Latest Malaysian Tax Scheme for ESPP is Stupid

If you do not know what ESPP is, you may skip this article.  Basically, ESPP stands for employee stock purchase plan. ESPP is one of the company’s compensation which allows you to purchase the company share with discount (e.g. 15%). Your company may or may not have this benefit and every company has slightly different way to implement this ESPP.

How this ESPP works is you can enroll this ESPP program for about let’s say 6 months. During this 6 months window, your company will deduct up to maximum certain percentage (e.g. 10%) of your salary every month and use this money to purchase the company share at the 6th month - the closing window (e.g. June 30) based on the “Subscription Value” with discount (e.g. 15%).

Let’s assume number of shares you have purchased with this ESPP is 50 shares and see the following example to illustrate the previous and the latest tax scheme for ESPP:

Subscription value                       = $30
Purchase price at 15% discount   = $30 X 0.85% = $25.5
Stock price on June 30 (highest)  = $51
Stock price on June 30 (lowest)   = $49
Stock price on June 30 (average) = $50
No. of shares purchased              = 50



Previous Tax Scheme for ESPP

Based on the previous tax scheme for ESPP, the taxable gain  is based on the discount (e.g. 15%) the company gives you.  In this example, the taxable gain will be $225 -  see the calculation below. This tax scheme makes a lot of sense because if the company doesn't offer you the discount, you will still need to purchase the share price at $30 not at $25.5  Because of the 15% discount, $225 is the extra money your company gives to you. Thus,  $225 to be considered as taxable income makes a lot of sense.

The taxable gain calculation based on previous tax scheme:
   = ($30 – $25.5) X 50 or ($30 X 15%) X 50
   = $225


Latest Tax Scheme for ESPP

However based on the latest tax scheme for ESPP, the taxable gain is no longer based on the 15% discount. but based on the average price of the last day of your ESPP closing window (e.g. 30 June). In this example, the average price on June 30 is $50. So it is automatically assumed that you gain $50-$25.5 = $24.5 although you didn't sell the share at June 30. Huh, what a crap?

The taxable gain calculation based on latest tax scheme:
   = ($50 – $25.5) X 50
   = $1225

So technically speaking, if you sell your ESPP share later at price lower than $50, you're actually being taxed more. Well, you may argue that what if you sell higher, then you're getting taxed less. Isn't that a good thing?Well, don't you know that capital gain in Malaysia is not taxable? If it is not taxable, why I sell higher, then I need to be taxed more? Think again!


Conclusion

Honestly if you ask me, there is something wrong with the latest Malaysian tax scheme for ESPP. The previous tax scheme is  reasonable but definitely not the latest. Although similar tax scheme is being applied to the restricted stock units (RSU) and stock options, I'm still okay with that because we do not fork out our own money. It is just like you're getting less compensation, not really that a big deal. However for ESPP, we basically fork out our OWN money to purchase the shares and now you simply tax me. This is not acceptable!

Well, what can you do? You can protest to the government or  just be alert of the price at the ESPP closing window (e.g. June 30) and if the price is high, you may want to consider a quick sell rather than keep it. I know this is suck...

[Update: 19 August 2011]: Let's look at the comment in this post from "HS Ooi". He gave a very good explanation why market gain is classified as the compensation instead of capital gain. Thus, it should be taxed. What do you think?


P/S: By the way, please don't confuse that you can claim back your money if your sell your ESPP share at lower price. I"m talking about taxable gain here and not the tax deduction in your monthly payslip. If there is extra tax deduction, you can only claim them back but this is not the case. The $1225 is reported as a taxable income in your EA form and it is part of your income.