Equity-based Compensation: The Basics for Australian Expats - Restricted Stock Units (RSUs)

Introduction

The United States and the broader Asia-Pacific (APAC) region acts as a beacon of opportunity for Australian Expats looking to accelerate their careers in industries such as Computer Software, Information Technology, Mining, Law Practice, and many more. With this opportunity, Australian Expats are commonly presented with unique compensation packages that include equity in the employer company, supplementing their ordinary wage income.

Some common examples of equity-based compensation include:

-        Restricted Stock Units (RSU)

-        Stock Options

-        Employee Stock Purchase Plans (ESPP)

This 3-part Article series will look to discuss the unique aspects of receiving different types of equity-based compensation and explain how Australian Expats can best manage them from a sound financial planning standpoint.

Why do companies offer equity-based compensation?

Fundamentally, companies offer equity-based compensation as it helps with employee retention, particularly for those more senior employees, which reduces staff turnover and can motivate employees to be more productive as their interests are aligned with those of the employer. Equity compensation can also assist with the working capital for the business as lower cash salaries can be negotiated.

What are Restricted Stock Units (RSUs)?

Restricted stock units (RSUs) are a way an employer can offer company shares to their employees. The shares are initially “granted” to the employee, which means they are restricted and subject to a vesting schedule. It is only once the shares have vested in accordance with the vesting schedule, can the employee dispose of the shares in return for cash or retain the shares and be entitled to dividends, voting rights, etc.

Vesting schedules can generally be categorized as either graded or cliff vesting. Graded implies the shares vest in interval portions, for example, 25% of the shares granted may vest each year over 4 years until the entire grant amount is received. Cliff means 100% of the shares granted will vest after a stipulated employment period is served. Outside of graded and cliff schedules, vesting schedules may also be performance-based and rely on meeting company-specific or share market targets. It’s important to note that where an employee terminates employment, in almost all circumstances the granted shares still restricted will expire and the employee forgoes the benefit.

Taxation of RSUs

Taxation generally occurs at the time the shares vest to you, with the amount assessable being the market value of the shares at the time of vesting included as ordinary employment income. In most cases, the employer will withhold the relevant tax prior to delivering the shares to you by holding onto shares to the value of the withholding tax, and company cash is used for the payroll tax. This helps with the dilution of shares. Withholding tax does not always occur and where this is the case employees need to ensure they have sufficient cash available to meet any upcoming income tax liability. Where vested shares are sold at a later date, capital gains tax (subject to the tax laws in that country) is generally paid on any appreciation from the market value at the time of vest to the sale price received.

Financial Planning Risks

The most common risk associated with receiving vesting RSUs is where employees inadvertently accumulate a large part of their total wealth in one company stock. This risk is referred to as diversification risk, or concentration risk, as they are largely exposed to the price movements of one asset in isolation, and any unforeseen changes to the company could result in total loss of capital in extreme cases. In simple terms, employees are placing all their eggs into one basket, instead of placing their eggs in multiple baskets to reduce the probability of loss.

This is where it helps to have a formal and structured plan in force as shares vest, where they are disciplined in selling down at least part of the vesting shares and using the proceeds to diversify their wealth. For example, using the proceeds to invest in a basket of shares, to pay down debt, or to purchase real estate, etc. By selling down systematically, for example, quarterly, employees can benefit from obtaining a smoother average sale price for their shares over the course of 12 months.

Financial Planning Opportunities

Where an Australian Expat is residing in a country where there is a low or no tax rate on capital gains (for example Singapore or Hong Kong), selling the shares within the first 12 months isn’t going to be a major concern due to the favourable tax treatment at the time you sell. For those living in Australia or the United States, where the shares were not sold initially at the time of vest and have appreciated in value, it may be worth considering waiting for 12 months in order to receive the more favourable long-term capital gains tax rate.

Generally, when shares are vested, employees may be restricted in terms of when they can dispose of their shares by company trading windows. The trading window will commonly occur on a monthly or quarterly basis and can last between several days to several weeks. During the trading window, the employee has the opportunity to dispose of their shares on the market while complying with any insider trading policy set by the company. It is often timed around a quarterly earnings call where the company reports its quarterly earnings and profit outlook.

Conclusion

In summary, while being afforded such compensation can be advantageous, and even lucrative at times, Australian Expats should take due care to manage this supplementary income from a tax planning and long-term risk mitigation outlook, especially in the face of heightened share market volatility. Partnering with a Financial adviser can help put you on a path to making the best use of this income to achieve your financial goals.

Stay tuned for Parts 2 and 3 of this 3-part Article series where I will discuss Stock Options and Employee share purchase plans (ESPPs).

Disclaimer – The above commentary is general in nature and should not be construed as tax or financial advice. Please consult a licensed tax accountant and financial adviser to determine whether the above information is suitable for you.