The reform of the taxation of employee share issues was finally confirmed at the end of 2020 and it entered into force on the 1st of January 2021. The new amendments to the Income Tax Act do not only clarify current valuation issues, but also provide opportunities to engage personnel in a tax efficient way.
Before the reform, benefits gained in employee share issues at unlisted limited liability companies were taxed as earned (wage) income with a progressive tax rate of up to over 50 %. The taxable amount corresponded to the difference between the fair market value and the subscription price of the shares. However, in case the subscription was offered to the majority of the employees, the benefit was taxable “only” to the amount the subscription price is less than 90 % of the fair value of the shares.
What has changed?
After the reform has entered into force, it will mark a substantial relief in determining the taxable amount.
From 1.1.2021 onwards, the determination of the taxable amount is no longer be based on the fair market value, but on the mathematical value of the shares issued. The determination of the mathematical value is based on the company’s net assets, which means that the value is, in simple terms, calculated by dividing the equity with the total number of shares. Thus, both self-created goodwill and differences between fair and tax values of assets will be excluded from the tax base. The mathematical value of a share is generally remarkably lower than its fair value.
When selling the subscribed shares, the difference between the subscription price (i.e. the mathematical value) and the selling price is, as currently, treated as capital gains income. Since the applicable tax rate for capital gains is 30 – 34 %, compared to tax rates of over 50 % for earned income, the taxation as capital gains income provides a further tax advantage compared to the alternative of paying of salaries.
Applying the mathematical value as described requires that the opportunity to subscribe shares is offered to the majority of the personnel (more than 50% of the company’s employees). However, the relief only applies to the employees, not to the management, and only to the subscribers owning less than 10 % of the stock. Thus, the reform is designed to engage the personnel as a whole rather than to reward single employees, managers or current owners. Although the terms of the share issue must be same for all employees, the number of shares offered to each employee can vary depending on, for example, the value of the employee’s work contribution.
How to utilize the new opportunities?
Since the value of a startup is typically based on future yield expectations rather than on the book value of the assets, the reform is welcomed especially in the startup scene. Planning and utilizing employee share issues provides a new and efficient way of increasing the competitiveness of a startup as an employer in the tightening competition for talents.
To ensure favorable tax treatment, the employee share issue should be planned carefully in advance. Our experts are happy to discuss the new regime as well as other ways to provide incentives to reward your employees.
Text and additional information:
Frans Bergman, Senior Associate, +358 40 772 4200, [email protected]