Why 409a Valuations Are Also Required For Non-US Private Firms?

The 409a valuation is a third-party assessment of a firm’s common stock to estimate the cost of buying shares. This appraisal depends on FMV (fair market value). Whether a non-US private firm requires this appraisal depends on the firm’s and valuation project’s characteristics. Surprisingly, when offering stock to workers who are US nationals and US tax residents, non-US firms must take into account US tax legislation for many important decisions. A non-US equity transfer must adhere to US Internal Revenue Code Section 409A.

What Does 409A Imply?

409A governs the taxing of a wide range of “deferred compensation” programs whereby an employee gets paid in one taxable year but must pay in a subsequent year. In general, 409A requires deferred compensation schemes to fulfill several difficult conditions, with failure to do so having substantial tax repercussions. Exclusions under 409A apply to non-US deferring compensation packages, whose equity structures and accounting standards are structured distinctly from the US.

When Offering Equity To US Workers, How Does A Non-US Business Comply With 409A?

To qualify for an exemption, you must first calculate the fair market value of your startup’s shares before issuing the options. It ensures that your non-US company’s strike price does not fall underneath the FMV of a company’s stock. The 409A guidelines demand an assessment by an independent party or the board to determine the FMV.

In determining the FMV of the firm, the appraiser may take into account the worth of property and equipment, the current value of future revenues, the selling price of similar enterprises, and so on. Because non-US assessment criteria may vary from US norms and subject the corporation to a breach of 409A, the assessor must follow US standards when assessing FMV. A 409a valuation is valid for twelve months or until a significant event, like financing.

It’s good to include an addendum explaining the 409A laws in the non-US employee stock option plan. Each foreign shareholding agreement that a US employee signs should include an addendum stating that the stock contract is susceptible and conforms with 409A. It necessitates a review of the amendment and the employee stock option scheme by US lawyers and local counsel.

What Happens If The 409A Isn’t Followed?

Failure to comply with 409A can result in severe tax repercussions and fines for US workers and non-US startups. The difference between the market price will claim the valuation of the company’s stock as income as it is considered an additional benefit for the US worker every time, even if the worker has not executed the option. For example, in the case of firm X, the difference in the values and the strike price, $0.01/share, is recognized as income for Y, and Y is a US worker taxed on those earnings.

 The non-US startup, for its part, would be responsible for disclosing the non-compliance on the employee’s tax form, withholding income tax on the 409A income, and perhaps facing fines from the US Internal Revenue Service if it failed to do so. Some companies may elect to shoulder the financial burden of repaying the tax debt incurred due to the 409A violation on behalf of the impacted employee.

Conclusion

To avoid severe tax implications, a non-US private firm must verify that it has a legitimate 409a valuation study before issuing stock options to US workers and non-US employees filing tax to the US government. To prevent a breach, it is equally critical to get competent legal counsel on 409A compliance if stock is to be granted to US workers under a non-U.S. plan.

Topic: 409A Valuation