Translating your ESOP abroad.

• Author: Gates, Jeffrey R.
• Position: Employee stock ownership plans - Includes related article - Employee Benefits

Until now, the idea of starting an employee stock ownership plan for international divisions wasn't for the faint of heart. But the new international ESOP may just change all that.

If you have an employee stock ownership plan, you may have toyed with the idea of extending it to your non-U.S. employees. But until recently, the daunting challenges of adapting ESOPs to other countries have stymied all but the most determined. Faced with a bewildering array of foreign legal and regulatory hurdles, many corporations have abandoned the idea of establishing ESOPs for their international operations.

But a model for an international ESOP is beginning to emerge, holding out the promise of new corporate-finance and employee-benefits strategies. For financial executives long denied the opportunity to develop an ESOP for their worldwide work force, this new development is a good reason to revisit the issue. And for global managers who haven't yet contemplated this vehicle, now's a good time to think about it.

The goal of the international ESOP is to replicate the methodology and the tax benefits of the U.S. ESOP. Under a domestic ESOP, a company-established trust acquires employer shares and holds them until employees are ready to take their distributions, which usually occurs at retirement. Employers get a tax deduction for the costs of funding the plan. And because employees don't have free access to their shares, they can defer paying personal-income tax until they do receive them.

But until recently, corporations have often run into problems when trying to transplant their U.S. ESOPs into other countries. For example, many foreign countries require employees to pay taxes on shares once they become nonforfeitable. Because vesting normally occurs during employment (well before the company distributes the shares), this tax liability creates an employee funding problem. Employers often try to get around this rule by tailoring their tax-qualified schemes to each country's laws, but that increases professional fees, not to mention the costs of management time and administrative overhead. And while some countries have developed ESOP legislation of their own, most are "near ESOPs" that usually won't fill the bill.

These obstacles have driven some corporations to grant stock options to their employees instead, a move that presents its own set of difficulties. For one, stock options often fail to produce career-long employee stockholders. Plus, in most countries, exercising a stock option triggers local income-tax liability. In practice, this often means that employees must sell shares to pay the tax or that employers incur the extra cost of "grossing up" employees' pay to cover the expense. And because exercising a stock option involves an investment decision, local investor-protection laws often apply to these schemes.

ESCAPING THE LABYRINTH

The international ESOP bypasses this regulatory maze. It operates through an ESOP trust with an employer-appointed trustee, normally a professional corporate trustee in an...