When employers use shares as bait

In Qatar it is all cut and dried: since it is not possible to offer compensation in the form of company shares, the question of how they should be taxed just does not come up. However, in 15 of the 16 countries in which partners of Ecovis participated in a fiscal policy survey on this topic, companies can use shares to compensate their employees and managers, or they can grant them an option to acquire shares at a pre-determined price. “Then again, there are differences in the prevalence of such forms of compensation from country to country,” says Dr. Ferdinand Rüchardt, a member of Ecovis’ board of directors and an expert on international fiscal law. “The top-ranking country of those surveyed here is Great Britain.” By contrast, according to Celal Çelik, one of Ecovis’ partners in Istanbul, “Compensation in the form of company shares is rather a rarity” in Turkey. There are also differences in regulations determining the point at which employees have to pay taxes on such shares (for example when they receive the shares, or upon their subsequent sale) and how they are assessed – and to what extent the company can claim tax deductions for costs. In Great Britain, for example, a difference is made between state-approved share compensation or options plans, which have to meet specific criteria to qualify for tax advantages, and non-approved shares which provide no tax advantages but are more flexible.

Let us take a look at a simple example. What are the fiscal regulations applying to employees or managers who have received company shares at the current market value as part of their remuneration? In 12 countries, one of which is China, the recipients are liable to pay income tax on this non-cash benefit (at the market value) at the moment the shares are transferred to them, at the individual income tax rates applicable (for example, in England at staggered rates of 20%, 40% or 50%, or, in Austria, after deduction of a certain tax-exempt amount).

Ecovis partners from four of such countries – Great Britain, Portugal, Spain and Germany – also stated that subsequent capital gains are taxed in accordance with standard regulations (i. e. if the amount for which the shares are sold is greater than the accrued market value). Fixed rates for unearned income or capital gains apply. In Spain, capital gains are to be shown in the tax declaration; here the tax rate is 19% up to € 6,000 and 21% for any amounts exceeding this. In Germany a withholding tax at a flat rate of 25% is deducted at source by securities custodians on all dividends, interest and capital gains (in addition to the solidarity surcharge, and church tax where applicable). Beneficiaries with a relatively low income and thus a low individual tax rate can claim these back in their tax declarations and will receive a refund. Capital gains of up to € 801 per person are tax exempt. In Great Britain, the capital gains tax is 18% for tax payers in the lowest income tax bracket, whilst everyone else pays 28%. Here, too, there is a tax-free allowance (GBP 10,000 in the fiscal year 2009/10). In both Germany and England, capital gains can be set off against corresponding losses.

There are three countries in which compensation in the form of shares at the current market value is not taxed until the shares are sold. In Korea taxation is assessed at the individual income tax rate, in Poland there is a fixed rate for capital gains and in Latvia a special rule with a rate of 15% applies.

In Latvia, incidentally, only joint stock companies are allowed to issue shares to their employees and management, for not more than 10% of their share capital. “The companies are not allowed to charge for these shares,” states Ineta Strazde, “Not even at a discount from the going rate.”  This thus excludes option plans which entitle employees to acquire shares at a pre-determined price. Moreover, only “registered shares” may be issued, and then only from the profit income after taxes.

Latvia is therefore one of six countries, two others being China and South Korea, in which the nominal value of the shares issued to employees and managers as a form of compensation may not be classed as expenses when determining taxable income. In four countries – China, Japan, Holland and Germany – companies may claim for a tax deduction for the market value of the shares at the moment of transfer. This is almost the same case, according to replies received from our Ecovis partners in four other countries which cite market value less any fees which the employees are required to pay for the shares to be granted. “In Austria, however, the market value only applies if it is identical to the acquisition value of the shares, otherwise the acquisition value applies,” says Martin Grill, CPA and tax advisor in Ecovis’ office in Vienna. As a last example, in Spain, according to Jörg Hörauf, one of Ecovis’ partners in Barcelona, “the costs which the company incurs from the outward movement of the company shares are classed as tax deductible labour costs”.

Company shares at a discount
In practice it is more often the case that companies do not simply grant company shares partially in lieu of salary, but that they offer employees and managers an opportunity to purchase shares at a discount from the current market value, as a form of incentive. This system exists in 14 of the countries surveyed; Latvia is not among them due to the restrictions mentioned above.

In two countries the tax authorities do not appear on the scene until the shares are sold: in South Korea levying a tax at the individual income tax rate, in Poland at a fixed rate for capital gains. However, in most of the countries (11 of them) the non-cash benefit (i. e. the markdown) is taxed immediately the shares are purchased, at the individual income tax rate (in Austria after deduction of a tax-exempt allowance). In Germany the benefit derived from the discounted or free assignment of company shares is tax-free up to € 360 p. a. per employee, where the employer voluntarily grants them in addition to the contractual salary to encourage the employee’s formation of capital. Any employee shares issued must comply with specific regulations of stock corporation law.

Ecovis partners from three of these eleven countries – Portugal, Spain and Germany – also mention that any capital gains earned from selling the discounted shares are liable to taxation in accordance with the general regulations governing capital gains.

In nine of the fourteen countries, the companies can make tax deductions for any expenses incurred by assigning shares at a preferential price, declaring them as operating expenses – this being in most cases the difference between the market value of the shares and the discounted acquisition price.

Stock options as an incentive
Great Britain is a special case. Here, discounted acquisition is only possible for non-approved stock options plans and for EMIs (enterprise management incentive arrangements) which require prior approval. In this connection, “discounted” means that the price to be paid for the shares is below their market value “at grant”, i. e. at the time the option is granted. The discount gain is subject to income tax, of which there are three variations (ref. table). If capital gains are realised when stock options are sold, they are subject to capital gains tax. This also applies to options which entitle the employee to acquire shares at the market value prevailing on the day they are granted (“at grant”) (ref. table). In each case, the company can declare as expenses the difference between the market value of the shares at the time the option is exercised (acquisition) and the acquisition price granted to the employee or manager, to obtain a tax deduction.

Not only in Great Britain, but also in thirteen other countries, companies can grant their employees and managers options for the acquisition of shares at a fixed price. Those so entitled will, however, only exercise these options in cases where the market value of the shares is considerably higher than the acquisition price. For this reason the non-cash benefit at the time the option is exercised is taxed in most cases, generally at the individual income tax rate.

In the Netherlands a lower rate may apply in case of a “lucrative interest”. A lucrative interest can be defined as shares for which it can be reasonably assumed that they are provided to give a special remuneration to the employee. “Each situation should be analyzed whether it is a lucrative interest or not”, says Marc Lodder, one of Ecovis’ partners in Amsterdam. “If the shares qualify as a lucrative interest then the tax rate could be reduced to 25 % under certain conditions. This is possible, for example, if the shares given to the employee represent more than 5 % of the company’s capital. Another example: Employees 1 and 2 could participate in a newly founded company with 3 % and 2 % of the shares respectively so that both of them would hold 5 % in total. In this case the tax rate can be reduced to 25 %, too (under certain conditions).

In Japan, notwithstanding the standard income tax regime governing the exercising of options, “In the case of qualified stock options which have to comply with certain fiscal requirements, the shares are not taxed until they are sold, and then at the fixed rate for capital gains”, Orie Tomihara, one of Ecovis’ partners in Tokyo, explains. In Switzerland, options granted for a restricted period only, and any which are not traded on the stock exchange, are taxed at the date the option is exercised, whilst all others are taxed at the time of grant. In Austria taxation applies when the option (not quoted) is exercised at a discount from the market value of the shares. In Poland taxes on investment income (fixed rate) are not due unless capital gains are realised when selling the shares. Partners of Ecovis in Portugal, Spain and German stated that, in addition to the taxation of non-cash benefits from the exercise of options (acquisition), later capital gains are taxed at the usual rates.

In five countries companies cannot debit the expense of stock option plans against their taxable profit. In the majority of the countries surveyed, this is possible; in these cases, the market value less acquisition price of the shares is entered as expenses. In Japan, companies cannot deduct qualified option plans from their tax burden.

Taxation of stock option and acquisition plans in Great Britain