The Supreme Court ruled Tuesday that proceeds from exercising stock options should be regarded as a part of salary and thus subject to a higher tax rate than for one-time income.
The top court’s first ruling on the matter rejected a suit filed by a former president of the Japan unit of U.S. chip-maker Applied Materials Inc.
Tuesday’s decision in favor of tax authorities upheld an earlier ruling by the Tokyo High Court and will probably affect affect similar lawsuits across Japan. There are 102 such suits pending, according to the National Tax Agency.
“Proceeds from exercising (stock options) are compensation for labor and services rendered and constitute salary income,” said Justice Tokiyasu Fujita, who presided over the case at the court’s No. 3 Petty Bench.
In the lawsuit, Keisuke Yawata, former president of the Japanese unit of Applied Materials Inc., was challenging a move by tax authorities to impose a higher tax applicable to pretax salary income on the 360 million yen in income generated by his sale of stocks after exercising stock options between 1996 and 1997.
He declared the amount as nonpretax income in the relevant tax years, thus rendering them eligible for a lower tax rate. However, tax authorities rejected this and imposed additional taxes of 79 million yen.
The Tokyo District Court ruled in August 2003 that the stock option income should be treated as nonpretax income subject to a lower tax because proceeds from such transactions are determined by the contingent factor of stock prices, which fluctuate.
But the Tokyo High Court overturned the ruling in February and rejected Yawata’s request, saying provision of stock options to employees is intended to motivate them to continue working at the company and constitutes compensation for labor and services.
Stock options refer to the rights to buy shares at predetermined prices, which allow the holder to generate a profit by selling shares provided that the market price is higher than the predetermined level.
The Commercial Code was revised in 1997 to allow companies to give employees stock options. Some preferential tax treatment is provided on income gained from such options under the code if certain conditions are met.
But most cases subject to the lawsuits over taxation concern stock options given to employees of the Japanese units of foreign companies that are outside the scope of the Commercial Code.
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