Equity incentives are one of the most powerful tools for attracting, rewarding, and retaining top talent. They give employees the chance to share in the success they help create, and they’re often a key part of compensation packages for startups and fast-growing companies.
But what happens when your team members are employed through an employer of record (EOR)? Can they still benefit from stock options or other equity plans in the same way as employees hired directly? The short answer is yes, but with some important differences.
In this guide, we’ll break down exactly how equity works for talent hired through an EOR, the challenges your company need to be aware of, and how the right partner can simplify the entire process.
First, what is an EOR?
An employer of record (EOR) is a third-party organization that hires people on your company’s behalf, and handles all core HR functions such as onboarding, payroll, benefits, and compliance. By using an EOR, companies can legally and efficiently hire talent in different countries, without having to set up a local entity there (or risk violating local employment laws).
Although the EOR is the legal employer and handles HR, you maintain the day-to-day work relationship, just as you would with a “regular” employee. You continue to make all decisions in regard to duties, compensation, projects, and termination.
So, how do stock options work if you hire someone through an EOR?
If you hire someone abroad through an EOR, stock options work a little differently. This is because, as mentioned, the legal employer on paper is the EOR; not your company. And if your worker is legally employed by an EOR, they’re technically not an “employee” of your entity under the plan.
To navigate around this, you can adopt numerous approaches, such as direct participant models, phantom equity, and hybrid structures. However, setting up and managing these plans can be extremely complex, and requires specialist legal support and guidance in multiple jurisdictions.
This is why it’s highly recommended to work with an EOR provider that is proven and experienced in this field, and can do all the heavy legal lifting for you. Learn more.
What does this look like in practice?
To illustrate how this works, let’s say that you are a startup with a US holding, and you have used an EOR to hire business development officers across the LATAM region, including Catarina in Brazil.
Back when you hired Catarina through Remote’s EOR, you used Remote Equity to grant equity incentives — as with all your staff. Specifically, Catarina received non-qualified stock options (NSOs), a common type of equity incentive.
However, now Catarina is leaving your company, and she wants to exercise her stock options. So what do you both need to do?
Step 1: Consideration
First, you need to establish the following:
What type of equity incentive has been granted? (In this case, it was NSOs, but it could be ISOs, RSAs, SARs, or virtual shares.)
What is the nationality of the company that has issued the equity incentives?
What is Catarina’s country of tax residence and place of work?
What is the type of professional relationship between Catarina and the company that has issued the equity incentives (i.e., the EOR)?
What are the main terms of the grant, such as the vesting schedule, exercise price, and exercise timing?
If the grant of stock options has been made through Remote, Catarina will have received access to a personal employee portal. This dashboard is continuously updated to take evolving legislation and market practices into account, and will give her access to important information, including:
A clear, jargon-free breakdown of her equity and what it means for her.
A thorough support guide reflecting the most common concerns and questions of Remote Equity users in Brazil.
Guidance from local specialists on what she needs to do (and when) to comply with local equity tax obligations.
The portal also gives Catarina an individualized overview of her current grants, detailing:
How much of her stock options have vested over time.
What she has to pay to exercise her stock options, including the exercise price and associated taxes (such as professional income tax and, if applicable, foreign exchange tax).
How much time she has to exercise her stock options after her contract is terminated.
Your company’s current valuation, so she can make an informed decision on whether to exercise or not.
Ultimately, she’ll be able to quickly weigh the pros and cons of exercising versus not exercising, and be able to efficiently inform you of her decision.
If Catarina has any doubt about her tax obligations or wishes to obtain more bespoke advice regarding her personal situation, she can rely on the network of local tax advisors that Remote Equity has built.
Step 2: Exercise
Catarina thinks your startup will be a huge success and decides to exercise her stock options. She informs you and the EOR of her choice.
The EOR provider has the legal obligation to withhold taxes and social security from Catarina’s salary; in this case, it would need to withhold income tax on the difference between the fair market value of the shares (at the time of exercise), and the exercise price Catarina has to pay to get her shares.
If you were using two different providers for EOR and equity incentive management, you would need to handle all the back and forth yourself. However, with Remote, this is handled in-house through one platform, making the entire process simple and painless.
Step 3: Post exercise
Catarina has exercised her stock options through your company’s cap table management solution, such as Carta, and has paid the relevant taxes. Her notice period has ended and she has left your company.
At this point, you can choose whether Catarina can still access her personal dashboard or not. You can also choose to hide sensitive information (such as your company’s valuation), but maintain limited access to Catarina’s tax and reporting obligations. This would enable Catarina to stay aware of any post-exercise obligations, such as reporting the holding of the shares in her annual tax return.
How does it work country by country?
Another way to illustrate how this all works in practice is to look at individual countries. Here, we'll focus on three of the most popular, especially for US-based companies:
United Kingdom
There are many different types of tax-favored schemes in the UK (sometimes called “tax advantaged” or “approved” schemes). The most widely used by startups who have less than 250 full-time employees (and comply with other conditions) is Enterprise Management Incentives (EMI), although as they grow larger, they often use CSOP.
Can you grant options qualifying as EMI in the UK?
Unfortunately, it is not currently possible to offer EMI in the UK to an EOR employee. Instead, some companies opt for “Unapproved Options” which, contrary to EMI, are generally taxed already at the time of exercise (rather than only at the time of sale of the shares).
Do you need to do anything at the time of grant of the options?
Yes; there are several formalities to follow when you grant stock options in the UK. You must register your share scheme with HMRC, and report the grants (and any exercises of options) in a yearly report of options called the ERS return.
Make sure you inform your EOR provider that you’re about to grant stock options so they can carry out the formalities on time. They can’t do it if you don’t inform them.
Who is responsible for reporting and withholding when the employee exercises the options?
This depends on the qualification of the shares. If they are "Readily Convertible Assets" (RCAs), then it’s the EOR who is legally responsible. If the shares aren’t RCAs, then it’s the employee.
The shares will typically be considered as Readily Convertible Assets if the exercise takes place in the context of a liquidity event.
There will be additional contributions (under the form of National Insurance contributions) if the shares are RCAs.
Australia
Australia is one of the few countries where, as a general rule, stock options are taxed at the time of grant (and not at the time of exercise or sale). There are some exemptions that allow taxation to be deferred to a later stage, but they do not apply to EOR employees.
It’s particularly important to make sure the employee and the employer understand there would potentially be a tax to pay at grant and that they would need to report something in their tax return. There are also some securities laws considerations to take into account if there are multiple grants of equity awards over a certain period of time.
Can EOR employees benefit from the start-up concession?
The startup concession allows certain types of equity awards qualifying as “employee share schemes” granted by startups to be deferred to the time of sale of the shares.
Unfortunately, the startup concession does not apply to EOR employees.
What does the EOR employee need to report?
The EOR employee needs to include the value of the options in their tax return relating to the year in which the stock options have been granted.
India
Granting stock options as a foreign company to people in India without having a local presence through a branch or subsidiary comes with a few uncertainties and legal obstacles. Alternatives to traditional stock options (such as phantom stock, VSOP or stock appreciation rights) can be recommended. In any case, it’s recommended to inform the EoR at the time you grant the options.
Can you grant stock options to EOR employees in India?
Yes you can, but there are certain things to take into account when you do so. New laws make it fairly difficult if you are offering stock options without an actual presence in India (such as when you have EOR employees). As a result, unless the law changes:
Your holding company needs to be an operational company
The EOR employee will not be able to sell their shares in the 12 month period that follows the exercise of their options
There are also formalities you need to take into account:
There are restrictions on the amount that can be transferred by the EOR employee for exercising their options.
There’s a tax levied by the bank used for transferring the money to pay the exercise price if money wires in one year exceeds a certain amount.
Once the shares are sold, the proceeds from such sale need to be repatriated to India within 90 days.
Is there a tax favoured scheme?
There is a tax deferral to the time of sale for startup companies. Unfortunately, it does not apply when the issuer of the stock options is based abroad.
When the shares are held for more than two years, there’s a long term capital gain taxation (which is lower than the usual rate).
Can we use the 409A valuation in order to determine the value of the shares to be taken into account for income tax purpose at the time of exercise of the options?
In India, the value of the shares needs to be determined by a Category 1 Merchant Banker registered with the Securities and Exchanges Bureau of India. A 409A valuation will most likely not be considered as a valid substitute.
It can result in additional paperwork, costs and administrative hassle in case the exercise takes place outside an exit event, so make sure you plan ahead.
Simplify everything with Remote
Setting up and managing equity incentives for your EOR team members may sound complicated and off-putting, but it doesn’t have to be. With the right provider, the entire process is clear and simple from start to finish, with full support and guidance at every step.
Remote Equity handles everything for you, enabling you to take advantage of the many recruitment and retention benefits of equity incentives.
We’d be happy to answer any questions and explain how it would all work for your company; to learn more, speak to one of our friendly experts today.
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