Common Questions About Pennsylvania Stock Options

Transcription

1 Global Stock Options Survey Eckert Seamans Cherin & Mellott, LLC Pennsylvania, U.S.A. CONTACT INFORMATION: Paul M. Yenerall Eckert Seamans Cherin & Mellott, LLC U.S. Steel Tower 600 Grant Street, 44th Floor Pittsburgh, Pennsylvania Telephone: Are there any corporate actions that need to be taken by the Committee or the shareholders to establish the plan? Under Pennsylvania law, the Plan may be adopted by action of either the full board of directors or the Committee. Because adoption of the Plan should not constitute a voidable interested transaction under Section 1728 of the Pennsylvania Business Corporation Law, additional corporate action should not be required under Pennsylvania law. In addition shareholder approval is required under the Securities Exchange Act of 1934, as amended because the Plan is an "equity compensation plan." 2. Are there any requirements in your jurisdiction about the composition or authority of the Committee? Because Company X is listed on the New York Stock Exchange any committee with responsibility for approving compensation of Company X s executive officers must be comprised of independent directors. Pennsylvania Business Corporation Law does not prescribe any specific requirements for the composition of the Committee. It should be noted that laws pertaining to banks and insurance companies may include their own independence requirements.

2 3. What does the Committee have to publicly disclose about its Plan-related decisions and when must those disclosures be made? Under the Pennsylvania securities laws, the issuance of securities pursuant to the Plan should be exempt from the registration requirements. Pennsylvania law provides an exemption for securities listed on the NYSE and any right to purchase such listed securities and an exemption for the issuance of securities in connection with a stock option, purchase, savings, pension, profit-sharing or similar compensatory benefit plan or compensatory contract for employees. There are also a number of public disclosures that must be made under the Securities Exchange Act of Is a participant subject to taxation: on receipt of the option; on exercise; or otherwise? Pennsylvania taxes stock options as a form of employee compensation. Unlike the federal tax treatment, Pennsylvania does not differentiate between ISOs and nonqualified stock options. Pennsylvania taxable income includes income from all stock options to the extent such income can be designated as Pennsylvania source income or is received by a Pennsylvania resident. 5. Does the tax treatment vary depending on where the Participant resides or habitually exercises his duties (i.e. outside your jurisdiction)? Yes. For Pennsylvania personal income tax purposes, the Pennsylvania Office of Chief Counsel has ruled that income from the exercise of stock options is includible in Pennsylvania income even if the taxpayer was not a Pennsylvania resident at the time the options were granted. For instance, a Pennsylvania resident taxpayer who exercised stock options granted while a resident of Idaho was subject to Pennsylvania income tax. 6. Does the tax treatment vary depending on the type of option or specific Plan provisions concerning the option? Yes. The federal income tax consequence to a participant depends on whether the option granted is an incentive stock option (ISOs") or a nonqualified stock option. For Pennsylvania personal income tax purposes, Pennsylvania taxes stock options as a form of employee compensation and does not differentiate between ISOs and nonqualified stock options. Therefore, all forms of stock options are taxed at the flat rate of 3.07 percent (in 2008) for personal income tax purposes upon exercise. 7. Is Company X entitled to claim a deduction from (or other reduction of) taxable income with respect to the option and, if so, when and how is this calculated?

3 Under Pennsylvania (PA) law, the PA corporate net income tax is levied on corporations (and certain other entities) at a flat 9.99 percent rate (in 2008). Taxable income for purposes of the corporate net income tax is federal taxable income before net operating loss and special deductions with PA modifications. Stock options are added back to federal taxable income for purposes of calculating PA tax, but only to the extent that they are not included in federal taxable income. 8. Does the tax treatment under 7 vary depending on where the Participant resides or habitually exercises his duties (i.e. outside your jurisdiction?) Yes. In each instance that an amount is treated as compensation received by a Participant, Company X generally is entitled to a corresponding deduction in the same amount for compensation paid. However, if the equity compensation received by the Participant is not subject to United States income taxation (i.e., the Participant resides outside of the United States and performs all of his duties outside of the United States), then Company X would not be permitted to take a deduction. 9. Are there special rules for significant shareholders (for example, more than 10% shareholders of the Company)? Yes. Code Section 422(b)(6) provides that an individual who owns more than 10 percent of the total combines voting power of the Company (or its parent or its subsidiary) is not eligible to be granted an incentive stock option. However, Code Section 422(c) (5) changes the application of Code Section 422(b) (6) from a total disqualification provision into a requirement that the ISO must have an exercise price at least equal to 110 percent of the fair market value of the stock on the date of grant (rather than 100 percent) and must have a maximum term of five years from date of grant. 10. What are the other principal tax considerations, if any, such as withholding for social insurance, employment taxes, unemployment taxes, etc., for Company X or its local subsidiary or branch office in your jurisdiction, and the participant? The Pennsylvania Department of Revenue has taken the position that stock options are subject to personal income tax withholding and reporting in the year that they are exercised unless the transfer or disposition of the underlying stock is subject to substantial limitations or restrictions. The amount subject to withholding is the difference between the cost of the option and the fair market value of the stock at the time the employee has the right to receive it. There are reporting obligations under the federal income tax regime to be concerned about. 11. What needs to be done, if anything, under your local law so that Participants obtain the favorable tax treatment offered by your jurisdiction?

4 For Pennsylvania income tax purposes, all income is taxed at the same tax rate so there is no favorable tax treatment available for stock options. For 2008, all taxable income in Pennsylvania carries a flat personal income tax rate of 3.07 percent. Thus, for the nonqualified option, gain on exercise, as well as subsequent gain on sale (i.e., the excess of fair market value on date of exercise) would both be taxed. 12. What securities law, or other regulatory (or exchange) requirements are there, if any, such as: filing requirements; prospectus requirements; offering exemptions; size of offering limitations; and currency requirements? Assuming Company X meets the eligibility requirements for Form S-8, Company X will need to register the securities issued under the Plan and any interests in the Plan on a Form S-8 registration statement. As required by Form S-8 and various provisions of the Securities Act, Company X must deliver a prospectus describing the Plan to the Participants and Company X s latest audited financial statements. There are also periodic reporting and proxy material requirements. Under the Pennsylvania securities laws, the issuance of securities pursuant to the Plan should be exempt from the registration requirements. 13. Is a cashless exercise permissible? Yes. Section 402 of the Sarbanes-Oxley Act prohibits a public company from, directly or indirectly, extending or maintaining credit in the form of a personal loan to any director or executive officer of such public company. As this prohibition could be construed to apply to cashless stock option exercises by Participants who are executive officers of Company X, the Plan should provide for delivery of any shares to be used in a cashless exercise feature of the Plan should comply with Section Are there any rules in your jurisdiction that prohibit or discourage a foreign subsidiary of Company X from granting options to acquire shares of common stock of Company X to the subsidiary's executives? With respect to ISOs, the term incentive stock option is defined by Code Section 422(b) to mean an option granted to an individual for any reason connected with his employment by a corporation, if granted by the employer corporation or its parent or subsidiary corporation, to purchase stock of any of such corporations. Consequently, under the ISO rules, a foreign subsidiary of Company X can grant options to acquire shares of common stock of Company X to the subsidiary s executives. With respect to nonqualified stock options, there are no similar restrictions. 15. Are the rules addressed in this survey applied differently based on whether the multinational operates in a particular jurisdiction as a branch office or as a domestic subsidiary? If so, what are these differences?

5 There is no difference between branch and subsidiary at the Pennsylvania or federal level for the issue covered by the survey. The responses in this survey with respect to U.S. federal securities laws would differ greatly if only a subsidiary or branch office of the multinational operated in this jurisdiction. 16. Do executive employees in other jurisdictions need to be covered by a plan of the subsidiary or a plan separate from your Plan to comply with your jurisdiction's law? There is no requirement within this jurisdiction requiring executive employees located in other jurisdictions to be covered by a plan of the subsidiary. The Plan may cover employees residing and working outside of the United States. Because incentive stock options ( ISOs ) are designed to provide favorable treatment under U.S. federal income tax law, non-u.s. employees who are not subject to taxation in the United States may derive no benefit from receipt of an ISO (as compared with a nonqualified stock option). Such non-u.s. employees likely will be taxed identically under their local laws without regard to the type of option they receive under Company X s global stock equity plan. 17. If known, please comment on the accounting issues which are relevant for this Plan. Under Financial Accounting Standard 123R, the amount of the compensation cost to Company X resulting from the grant of an ISO is equal to the fair value of the option on the date of grant. For nonqualified stock options, the option is valued on the date the date of grant. The value is taken as an accounting charge over the vesting period of the option. Compensation cost is reported directly on Company X s financial statements. 18. List any other requirements of importance in your jurisdiction. Consideration should be given to Internal Revenue Code Section 409A, a penalty provision. Incentive stock options are not subject to Code Section 409A because statutorily in order to be an ISO, the exercise price must equal the fair market value of the stock at the date of grant. Nonqualified stock options are similarly accepted from Code Section 409A if the exercise price may never be less than the fair market value of the underlying stock when the option or right is granted, the numbers of shares subject to the option are fixed on the grant date, and there is no other deferral feature. 19. Severance Risks: Will the value of granted options legally need to be included in severance calculations? There is no legal requirement to include the value of options in severance pay calculations. Under U.S. federal securities laws, disclosures in annual reports on Form 10-K and proxy statements relating to executive compensation require, among other things, quantification of potential payments due to the named executives of Company X upon such named executives termination of employment or a change in control of Company X. Therefore, with respect to any

6 Participant who is a named executive officer of Company X, Company X would have to quantify the value of the granted options for disclosure. 20. Acquired Rights: Will Plan participants become legally entitled to future grants or immediate vesting at termination of employment or service? Company X is permitted under the laws of this jurisdiction to include in its Plan acquired right provisions. Specifically, Company X can provide that if a Participant terminates employment or service with Company X, or if Company X terminates the Participant without cause, any portion of the option that has become exercisable generally may be exercised within 90 days after termination. This exercise period can be extended to one year in the event of death or disability. 21. Data Privacy: Will Company X or the local subsidiary or branch office need to take any additional measures to adhere to local data privacy laws? Company X or the local subsidiary or branch office will not need to take any additional measures to adhere to local data privacy laws with respect to options.