Publications
Companies acquiring the stock of foreign targets or targets with foreign subsidiaries may wish to consider the benefits having the foreign company’s employees become a part of the acquirer’s stock compensation plan and implementing a “stock recharge arrangement” between the acquirer and the foreign subsidiary.
A stock recharge arrangement is an agreement between a US parent corporation and a foreign subsidiary whereby the foreign subsidiary agrees to reimburse the parent corporation for the costs associated with issuing the parent company’s stock to the subsidiary’s employee pursuant to an equity incentive compensation plan.
If the parent and subsidiary corporations comply with requirements set forth by regulations issued under Section 1032 of the Internal Revenue Code (Section 1032 regulations), then the recharge payment will be treated for US tax purposes as payment to the parent corporation in consideration for its stock. This means the recharge payment will not be taxable to the parent corporation as a dividend or otherwise.
Using Stock Incentive Plans to Repatriate Cash Tax-Free
A stock recharge agreement can thus be a tax-efficient means of repatriating cash from the foreign target to the acquiring US parent corporation to help defray acquisition transaction costs and to replenish cash at the parent corporation level (e.g., to facilitate stock buybacks or fund operating cash needs).
Even if the target foreign corporation does not have enough cash to fund the stock recharge payments, an intercompany note can be used to create a repatriation pipeline with respect to future cash.
Requirements under the Section 1032 Regulations
To qualify for tax-free treatment under the Section 1032 regulations, the following requirements must be met:
Exercised Stock Options: The foreign subsidiary can make a tax-free remittance to the parent corporation upon the exercise of ISO or NSO stock options by the subsidiary’s employee and transfer of the parent’s stock to the employee. The maximum tax-free remittance is equal to the “spread” amount, i.e., the fair market value (FMV) of the stock on the exercise date minus the exercise price paid by the employee.
Vested Restricted Stock Awards: The foreign subsidiary can make a tax-free remittance to the parent corporation upon the vesting of a restricted stock award, i.e., the date on which previously issued stock grants are no longer subject to a substantial risk of forfeiture. The maximum tax-free remittance is equal to the FMV of the parent’s stock on the vesting date, provided that the US parent and not the foreign subsidiary holds the reversionary interest in the event of forfeiture. In addition, if the employee provides any consideration for the stock, the FMV remittance to the parent corporation must be reduced by the consideration provided.
Vested Restricted Stock Units:- The foreign subsidiary can make a tax-free remittance to the parent corporation upon the vesting of a restricted stock unit award, provided that stock and not cash is transferred to the employee upon vesting. The maximum tax-free remittance is equal to the FMV of the parent’s stock on the vesting date, but the FMV amount must be reduced by any consideration paid by the employee for the stock.
Any reimbursement made by a foreign subsidiary to a US parent corporation for vested restricted stock units payable in cash to the employee upon vesting is not eligible for tax-free treatment under the Section 1032 regulations, because no stock is actually transferred to the employee.
Remittances Made at Other Times: Any remittances made by the subsidiary at any time other than immediately after the exercise date for stock options and immediately after the vesting date for restricted stock awards and the vesting and transfer dates for qualifying restricted stock units will not qualify for tax-free treatment under the Section 1032 requirements and will likely be characterized as a taxable distribution for US tax purposes.
Can Your Company Benefit from a Stock Recharge Arrangement?
Due to the tax beneficial rules under the Section 1032 regulations, a company acquiring a foreign target may find it advantageous to include the target’s foreign employees as part of the acquirer’s equity incentive compensation plans and provide for an accelerated vesting schedule. This will permit employees to exercise their options and allow for the immediate vesting of restricted stock grants and eligible restricted stock units.
These events will trigger tax-free treatment under the Section 1032 regulations for amounts paid by the foreign target to reimburse the parent corporation under a stock recharge arrangement for costs associated with issuing its stock to the subsidiary’s employees, thereby providing a tax-efficient means of immediately transferring cash from the foreign target to the US acquirer.
Companies also should evaluate the tax effect that a stock recharge arrangement would have in the foreign subsidiary’s jurisdiction, This includes asking whether the foreign country would permit a tax deduction for such stock recharge payments and whether foreign withholding taxes would apply. Furthermore, certain jurisdictions, such as China, may not permit a stock recharge payment at all, for reasons relating to foreign exchange controls.
When a foreign target has an established holding company that is cash-rich, certain elections may be made for US tax purposes that would permit the holding company to utilize its cash to fund stock recharge payments, not only for its own employees but also for employees of the holding company’s subsidiaries.
All of these factors should be evaluated as part of a cost/benefit analysis to determine whether a stock recharge arrangement between the acquirer and the foreign target should be adopted.