in that should you pick up a share stock option, in the case of the US, you could file an 83(b) election form If you think the value of your stock will increase, so that you are not forced to pay taxes on “phantom income” each year.
You will only pay taxes once you trigger a taxable event for capital gains tax, let’s say, if you chose to sell the shares at some point in the future.
However, presently, in Uganda, you will pay a phantom value on the gradual increase on your employee stock option and a capital gains tax should you choose to sell your shares in the future. In the long succession of endeavours, this will make them totally worthless.
The consequences of not filing an 83(b) election in the United States are similar to having employee stock option in Uganda. For example, If you own 10 per cent of the stock of our startup, which we started called Pixan corporation, assuming it was incorporated in the US.
It vests over four years, or 25 per cent per year. You purchased this stock for $100 (fair market value) on January 1 of Year 1. During Year 1, the Company raised some outside financing that values the company at $10 million. At the end of Year 1, the value of the company is $10 million and the value of your stock is worth $1 million.
You have about $250,000 in taxable income in Year 1 (value of company at year-end, $10 million less value of company at beginning of year, $1K ownership percentage, 10 per cent vesting in Year 1, 25 per cent). You owe about $100,000 in Federal and State taxes in the United States.
You will pick up additional taxable income in Year 2 through Year 4 if the value of the startup continues to increase. You do not get any tax relief if the value of the company decreases. Remember, this “phantom income” is triggered just by the value of the company increasing – not by exercising the options or selling the stock.
In my view, this was done so that they stop employees from using it as a “saving for old age option” while totally abandoning this NSSF scheme.
Looks like NSSF still needs more voluntary contributors now that they are going to amend the NSSF Act to make government compulsorily borrow from the Fund. If that was the intention of government, then it has been achieved. National Organisation of Trade Union, please inform your members.
Mr Kizito is the head of legal & corporate
affairs, Pixan Corporation.
@louisNamwanjakizito
