Bonds issue under the UAE Local Laws

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Equity-based incentive compensation plans allow recipients to issuance and exercise of stock options dubai an ownership stake in the company. By offering share ownership in the company, employers not only reward employees but provide them with a valuable complement to traditional cash-based compensation packages.

As companies continue to expand globally, equity-based compensation is increasingly offered to employees located in countries other than the country where the stock award issuing company is located.

Cross-border issuance of equity-based compensation can lead to issuance and exercise of stock options dubai number of cross-border tax and transfer pricing issues for multinational companies. In this article, we briefly discuss some of the key international tax and transfer pricing issues that typically arise when equity-based compensation is provided by multinational companies to employees of its foreign subsidiaries. Our discussion assumes that the company issuance and exercise of stock options dubai the stock awards is the parent-issuer resident in the United States, although much of the discussion is equally applicable when the parent-issuer is resident in another country.

Equity-based incentive compensation awards come in many forms and include the following:. The exercise price is typically the market price of the stock when the option is granted; the vesting period is generally two to four years; and the option is usually exercisable for a certain period, often five or 10 years.

If the price falls, the option will simply not be exercised; the contract does not obligate the employee to buy the stock. Employee stock options typically cannot be transferred and consequently have no market value. Some stock awards have special features designed to do more than just increase incentive value. There are other variations. Since a vast majority of equity grants are in the form of stock options, that is the primary focus of this article.

The valuation methods we refer to are typically used for valuing stock options. Key events in issuance of equity-based incentive compensation. From the standpoint of financial reporting and tax accounting, three key events occur with respect to stock options.

Second event is the vesting date when the stock option vests and becomes available for exercise by the recipient. When recipients exercise their stock options, the company provides the shares to the employee by either purchasing the stock from the market, through treasury stock, or by newly issued shares. In each of these scenarios, the base issuance and exercise of stock options dubai to the company is the difference between the market price and the exercise price.

Financial reporting and tax aspects of equity-based incentive compensation. Issuance of equity-based compensation has both financial reporting impact and tax implications. When a US company issues equity-based compensation to its employees, it must recognize that compensation in its financial statements by recording a book expense in relation to issued equity-based compensation.

Generally, these options are not taxed to the employee nor deducted by the employer. The spread between the market price and the strike price is deductible to the employer when the employee includes the proceeds from the exercise in income. For tax purposes, stock options are expensed at the time they are exercised. International equity award grants. Thus, the cost of the equity issued issuance and exercise of stock options dubai initially with the US parent.

That is, when the granted stock options have vested and are exercised, the US parent would have to incur the cost associated with exercise. But the cost of equity compensation awards issuance and exercise of stock options dubai to non-US employees is not deductible in the US under the US tax laws and thus, offers no tax benefit to the US parent. In certain circumstances, it may be tax advantageous to push down the cost to a foreign subsidiary where a deduction can be claimed. Figure 1 illustrates the sequence of payments.

Payment sequence under a recharge agreement. Tax impact of recharging. If the US parent and subsidiary corporations comply with requirements set forth by regulations issued under Section of the Internal Revenue Code, the recharge payment will be treated for US tax purposes as payment to the parent corporation in consideration for its stock.

This means the recharge payment will not be taxable to the parent corporation as a dividend or otherwise, and serves as a mechanism to repatriate cash to the US. From the US perspective, the US parent can use either the grant-date method or the spread-at-exercise method to determine the value of the stock options costs for purposes of recharging.

Under the spread-at-exercise method, the value is determined on the date of the exercise and is based on the difference between the market value of the stock price and the exercise price. The grant-date issuance and exercise of stock options dubai could also be used, which as noted above, follows the fair market value principles and is calculated on the date of the grant. However, it bears noting that Section regulations follow the spread-at-exercise method, and to that extent using the grant-date method may result in some tax implications.

Foreign subsidiaries may be able to claim a deduction for the payment for equity-based compensation under a recharge agreement. However, local tax and accounting requirements differ in what forms of compensation are eligible, the value of the compensation that can be deducted, and accounting requirements.

Some countries, such as the UK, provide statutory deductions irrespective of any cost in the local entity i. Many countries allow a corporate deduction if the local entity recognizes an appropriate expense issuance and exercise of stock options dubai. Further, in certain countries the deduction may only be available for shares purchased in the open market and not for newly issued shares.

Other countries, such as the Netherlands, generally do not allow a deduction even where there is a local entity expense. Furthermore, in certain jurisdictions, such as China, recharge may not be possible for foreign exchange control reasons.

The Appendix below summarizes local tax and accounting requirements applicable to the deductibility issuance and exercise of stock options dubai recharged costs in Australia, Brazil, Canada, China, Germany, Hong Kong and the United Kingdom. In the experience of the authors, companies equally use the grant-date method and the spread-at-exercise method to determine the cost of stock options in recharging equity-based compensation.

Due care should be taken in choosing the method for recharging costs because it also impacts transfer pricing relationships as discussed below. Transfer pricing implications of recharging. Although the grant of equity-based incentive compensation to employees of overseas subsidiaries has limited direct tax implications from the US standpoint, it can have a bearing on intercompany pricing, which could result in additional cost burden on the foreign subsidiaries and also indirectly affect the tax liability of the US parent.

Depending on the transfer pricing relationship, foreign subsidiaries can be broadly categorized into two groups: Recharging to an LRE. First consider the case of an LRE that is provided a guaranteed level of profit though a cost-plus payment by the US parent, issuance and exercise of stock options dubai in Figure 2. This implies that the recharged cost is essentially passed back to the US parent though the payment that the US parent provides to the local subsidiary.

Alternatively, if the LRE is compensated by a foreign principal, the foreign principal may issuance and exercise of stock options dubai the cost of the recharge through the payment provided to the LRE. Impact of recharge on intercompany pricing of LREs. However, if the payment made by the US parent to the issuance and exercise of stock options dubai subsidiary is deductible in the US, this higher tax burden may be offset by lower taxes for the US parent.

In effect, the cost of equity-based compensation that is pushed down to the foreign subsidiary is round-tripped back to the US parent via the payment to its foreign subsidiary. This effectively allows the US parent to get the same benefit from the deduction that it would have lost had it not recharged the equity grants.

The cost of equity-based compensation included in the cost base becomes important in this scenario because the compensation to the LRE is based on the cost base of the LRE. Issuance and exercise of stock options dubai can use either the grant-date method or the spread-at-exercise method in this regard. That is, unrelated parties negotiate prices ex-ante on the basis of expected costs likely to be incurred.

Thus, pricing takes into account the grant-date value of any equity-based compensation that the company expects to offer to its employees.

Indeed, unrelated parties typically do not adjust prices on the basis of actual stock price performance. This is also reflected in the financial statements released by the companies that disclose the grant-date value of equity-based compensation given to its employees. In other words, the financial performance disclosed to investors, which forms the basis for their investment decisions, includes the grant-date value of equity-based compensation.

However, issues can arise in using the grant-date method because the local tax deduction, if allowed, typically follows the spread-at-exercise method, which can produce a materially different value from the grant-date method. This can result in lower than desired level of profitability if the value under the spread-at-exercise method is higher than the value under the grant-date method. On the other hand, if the spread-at-exercise method value is lower than grant-date method value, it may result in higher-than desired level of profits in the LRE.

This suggests that the LRE issuance and exercise of stock options dubai only claim a local tax deduction equal to the grant-date value so that consistency between costs and revenue is achieved. However, this may not be possible in all countries. The advantage of using the spread-at-exercise method in pricing intercompany fee is that it ensures consistency between the deduction available and the payments that that the LRE will receive and therefore the LRE is more likely to achieve the target level of profitability.

Another advantage of the spread-at-exercise method is that the cost plus fee paid by the US parent or the foreign principal to the LRE may be deductible to the US parent or the foreign principal. Thus, equity compensation award costs, which were not deductible by the US parent or the foreign principal effectively may become deductible through the service fee paid by the US parent or the foreign principal. Further, over an extended period of time, the values under the two methods are likely to converge, and the corresponding tax liability is likely to be similar under both methods.

Another peculiarity associated with the spread-at-exercise method is that in certain situations the spread can be substantial due to a run up in the stock price this happens most often in the case of a startup company going public. Correspondingly, the cost base and the plus can be also be substantial resulting in an increase the tax burden of a cost plus LRE. In such situations, it may be more optimal to recharge the equity-based compensation to a foreign principal.

In conclusion, neither method is perfect. Taxpayers should evaluate and choose a method taking into consideration the anticipated results. More importantly, taxpayers should stick with the chosen method to ensure consistency.

Recharging from an RBE. When the local subsidiary is an RBE issuance and exercise of stock options dubai profits are determined by the performance of the business, and the costs from the recharged equity grants are deductible, the tax burden is reduced because the profits are lower due to the recharged costs. This is shown in the figure below. Impact of recharge on intercompany pricing of RBEs.

Impact of stock-based compensation on cost sharing and intercompany service fees. The US transfer pricing regulations have adopted the view that equity-based compensation is a cost for transfer pricing purposes. The cost sharing regulations clarify that equity-based compensation should be taken into issuance and exercise of stock options dubai in determining the operating expenses treated as intangible development costs of a controlled participant in a qualified cost sharing arrangement under Treas.

Similarly, the intercompany services related regulations also clarify that equity-based compensation should be included in the cost base for purposes of determining chargeable costs. Under the cost sharing regulations, the default position is that the value of equity-based compensation using the spread-at-exercise method is the cost that should be included in the cost pool for intangible development activities within the scope of a cost sharing arrangement.

Taxpayers can alternatively elect to use the grant-date method when the equity-based compensation is in a regularly traded stock on a US securities market. Again, the key is to choose a method and use it consistently. The US transfer pricing regulations pertaining to pricing of intercompany services also clarified the IRS intent that total services costs should include equity-based compensation for cost-based services methods e.

While the services regulations do not endorse any particular method, the examples provided use the grant-date method. In relation to tangible and intangible property transactions, the US regulations for the application of the CPM also address equity-based compensation. Ensuring your strategy is cohesive.

Equity incentive compensation granted to employees located in foreign countries can lead to a number of tax, accounting and transfer pricing issues. Many issuance and exercise of stock options dubai these issues result from the local regulations applicable to the recharge of equity compensation costs, while others arise due to transfer pricing relationships.

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Companies have many different ways to raise financing; either by way of equity financing or by way of debt financing. Classic examples of equity financing are for corporations to increase their share capital by inviting existing shareholders or new strategic investors i. Alternatively, corporations may, instead of equity financing, decide to raise financing through debt financing. The commonly used debt financing means are: As explained above, bonds are one of the most commonly used instruments by corporations to raise financing.

Bonds can be a cost-effective but less flexible form of finance than equity shares. It is more cost-effective because lenders are entitled to only a fixed rate of interest, but less flexible because they are usually entitled to that interest, whether a company is doing well or badly, whereas the declaration of dividends on ordinary shares is usually a matter for the discretion of the Board whose recommendation must be ratified by shareholders.

Also, the financing cost a company must incur depends to a considerable extent on whether it can offer a lender security and the quality of the security offered. The legal relationship between a company and its bond holders is a contractual relationship of a debtor and creditor. In contrast, with a shareholder, the bond holder is in law not a member of the company having rights in it but a creditor with rights against the company. In other words, shareholders have rights in the company but bond holders have rights against the company.

Issuance of bonds is something that we can only expect from a large company of perceived creditworthiness. A bond in this context is a bearer security of certain nominal value issued for money by a company which promises payment of the nominal value at a certain date in the future and, usually, regular interest payments in the meantime.

Some bonds are issued for much less than their nominal value and no interest is paid on them. Another type of bonds is where a company issue bonds against a loan and grant the lender an option to convert the value of the bonds a lend holds into shares in the issuing company. The conversion terms and rate are to be set beforehand between the issuing company and the lender.

As this article will explain, in the UAE this type of bond namely convertible bonds confers particular practical benefits and advantages to companies and investors who have particular interests to hold a significant stake in the issuing company. The decision to issue new equity, convertible and fixed-income securities to raise capital funds is governed by a number of factors. One is the availability of internally generated funds relative to total financing needs.

Further, the cost of alternative external sources of funds i. As we will see later on in this Article, sometimes UAE joint stock companies issue convertible bonds to facilitate bringing on board new strategic investors, but to do it is necessary to circumvent preemption rights of existing shareholders to subscribe to newly issued shares. The Commercial Companies Law No. Under the CCL, a public joint stock company may, following the approval of its EGM, enter into loan agreement s in consideration for negotiable loan debentures of equal value, i.

As the case in all common and civil law jurisdictions, the UAE legislation designed to protect the best interest of the prospective holder s before the company in question issues the CBs and general public subscribe to it.

The law seeks to ensure that the financial position and overall performance of the company allow it to issue CBs. On one hand, to ensure that the issuer of the CBs will be in a financial position to repay the face value of the CBs in addition to the applicable interest rate, and on the other hand, if the CBs holder decides to convert the CBs into shares in the issuer, the CBs holder will become a shareholder in a vibrant and lucrative entity.

Furthermore, the CCL indicates that the value of the CBs must not exceed the existing capital as disclosed the latest certified balance sheet of the public joint stock company, unless the CBs are guaranteed by a UAE Sovereign entity or by a UAE-licensed bank.

As the issue of CBs may diliute the existing shareholders of a public joint stock company, the CCL requires the shareholders of the issuing company to approve the isssue of CBs in a general assembly with special attendance and voting quorums. Although, CBs grant its holder a right against the issuer of the CBs, the resolutions of the general assemblies of the shareholders of the issuer shall apply to CBs holders. However, the general assemblies may not alter the rights of the holders of such CBs except with the approval of the CB holders in a special meeting.

As a matter of contract, CBs may not be converted into shares unless this was provided for in the loan agreement s and the conversion must be implemented in accordance with the terms and conditions stated in the loan agreement s. CB holders will still have the right under the CCL to choose between either the conversion of the CBs into shares, or repayment, unless the CBs were issued on terms such that conversion is mandatory. In such event the provisions of the Resolution will apply to the issuer of the CBs and the CBs sought to be listed.

In principle, the provisions of the Resolution shall not apply to those CBs or certificates of deposit or any other debt instruments which are not offered to the public through a Public Subscription that are issued by banks and specialised financial and investment institutions on behalf of their customers, such debt instruments are subject to special regulations to be issued by the Central Bank. Any condition to the contrary in the company articles or in the resolution adopted to increase the capital shall be void.

As clearly indicated in the above Article, existing shareholders of public joint stock companies have a preemption right to subscribe in shares that will be issued as a result of a capital increase. Therefore, if a public company wishes to invite a strategic investor to invest in the company by way of a capital increase, such invitation will always be subject to with the preemption rights conferred to the existing shareholders by the CCL making commercial negotiation of placement terms problematic.

The only way out is for the existing shareholders to waive their rights to subscribe to the capital fresh shares, which is cumbersome and impractical. Alternatively, the company in question may circumvent the preemption rights of the existing shareholders by issuing CBs to the strategic investor, offering him the right, or the option, to convert such CBs into equity in the issuing company.

The strategic investor in can convert the CBs into equity, and in which case the existing shareholders will have no option to tab in and exercise their preemption rights.

The value of the underlying loan will be the consideration for the newly issued capital increase shares which will be subscribed for by the strategic investor. In practice, the structure is commonly used in the UAE. However, there is a residual legal problem under Article of the CCL, which states that: The argument based on this provision would be that an extraordinary general assembly of the issuing company which approved the issuance of CBs might be void because it impliedly deprives the existing shareholder from one of their rights granted to them by the law, being their right to have priority to subscribe in new capital increase shares that will be allotted to the CBs holder s.

The likelihood of having a successful claim made on the above argument is relatively remote unless someone can establish undisputable evidence that the underlying rational of the resolution of the extraordinary general assembly is to deprive the existing shareholders from their preemption rights. In practice, this is less likely to happen. The law is silent as to the pricing of CBs or its term or the maturity period. Typically, the conversion of CBs takes from eight to twelve months.

However, there are exceptional cases where conversation took place in six months or less. Article of the CCl prevents any limited liability companies from carrying on or offering for public subscription any shares or negotiable stocks or securities, i. However, there are pros and cons to the use of convertible bonds for financing; investors should consider what the issue means from a corporate standpoint before buying in. Bonds issue under the UAE Local Laws by - - Companies have many different ways to raise financing; either by way of equity financing or by way of debt financing.

Why Do Companies Issue convertible bonds? Article of the CCL states that: Can limited liability companies issue CBs?