Employee Stock Purchase Plan, ESPP – How do we lose out to the government, you asked?
In my previous post on differing implementation of Employee Stock Purchase Plan, I quoted on an amendment in Malaysia taxation system on ESPP being the probable reason behind the change in the determination of applicable stock purchase price and date from Scenario 1 to Scenario 2.
Quoting ChampDog’s original posting on this, lets assume the following constants.
Your company practises Scenario 1
Subscription price: $30
Subscription price less 15% discount: $25.50
Purchase (subscription) period last trading day closing price: $50
Number of shares purchased: 50 units
Previous Tax Scheme for Employee Stock Purchase Plan, ESPP
Taxable gain is the total discount in purchasing the shares. This is straightforward.
In this case: (30-25.50) x 50 = $225
Current Tax Scheme for Employee Stock Purchase Plan, ESPP
Taxable gain takes into account the purchase period last trading day closing price, AND the actual discounted purchase price.
In this case: (50-25.50) x 50 = $1,225
Regardless whether you realize your capital gain (sell the shares) or not, you will be taxed upfront for the paper gain. This may not appear on monthly pay slip but it will show in the EA form.
However, we knew that capital gain is not taxable in Malaysia, so isn’t this just plain idiotic?
LHDN, however, defined the 15 percent discount in ESPP as a form of given to you because of your employment. Hence it is taxable.
Anyway, what if the share price drops a lot after the purchase date, and you are still holding onto your shares purchased via ESPP? Doesn’t matter, LHDN already locked onto your $1,225 worth of taxable income.
If so, it makes our employee stock purchase plan much less an attractive, especially if you plan to hold onto your stocks for long period, and the share is prone to price drop in the short term. It is very likely that you will be taxed more in this case for the Year of Assessment in question. Of course, if the share price appreciates further after that, you will feel less of an impact.
The government is finally getting smarter in catching up with the loophole 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. 🙂
Key takeaway – LHDN screwed us big time on employee stock purchase plan. No surprise, though.