Transfer pricing and employee stock options

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The item Transfer pricing and employee stock options represents a specific, individual, material embodiment of a distinct intellectual or artistic creation found in International Bureau of Fiscal Documentation.
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Summary: The arm's-length principle of transfer pricing requires that transactions between related entities be undertaken at prices and on terms and conditions that would exist between entities dealing at arm's length. Applying the arm's-length principle to employee stock options introduces practical and theoretical issues that are difficult to reconcile and resolve. Employers almost never grant options to acquire shares of arm's length corporations to their employees or to employees of their subsidiaries, since to do so would not serve any incentive alignment purpose. Further, employee stock options are difficult to value because they are explicitly designed to be non-marketable, nontransferable, non-exercisable before vesting, and forfeitable if employment is terminated before vesting. The resulting limited demand for and illiquidity of employee stock options renders their valuation imprecise for all purposes - tax, accounting, and economic. In this article, the authors examine the arm's-length principle and its application to employee stock options in cost-sharing arrangements and recharge agreements between non-arm's-length entities. They also explore the methodology and the timing of valuing such options for the purposes of transfer pricing

Work

Summary: The arm's-length principle of transfer pricing requires that transactions between related entities be undertaken at prices and on terms and conditions that would exist between entities dealing at arm's length. Applying the arm's-length principle to employee stock options introduces practical and theoretical issues that are difficult to reconcile and resolve. Employers almost never grant options to acquire shares of arm's length corporations to their employees or to employees of their subsidiaries, since to do so would not serve any incentive alignment purpose. Further, employee stock options are difficult to value because they are explicitly designed to be non-marketable, nontransferable, non-exercisable before vesting, and forfeitable if employment is terminated before vesting. The resulting limited demand for and illiquidity of employee stock options renders their valuation imprecise for all purposes - tax, accounting, and economic. In this article, the authors examine the arm's-length principle and its application to employee stock options in cost-sharing arrangements and recharge agreements between non-arm's-length entities. They also explore the methodology and the timing of valuing such options for the purposes of transfer pricing