Taxation of Stock Options
Case 21
<Question>
I am from the US and have been working at a Japanese company for 3 years (I am a non-permanent resident in Japan). Before coming to Japan, I worked at the parent company of the Japanese company in the US, and stock options were rendered. I exercised and sold the stock options this year, so I would like to know the taxation under the following conditions.
1. Unqualified stock option in the US
2. The details of the stock options
|
Vest |
Exercise |
||||||
|
Date |
Number |
Unit price |
Total |
Date |
Number |
Unit price |
Total |
| 1996, April 24 | 7,000 | $120 | $840,000 | 2013, July 21 | 7,000 | $180 | $1,260,000 |
|
Sold |
|||
|
Date |
Number |
Unit Price |
Total |
| 2013, December 14 | 7,000 | $200 | $1,400,000 |
3. Working status
Company in US (the parent company): Until 2008, December 31
Company in Japan: 2009, January 1 ～
<Answer>
Basic taxation of stock options depends on whether they are qualified stocks or unqualified stocks. The qualified stock option is not subject to Japanese income tax until it is sold, on the other hand the unqualified stock option is subject to Japanese income tax when it is exercised and sold. In your case, it is the unqualified stock option in the US though, whether it is qualified or unqualified is judged based upon Japanese income tax laws. There is no information to judge it, so we regard this case as an unqualified stock option.
Basically, taxation is determined by employment income and capital gains based upon Japanese income tax. The following is the example of taxation.
1. Vested stock options at JPY 1,000
2. Exercise the right at JPY 2,000
3. Sold the stocks at JPY 4,000
|
Non-qualified stock option |
Qualified stock option |
|
| Granted stock option |
No tax |
No tax |
| Exercising the right | Impose the income tax as employment income (JPY1,000 = JPY2,000 – JPY1,000) |
No tax |
| Sold the stocks | Impose the income tax as Capital gains (JPY2,000 = JPY4,000 – JPY2,000) | Impose the income tax as Capital gains (JPY3,000 = JPY4,000 – JPY2,000) |
This is quite a simple example, so the following points should be considered in your case.
- Calculate the domestic source income and other incomes outside of Japan
- Foreign exchange rate from US dollar to Japanese Yen
- Tax treaty for capital gains
- Foreign tax credit
Domestic source income or other income
Non-permanent residents are subject to Japanese income tax on domestic source income and other income paid in Japan or remitted from outside of Japan. Therefore, clarification of the income is quite important. First of all, regarding employment income (exercised income), the following is considered;
(Employment income)
It has to be calculated based upon a pro-rata basis as follows.
(1) The number of days from vested date of the stock option to exercise date.
(2) The number of days from entry into Japan to the exercise date.
(3) The number of days worked outside of Japan from the vested date to the exercise date.
(Capital gains)
It is regarded as domestic source income in Japan though, the tax treaty has to be considered.
Foreign exchange rate
There are 3 exchange rates, TTB, TTM and TTS though, TTB is applied to the profits on each exercise date or sell date.
Tax treaty for the capital gains
Japan-US tax treaty says ““Gains from the alienation of any property other than that referred to in the preceding paragraphs of this Article shall be taxable only in the Contracting State of which the alienator is a resident (Article 13(7))”. Basically, Japan has the right to impose the tax on it regardless of foreign source income, however, the tax treaty Article 4 stated that the capital gains is supposed to be taxed in the source country in the case of non-permanent residents. Therefore, US tax is imposed in this case.
Foreign tax credit
When the stock options are exercised or sold, the withholding tax must be imposed in the US. Employment income (income by exercised stocks) consists of domestic source income and other income. The withholding tax in the US is imposed both on domestic source income and other income. The domestic source income is subject to Japanese income tax, so this portion creates a double taxation problem between Japan and the US. The foreign tax credit is given in order to mitigate double taxation of income when income subject to Japanese income tax is also subject to income tax in another country (If you lived in the US when the stock option was exercised or sold, the foreign tax credit might not be administered. It depends on the case).
These are the main features of stock option taxation. The following is the calculation process of this case:
Employment income: $420,000 ($1,260,000 – $ 840,000)
Capital gains: $140,000 ($1,260,000 – $1,400,000)
Total income: $560,000
Total days: 4,498 days (1996, April 24 – 2013, July 21)
Total days as a resident in Japan: 1,187 days (2009, January 1 – 2013, July 21)
Total days working in US: 3,311 days (4,498 – 1,187)
Domestic source income: $110,836 ($420,000 ×(1,187 days ÷ 4,498 days))
Other income: $309,164 ($420,000 – $110,836)
As a result, $110,836 is subject to Japanese income tax as domestic source income. Additionally, the adopted exchange rate is based upon the exercise date.
Regarding capital gains, they are subject to US taxation as you are a non-permanent resident.
The withholding tax must be imposed in the US though, when you exercised the stock option you were already in Japan, so the foreign tax credit is available in Japan.
By Certified Public Accountant, Koji Takahashi,
Tokyo & Yokohama
