Whether the Exercise of Stock Option at an Exercise Price Lower than Market Value of the Stock Gives Rise to a Taxable Event for the Person Exercising the Option

February 14, 1995 BIR RULING NO. 027-95 72 000-00 027-95 Law Office of A.M. Sison, Jr. & Associates 14th Floor, Pacific Bank Building 6776 Ayala Avenue, Makati Metro Manila Attention: Mr . Nelson D . Emplamado Gentlemen : This refers to your letters dated June 24, 1994 and July 26, 1994 stating that as a performance incentive, the key managers of your clients, The Coca-Cola Export Corporation (TCCEC) Philippine Branch and Coca-Cola Far East Ltd. (CCFEL) - Philippine Division Headquarters are given stock options under the unqualified stock option plan of the Coca-Cola Company of Atlanta, Georgia, U.S.A., parent company of both of your clients, wherein the said key managers are given the right to purchase shares of stocks of the parent company at a price (exercise price) which may be lower than the prevailing market value of the stock at the time of exercise; that the Coca-Cola Company stock option plan provides for a three-year accrual (vesting) period; that no option may be exercised for the first twelve (12) months of the grant; that after this period, one-third (1/3) of the stock option becomes exerciseable, with an additional 1/36th of the said option becoming exerciseable each month until the end of the three-year vesting period; that the optionee has up to ten (10) years to exercise the options after the same are granted; that however, a terminated employee has only six (6) months after his termination to exercise the option on shares accrued as of the date of termination; that alternatively, employees who retire, become disabled or die (in this case their estate) have twelve (12) months within which to exercise their options and all shares accrue as of the date of retirement, disability or death; that payment of the option must be made in cash or shares of already owned stock (at least six months old); that TCCEC-Philippine Branch and CCFEL-Philippine Division headquarters do not get involved in the actual exercise of the stock options; that the optionees, particularly those who are no longer employees of either TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters, deal directly with the parent company; that the optionees pay directly with the parent company; that the optionees pay directly to the parent company the exercise price, and the stock certificates are issued by the parent company's stock transfer agent directly to the optionee; and that while TCCEC-Philippine Branch and CCFEL-Philippine Division Headquarters do not get involved in the actual exercise of the stock options, one or the other, is however, charged by the parent company for the difference between the market value of, and the exercise price for the stocks paid by their respective employees, which charges are claimed by either as expense for employees' benefits. Based on the foregoing representations, you now request in behalf of your aforenamed clients a ruling on your following queries: "1. Does the exercise of stock option at an exercise price lower than market value of the stock give rise to a taxable event for the person exercising the option? 2. If it does give rise to a taxable event, are TCCEC-Philippine Branch and CCFEL-Philippine Division Headquarters required to withhold the tax?" In reply, please be informed that your above-quoted queries are answered as follows: 1. In view of the fact that the difference between the market value of, and the exercise price paid by the employees for the stocks is charged by the parent company to either TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters, as the case may be, and such is claimed by either as expense for employees' benefits, the exercise of the stock option at an exercise price lower than the market value of the shares of stock gives rise to a taxable event for the person exercising the option. In reality, the price at which the stock is purchased is not at exercise price but at market value, and that the difference between the market value and the exercise price is borne by either TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters, for the benefit of their respective employees who will exercise the option. Hence, such employees actually receive benefits from TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters, as the case may be, to the extent of the difference between the market value of, and the exercise price paid by the employees for the stocks. Since the benefit was given as performance incentive for services rendered by the employees, then the benefits shall be considered as additional taxable compensation income. 2. TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters, as the case may be, being the employer, is responsible for the withholding, returning and paying the tax pursuant to Section 6 of Revenue Regulation No. 6-82, as amended. However, the Office agrees with your observation that since no funds related to the exercise of the option pass under the custody and control of either TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters because the optionees pay directly to the parent company the exercise price and the stock certificate are issued by the parent company's stock transfer agent directly to the optionees, there are no funds under their control, in respect to those who have retired, resigned or are no longer employees of either corporations, from which the tax may be withheld. Hence, the requirement for TCCEC Philippine Branch or CCFEL-Philippine Division Headquarters to withhold the tax would be very difficult, if not impossible. In view thereof, this Office is of the opinion that TCCEC-Philippine Branch or CCFEL-Philippine Division Headquarters, as the case may be, is required to withhold the tax only from the optionees who are still employees of either corporation. With regard to those optionees who have retired or resigned or are no longer employees of either said corporation, they are not required to withhold the tax because of the impossibility thereof, but should instead provide this Office with information under BIR Form 17.01-B, of income earned by such optionees by reason of the exercise of the stock option. Very truly yours, LIWAYWAY VINZONS-CHATO Commissioner of Internal Revenue