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Tax Matters Part 1: Did you know that you can defer taxes on your ESOP for up to 5 years

Tax Matters Part 1: Did you know that you can defer taxes on your ESOP for up to 5 years

Although tax filing season for individuals in Singapore is over, this post may come in handy in the future. With taxes ingrained in our everyday life – think goods & service tax, electricity and water tax, airport tax, electronic road pricing (ERP), income tax, and so on and so forth, we may feel overwhelmed by the various amount of taxes that we need to pay. Hence, the more you understand the nuances of taxes, the better it is for you in terms of savings or structuring it to the most optimal structure. For those who have expertise in tax structuring, it is no doubt this specific role is highly sort after on both the corporate and wealth management front.

If you’re working for a listed company like I am, there is a chance that part of your compensation comprises of shares in the form of Employee Stock Ownership Plan (ESOP). What is ESOP? Very simply, it is an employee benefit plan that allows employees to own part of the company that they work for.

ESOP is calculated in your overall income assessment for the year. Based on the Inland Revenue Authority of Singapore (IRAS), it says:

Gains and profits arising from Employee Share Options (ESOP) plans and other forms of Employee Share Ownership (ESOW) plans are subject to tax if the plans are granted to an employee when he/she is employed in Singapore.

It is important to note that should you be granted shares for a particular calendar year, you can have the option of deferring your ESOP from a period of 1 to 5 years. Caveat is that it is subject to an interest charge, typically the average prime rate. Based on the Monetary Authority of Singapore, the prime lending rate as of June 2021 was 5.25%.

For your info, if your company hands out ad-hoc bonuses or payouts to you, or even electricity bills payouts, it can be considered as “Other Income”. Yes, it all goes to paying the government more taxes.

This option doesn’t seem too favourable especially if you need to pay a 5.25% interest per year depending on the number of years that you defer your taxes on your ESOP. When then is it advisable to do so?

Below are a few scenarios that I can think of and it involves using some assumptions.

When your yearly income for a particular year is too high

Income earned may not always be linear in a given year. For example, if your company gives you an additional ad-hoc bonus (not performance bonus) such as a retention bonus in a bid to prevent you from leaving, your total taxable income for that year will increase. On top of that, if you have shares granted or vested in the same year, it will add on to your total taxable income in that yearly assessment. After claiming for other reliefs such as NS relief, parent relief, topping up to your own CPF SA etc, you may still find yourself in a high income bracket.

If you foresee that in the coming years, you are unlikely to obtain the current one-off high income earned for that year, it is advisable to defer it to spread out the taxable income. Of course, some reasonable assumptions must be made eg. if you foresee that bonuses or increments are unlikely to remain elevated due to the current inflationary environment and that you will not receive other one-offs bonuses, and also after paying for the interest charge for deferring, it still saves you money because you qualify for a lower income bracket.

When you are cash tight

With the ongoing pandemic (or endemic if you wish), high inflationary, and high-interest rates environment, the outlook of global markets may not seem so good. Some may have just gotten married, bought a house and are servicing their mortgage loans, or have a family to feed for which all these will render one cash tight. Deferring your ESOP to be calculated in subequent taxable years will allow you a temporary buffer to tide through this period. With so many categories of expenses that one has and also the expensive standard of living in Singapore, it is crucial to manage one cash flow properly so as to not miss out on opportunities where you think you can get a better return.

When you anticipate quitting your job to pursue entrepreneurship in the next few years

If you’re a high earner, the ability to reduce every amount of your taxable income is crucial. But, there is only so much we can reduce our taxable income through reliefs. Should you already know that you are will be quitting your full time job to pursue entrepreneurship, and assuming for the first few years you may not earn much from entreprenuership, it is wise to defer your ESOP to lower your taxable income for that year that you are granted ESOP. Also, this allows you more cash buffer to invest in your business at the initial stages. Of course this point contains a lot of assumptions, but for simplicity purposes we will assume most start-ups / businesses are not profitable in the first few years.

One scenario I can think of on when to not defer your tax on ESOP is when you forecast that your total income (ie. increment of base salary and bonus) to be higher than your current in the coming years. This could be due to an anticipation of a promotion or changing jobs where you think you can get a higher salary. In this case, it will be wise to just accept the calculation of your ESOP and pay the appropriate taxes accordingly.

Taxes are always a sensitive and personal thing. Nobody likes to pay more taxes when they really should, and it is all a balancing act on whether you have better uses for your cash. The purpose of this article is for education purposes only and to let you know that you have options on tax structuring.

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Best wishes,

Finance and Toast

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