Unusual interpretation about a Stock-Option

According to the facts described in the Ruling, the employer had granted its employees the right to buy shares through a stock option plan. Such plan provided that, once the option was exercised, the employee would not be able to sell the shares for five years; and that if any dividend was distributed, it would be used to buy more shares.

The employer asked the Tax Authority whether the employee had to recognize taxable income in the year in which he/she exercised the option or in the year in which he/she was able to freely dispose of the shares.

According to the Income Tax Law, income arising from labor relationship is taxable on a cash-basis method (“percibido”). According the Income Tax Law’s Regulatory Decree, income is quantified by the difference between the market value of the stock at that time, or the pro-rata net equity value thereof and the acquisition cost.

The Tax Authority ruled that the employee had to recognize taxable income in the year in which he/she exercised the option. To decide so, it argued: that the shares had entered into his/her estate when exercising the option; and that the Income Tax Regulatory Decree provides not only how to determine taxable income, but also, when it has to be recognized.

This Ruling is interesting because of the Tax Authority’s interpretation of the Income Tax Regulatory Decree and its implications on the cash-basis method (“percepción”) concept.