Hong Kong: Taxation of share grants when subject to forfeiture provisions (court decision)

A court decision concerning taxation of share grants when subject to forfeiture provisions

A court decision concerning taxation of share grants when subject to forfeiture provisions

The Court of First Instance held that the economic benefit derived from a grant of shares was subject to taxation at the time of the grant of the shares—despite the fact that the shares were subject to certain forfeiture provisions (that is, the shares could be forfeited if the employee ceased working for the group of companies).

The case is: Forlee v. Commissioner of Inland Revenue [2021] HKCFI 2476 1846 (24 August 2021)

Summary

The taxpayer (an individual) was employed in the UK from 2002 through 30 June 2014. On 1 July 2014, the taxpayer transferred within the group and was employed under a Hong Kong employment agreement.

  • During the UK employment period, the taxpayer was awarded shares on dates in 2012, 2013, and 2014 under the group’s share incentive plan. These UK awards were granted to the taxpayer during and in respect of his UK employment.
  • When awarded, the shares were transferred and held by the taxpayer’s nominee as an agent of the taxpayer, and on behalf of the taxpayer for his sole and absolute benefit until the end of the relevant retention period.
  • Subject to the provisions of the plan, the taxpayer had all the rights of a shareholder in respect of the UK share awards from the date of the share award. He had the right to dividends, the right to vote, and the right to direct the nominee how to vote.
  • In respect of each tranche of these shares, the expiry date of the forfeiture rights were set from 2012 to 2017 (i.e., the “release dates”). If the taxpayer ceased to be an employee of the group before the release dates, he would forfeit the unreleased shares, and would have no entitlement under the plan, unless a committee decided otherwise.
  • Upon release, the shares ceased to be subject to forfeiture, but the taxpayer was not able to transfer or dispose them until the expiration of the plan’s relevant retention period.

The previous position of Hong Kong’s Board of Review was that the benefit of the shares accrues to the taxpayer on the release dates (i.e., that it was only after the shares were free of risk of forfeiture that they accrued and became taxable).  Although this delayed the taxing point, this brought the shares within the charge to Hong Kong salaries tax on the basis that a part of the period over which the shares were earned coincided with the period of Hong Kong employment.

The Court of First Instance focused on the date when the taxpayer in the present case was able to turn the shares into a “pecuniary account” and held that the fact that the shares were not fully transferrable or disposable did not preclude the accrual of the benefit of the shares to the taxpayer. Rather, the court looked to the fact that from the date the shares were awarded to the taxpayer, he became entitled to claim the income represented by the shares.

The court found the fact that the shares were subject to forfeiture prior to the release date did not affect the accrual of income. The court distinguished between vesting and forfeiture, articulating that “forfeiture” was the loss of a right/interest and that there could not be forfeiture without prior vesting of the interest. The court thus rejected the Board of Review’s findings that the dividends related to the shares were taxable as income from employment, and held that the dividends were due to the taxpayer by virtue of the fact that the taxpayer’s nominee was registered as the holder of the shares (on behalf of as agent and for the sole benefit of the taxpayer).


For more information contact a KPMG tax professional:

David Ling | +1 609 874 4381 | davidxling@kpmg.com

 

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