France: Tax Authorities Clarify Taxation of Equity Compensation in International Context
A few weeks ago, the French Ministry of Finance issued decrees which will facilitate the collection of data (and tax) on the French sourced gains derived from equity awards when the beneficiary has left France. Tighter control will be achieved by tracking the “French source portion” of gains under new employer reporting requirements. The French tax authorities have now issued two instructions that focus on international aspects, including what is meant by “French source portion” of the equity gains.
Determination of French Source When Working in More than One Jurisdiction
The first instruction1 sets out how the “French source portion” of the gain should be determined when beneficiaries have worked in more than one jurisdiction during the life of an equity award.
A report of the Committee on Fiscal Affairs Discussion of the Organization for Economic Cooperation and Development (OECD) adopted in June 2004, made it clear that such gains should be regarded as employment income to which Article 15 (Income from Employment) of the OECD Model Treaty applies. However, the conclusion that gains are considered employment income was at odds with the French tax administration’s practice, as well as the legal framework that existed at the time.
Just before the issuance of the instruction, some tax local centers took the view that stock option gains were treated as capital gains and fully taxable in the country where the individual was a resident at the date of taxation (usually in cases where France was the country of residence). However, in other cases (usually where the individual was a nonresident), they took the contrary position and would seek to tax at least part of the gain if beneficiaries had worked in France during the life of the award.
The position that the French tax authorities now use is that the acquisition gain made by beneficiaries of equity awards is taxable in France when it relates to duties performed in France. In accordance with the general position of the OECD, the acquisition gain would be considered acquired over the “vesting” period applicable under the plan.
The acquisition gain therefore needs to be pro-rated according to the time spent in each of the countries in which the employee performed his or her professional activity during the vesting period. Where the individual is a nonresident at the relevant date, a new withholding will apply on the “French source portion” as provided below. For example, if the employee spent two years in France over a total vesting period of four years, half of the gain would relate to France and would be taxable there.
Tax instructions express the view of the French tax administration and its interpretation of legislation. As such, they can be relied upon by taxpayers when filing their tax returns and provides for some welcome clarity. However, the instruction does not completely resolve all the issues surrounding the legal qualification of the exercise gain where a four-year period has been met and the options were granted prior to June 20, 2007. (Before that date, the stock option regime was clearly connected to the general regime for capital gains tax in the French tax code.) That situation may not be fully resolved until a higher court renders a decision.
The instruction could apply to all open situations and it may be worthwhile reviewing these where appropriate for cases where relief for double taxation was denied and the statute of limitation has not run its course.
French Source Income for Non-Tax Resident Employees and Withholding Tax on Equity Compensation
French source remuneration paid to employees that are non-tax resident in France is generally subject to withholding tax. Because of the intricacies of equity compensation, it was felt that this mechanism was not suitable to address the issue of perceived tax “evaporation” and under-reporting when the beneficiaries had left France and became nonresidents prior to the taxable event. Thus, a specific withholding tax was introduced by Article 57 of the Amended Finance Law for 20102 (for details of the withholding tax see Flash International Executive Alert 2011-005 (Amended), January 10, 2011).
The withholding tax applies to gains and benefits derived from French qualified stock options, French qualified free shares (i.e., qualified RSUs), and special stock-options for French start-ups called BSPCE as well as, more generally, to any grant of securities on preferential terms to employees or company officers where part of the award relates to the exercise of their activities in France. The rules apply when the beneficiaries are not tax residents in France at the relevant date of taxation.
The second aforementioned instruction3 examines the scope of the withholding tax, the taxable event, the basis for the withholding, responsibilities for withholding, and any adjustments to the withholding tax via the taxpayer’s individual tax return. It makes it clear that the withholding is in effect from April 1, 2011, even though the framework was not in place until much later on – that is, all awards that vested after that date if the beneficiary is not a tax resident of France on the date of the taxable event. The instruction also excludes from the scope of withholding those options granted prior to June 20, 2007 (possibly pending a higher court decision on the nature of such gains (see above)).
The withholding tax should normally be paid on or before the 15th of the month following the taxable event. However, the French tax administration accepts that where the taxable event occurred between April 1, 2011 and March 31, 2012, the payment of withholding tax can be deferred until May 15, 2012. Companies are advised to review their obligations for all their beneficiaries that have vested awards post-April 1, 2011.