Employee Stock Ownership Plan (ESOP): What you need to Know

Written by Carson Hamill CIM®, CRPC®, Associate Financial Advisor and Assistant Branch Manager & Dean Moro BComm, CIM®, Associate Financial Advisor

An Employee Stock Ownership Plan, commonly known as ESOP, is a retirement benefit plan that allows employees to own a part of the company they work for. ESOPs have gained popularity over the years as an effective tool for employee retention and motivation. In this blog, we will discuss important facts you should know about ESOPs.

• What is an ESOP
• How do ESOPs work
• What happens when you leave the company
• Benefits of ESOPs
• Drawbacks of ESOPs
• Cross border issues for ESOPs

What is an ESOP

ESOPs (Employee Stock Ownership Plans) are employee benefit plans that allow employees to become partial owners of the company they work for. The plan will grant company stock to the employee, generally based on their tenure.

How do ESOPs work

An ESOP is set up by a company, which establishes a trust to hold company stock on behalf of the employees. The company makes contributions to the ESOP trust, either in cash or shares of stock, and these contributions are used to purchase company stock. The purchased shares are then allocated to individual employee accounts based on a predetermined formula that considers factors like compensation and length of service.

Over time, employees become vested in their allocated ESOP shares, which means they gain ownership rights. The vesting schedule, determined by the company, outlines the timeframe for employees to become fully vested. Once vested, employees can benefit from the growth and profitability of the company, as the value of the ESOP shares increases.

What happens when you leave the company

When employees leave the company or retire, they have options for exiting the ESOP. They can choose to sell their vested shares back to the company or on the secondary market, allowing them to realize the value of their ownership. The company usually provides mechanisms and options for employees to liquidate their ESOP shares and receive their portion of the value.

Benefits of ESOPs

ESOPs offer several benefits to both employers and employees. Some of these benefits include:

• Ownership: ESOPs provide employees with an ownership stake in the company, making them feel more connected and invested in its success. When employees have a sense of ownership, they are often more motivated to work hard and contribute to the company's growth.
• Tax benefits: Companies can deduct contributions made to the ESOP plan from their taxable income, which can result in significant tax savings.
• Motivation: ESOPs can motivate employees to work harder and increase their productivity, as they have a stake in the company's success.
• Retirement income: ESOPs can provide employees with a retirement savings plan, where their shares in the ESOP account grow over time. This long-term benefit encourages employees to stay with the company, as their retirement savings are directly tied to the company's success.
• Business succession: ESOPs can be used as a tool for business succession planning as they provide a way for owners to sell their shares to employees. And there can be tax advantages as well. Selling shares to an ESOP can potentially allow for tax deferral or an exemption on the capital gains from the sale, depending on certain conditions and compliance with regulations.
• Employee retention: An Employee Stock Ownership Plan (ESOP) helps with employee retention by providing employees with an ownership stake in the company, creating a sense of loyalty and commitment. ESOPs offer financial incentives and retirement benefits tied to the company's success, motivating employees to stay long-term.

Drawbacks of ESOPs

ESOPs are not without their drawbacks, and some of these include:

• Concentration risk: Employees' retirement savings are tied to the performance of a single company's stock, which can be risky.
• Limited diversification: Employees may not have the option to invest their retirement savings in other assets, which can limit their ability to diversify their portfolio.
• Complexity: ESOPs are complex retirement plans that require significant administrative and legal work.
• Cost: Establishing and maintaining an ESOP can be expensive for companies.

Cross Border Issues with ESOPs

There are several cross border tax issues associated with ESOPs, especially when employees participating in the ESOP are subject to tax obligations in multiple jurisdictions. Here are some key considerations regarding cross-border issues with ESOPs:

1. Tax residency: The tax treatment of ESOPs can be influenced by an employee's tax residency status. Different countries have varying rules on how ESOPs are taxed for residents and non-residents. This can impact the taxation of ESOP contributions, vesting, and distributions.
2. Double taxation: When an employee is subject to tax obligations in both their home country and the country where the ESOP is established, there is a risk of double taxation. Double taxation occurs when the same income, such as ESOP gains or distributions, is taxed in two jurisdictions. To mitigate this, countries may have tax treaties in place to address double taxation and provide relief through mechanisms such as foreign tax credits or exemptions.
3. Withholding obligations: ESOP distributions may trigger withholding tax obligations for the employer. Employers are typically required to withhold taxes on the value of ESOP distributions at the applicable rates. However, withholding requirements can vary between jurisdictions, and employers need to ensure compliance with local tax laws.
4. Reporting requirements: Employees participating in cross-border ESOPs may have additional reporting obligations in both their home country and the country where the ESOP is established. These reporting requirements can include disclosing ESOP holdings, gains, and other relevant information for tax purposes.
5. Exchange control regulations: Some countries have exchange control regulations that restrict or regulate the transfer of funds or shares across borders. These regulations may impact the ability to transfer ESOP shares or repatriate proceeds from the sale of ESOP shares.
6. Compliance with local law: Companies operating ESOPs in multiple jurisdictions need to ensure compliance with local laws, regulations, and disclosure requirements related to employee benefits, securities, taxation, and corporate governance.

It's important to note that cross-border tax issues related to ESOPs can be complex and vary based on individual circumstances, the countries involved, and any applicable tax treaties. In comparison to the United States, Canada may have more regulations or restrictions in place regarding the granting of incentives that allow employees to own shares in the company they work for. The government may impose higher tax rates or more stringent requirements on corporations providing such incentives.

In the United States, ESOPs have specific tax advantages. In the U.S., Employee Stock Ownership Plans (ESOPs) may enable employees to purchase shares on the stock market at a discounted rate compared to the fair market value, without incurring taxes on the discount at the time of purchase. Additionally, an employee stock purchase plan allows employees to use after-tax payroll deductions to acquire their company's stock, usually at a discount of up to 15 percent.

As always, it is highly recommended you seek guidance from a tax professional with expertise in international taxation to ensure compliance with tax laws and to optimize tax outcomes when dealing with ESOPs.

Next Steps

If you’re planning on moving to Canada and need assistance with your investments, estate planning, and portfolio management, please call or email Snowbirds Wealth Management, as we specialize in cross-border financial planning and wealth management. We work closely with experienced cross-border lawyers and accountants to ensure you have a team behind you.

About Snowbirds Wealth Management

Gerry Scott is a portfolio manager and founder of Snowbirds Wealth Management, an advisory firm focussed on the cross-border market. Together with Dean Moro and Carson Hamill, associate financial advisors and assistant branch manager with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada, and Canadians residing in the United States. Licensed in both Canada and the US, they provide tailored investment solutions to minimize the tax burden when moving assets across borders.

To schedule an introductory call, please click here.

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