BAKER & McKENZIE Global Equity Services - New Russian Tax Law May Negatively Impact Options and ESPPs

www.bakermckenzie.com

Two
new Russian tax rules (FSFM Order Nos, 10-65 pz/n and 10-67 pz/n) were
adopted December 12, 2010 and apply from January 1, 2011.  These
new rules, together with the provisions of Articles 212, 214.1 and
305.2 of the Russia Tax Code, arguably result in the following tax
treatment of stock options and (probably) ESPPs:

1. For non-traded options over public company shares (e.g.,
   stock option grants by U.S. public companies), an option value is
   determined at grant under a modified Black-Scholes formula set out in
   item 4.12 of FSFM Order No 10-67 pz/n.  This formula determines a market value for the option, which is then taxed at grant at 80% of this modified Black-Scholes value.  Apparently, the market value of the option could also be determined by engaging an independent appraiser.

2. Because
   the current rules taxing options on exercise were not removed from the
   Russia Tax Code, apparently options will also be taxed again at
   exercise, and there is no provision in the new rules for increasing the
   basis for the taxable income taxed at grant, so double tax will likely
   occur (remember Russia has the peculiar fluctuation allowance permitting
   up to a 20% increase to go untaxed).  Also, there would be a capital gains tax on sale for any post-exercise increase in value of the shares.

3. If
   the options are granted by a non-Russian company that has no presence
   in Russia, the obligation to estimate, report and pay taxes on grant,
   exercise and sale will remain that of the option holder. 

4. Apparently,
   the new rules do not apply to RSUs, which would remain taxed at
   vesting, whereas restricted stock will likely be taxed at grant (and not
   again at vesting). 

Our Moscow office is seeking to clarify the tax treatment of equity awards in Russia and is working on a more detailed alert.  There
is also a possibility of a group of clients coming together to apply to
the Russian Ministry of Finance for a ruling to clarify and (we hope)
mitigate the impact of the new rules. 

The tax reporting deadline for awards made in 2011 is April  30, 2012. 

Although
these rules are brand new and their application to equity grants to
employees in Russia remains uncertain, we wanted to alert you right away
in case you are making grants in Russia in the near future.  Obviously, we will advise you of any developments or clarifications and circulate the alert from our Moscow office.