In Korea, news articles related to the grant or exercise of stock options by various companies are frequently observed. The stock option system grants incentive bonuses as options rather than directly in cash or stocks, providing economic incentives in the form of stock price gains based on business performance. This system is significant as it motivates executives and employees to enhance performance and drive technological innovation. One of the advantages of stock options is that the recipients can exercise their options at their discretion and benefit from certain tax advantages under specified conditions.
There are various types of stock-based compensations other than stock option as followings, which are becoming increasing common in Korea:
- Restricted Stock Unit (RSU): Either shares of company or cash (or cash equivalent) are granted to employees, upon fulfillment of certain conditions
- Employees Stock Purchase Plan (ESPP): A compensation plan that allows certain employees to purchase shares at a discounted price
- Phantom Stock: Hypothetical stocks are granted to employees and the company will reward employees with the equivalent cash value of the company's actual stock at a future date
Below is an overview of the general taxation scheme related to stock options, noting that the timing of taxation may vary depending on the type of compensation plan.
General Taxation Scheme
Employees:
Under Korean tax law, the grant or vesting of stock options does not constitute a taxable event; taxation occurs when stock option is exercised. When employees exercise the stock option, the spread between the market price of the stock and the amount paid by the employee for the stock is subject to personal income tax1 as earned income. Stock options exercised by former employees would be treated as other income instead of earned income.
When employees sell the stocks, capital gains incurred upon the sale of shares is generally taxable in Korea with the applicable tax rate varying based on factors such as the company's status2.
For certain qualified stock options granted by venture firms under specific conditions outlined in the Special Tax Treatment Control Law (STTCL), special tax treatments may be allowed for employees including a non-taxation of gains subject to limits and selection of taxation time on gains.
Employers:
Employers must consider several aspects, such as withholding treatment, the tax deductibility of expenses related to stock options, and the tax year to which these expenses are attributed. In case where stock-based compensation was received from a foreign parent company, Korean subsidiaries or branches of foreign companies can recognize relevant expenses as tax deductible only if all of the following requirements are met:
1. Compensation Plan Requirements:
- Payments must be made with stocks or cash equivalent to stock value.
- Payment must adhere to a pre-established compensation plan.
- For executives, payments must not exceed amounts specified by the Articles of Incorporation, general shareholders' meeting, general meeting of members, or Board of Directors' resolution.
- Payments to controlling shareholders3 who are executives or employees must not exceed the amounts paid to non-controlling shareholders in similar positions without justifiable grounds.
2. Foreign Parent Company Requirements:
- The foreign corporation's stocks must be listed on a securities market under the Capital Markets and Financial Investment Services Act or a similar foreign market.
- The foreign corporation must directly or indirectly own more than 90% of the voting stocks of the domestic corporation that compensates for the cost of exercising or paying stock options.
3. Other Requirements:
- The right must be to acquire or purchase the foreign parent company's stocks at a pre-determined price
- The right must be granted or paid within the range of 10% of the total issued shares.
- There must be a prior written agreement with the foreign parent company regarding the exercise of stock options or reimbursement of costs.
Recent Tax Law Changes
Effective from January 1, 2024, new tax law provisions (Article 164-5 of the Personal Income Tax Law (PITL) and Article 216-5 of the Presidential Decree of PITL) require Korean subsidiaries or branches of foreign companies to file the following information concerning stock-based compensation issued to employees by foreign parent companies:
- Personal information of employees/executives;
- The transaction details of the grant, exercise and payment of the stock-based compensation; and
- Profits arising from exercise and payment
This information must be submitted by March 10 of the year following the tax year in which the exercise or payment occurs.
Key Takeaways
It is critical for employers and employees to carefully review the chosen compensation plan, as the taxation method may vary depending on the type of compensation plan. In particular, employers who have issued or intend to issue stock-based compensation granted by a foreign parent company must undertake thorough preparation to ensure that related expenses are recognized as deductible. Additionally, they must comply with the newly introduced filing obligations as outlined above.
Footnotes
1. Ranging from 6.6% to 49.5% including local income tax
2. A separate taxation method will be applied effective from 1 January 2025.
3. As defined in Article 43 Paragraph 7 of the Presidential Decree of the Corporate Income Tax Law
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.