Taxation of personnel issue and employment stock options from the employee’s point of view
Listed companies in particular often have share and option-based incentive schemes aimed at bringing the company’s key employees’ and shareholders’ interests closer together and rewarding key employees on the fulfilment of set objectives. Naturally, the same means of increasing employee commitment are also available to non-listed companies.
In addition to the those mentioned above, incentive schemes may be based, for example, on a pure monetary performance (incl. bonuses) or virtual ownership structure, such as monetary performance tied to share price performance or so-called synthetic options. These or the transfer tax consequences of incentive schemes are, however, not addressed in this text.
Personnel issue means the offering of shares to the company’s employees. Personal income tax on personnel issue is tied to the relationship between subscription price and fair value of a share, so that when subscription price is equal to fair value no taxable benefit is generated for the employee who owns the share. If subscription price falls below fair value, this discount is considered a benefit obtained through employment and is therefore taxed as earned income of the employee received at the time the share was issued.
However, taxable benefit does not arise if the discount is less than 10% and the benefit is available to the majority of staff, i.e., they have the opportunity to participate in personnel issue if they so wish. However, in terms of taxable benefit generated, it does not matter what proportion of staff actually register shares as a result of personnel issue.
For listed companies, fair value is the average share price during the calendar month prior to the share issue decision (i.e., trade weighted average exchange rate) or the average share price of the calendar month following when a share registered in the share issue was first noted, whichever is lower. Fair value in a non-listed company is, in turn, primarily determined according to previous sales of the same company's shares or, for example, the last funding round, and secondarily in an otherwise reliable manner, such as according to the Tax Administration’s valuation formula.
Employment stock options
For tax purposes, employment stock options refer to the employee’s right to receive or acquire the company’s shares based on their employment relationship and on a certain kind of contract or commitment, such as a stock option. An employment stock option also creates taxable benefit for the employee if the option allows him or her to register the share at a lower price than fair value. In determining the benefit amount, the total price paid by the employee for both the share and option is deducted from the share’s fair value at the time of registration.
All discount received through exercising employment stock options is considered earned income of the employee regardless of the size of the discount or whether stock options are offered to the majority of staff. Tax is not paid on the benefit until the year in which the employment stock options are exercised, i.e., the employee receives or acquires shares under the option or surrenders the option. In the latter case, the value of the benefit is considered to be the selling price minus the possible price of the option.
Donating or surrendering the option to a related party is not considered exercising the option – in this case, tax will only be payable when the transferee exercises the option. Even in this case, the benefit is the original recipient’s earned income, not the transferee’s, and income tax cannot therefore be avoided, for example, by donating options to a family member.
In the case of employment stock options, fair value for listed companies is considered to be the average rate on the day the share was registered, not the date the option was received or acquired. The fair value of non-listed companies’ shares is determined in the same manner as in personnel issue. In practice, the difference between receiving a share based on an employment relationship and a stock option arises from the fact that the increase in value following receipt of a share becomes taxable as capital income at the time of transfer, whereas the increase in share value that follows receipt of an option becomes taxable as earned income at the time of registration.