Stock option plan
How do you reward employees whose performances are in line with or even surpass the predetermined objectives? Many enterprises still opt for the standard salary increase or bonus, but unfortunately, this might not always be the best or most profitable option for the enterprise and the employee involved…
A reward in cash:
- will cost both parties a lot of money: social security contributions are owed by the employee (13.07%) and the employer (+- 27%) and holiday payment on variable amounts is owed on this amount. Moreover, payroll tax on exceptional benefits is extremely high, increasing the fiscal pressure on the employee's income.
- requires the enterprise has the necessary cash to offer such a salary increase or bonus
- does not necessarily reflect the actual performances of the company
- does not constitute an incentive for the employee to stay with the company in a long term perspective.
Fortunately, there’s a more profitable alternative to reward employees in line with the company performances, financially and fiscally beneficial, and to tie them to the company for the long term: the stock option plan.
What is a stock option plan?
In a stock option plan one or more beneficiaries are granted the option to buy or subscribe to newly issued shares at a predefined price within a predefined period.
When meeting certain conditions, the future capital gain realised upon exercise of the stock options is not taxable as a professional income and no social security contributions are due. This exemption from social security contributions doesn't count for beneficiaries under the social security system for the self-employed.
How does a stock option plan work?
1. The enterprise issues a stock option plan and explains to the beneficiaries how the plan works, what options are offered and what conditions apply.
2. The beneficiaries communicate whether they want to participate in the plan or not. Those who wish to participate, are granted the options that are generally offered for free. They are not yet attributed the underlying shares. In as long as the beneficiary accepts the offer in writing within a period of 60 days after the offering, the following counts:
A. The employee pays the tax due on the moment he is granted the options (this is the 60th day following the moment of the offering).
That amount is taxed as a professional income according to the applicable income tax rates (no social security contributions). The flat-rate calculation goes as follows:
General: 18% of the value of underlying shares upon attribution (+ 1% per year when the exercise period is >5 years)
- Lower tax (half): 9% of the value of underlying shares (+ 0.5% per year when the exercise period is >5 years) when meeting the following conditions:
- it concerns options on shares of the company for which the employee performs professional activities or on shares of another company that holds a direct or indirect participation in the company the employee is working for.
- options are not exercisable before the end of the 3rd calendar year following the offer.
- options are not exercisable after the end of the 10th year following the offer.
- no “hedging” - the risk linked to the process may not be borne by the employer.
- exercise price must be fixed or determinable at the moment of the offer.
- options are non-transferable among the living.
This option is exempted from social security contributions and is therefore not included in the basis of the calculcation of the holiday payment on variable amounts.
Beware: in case the options are not accepted in writing within 60 days after the offering, the beneficiary will be taxed on the moment of exercising the options and thus on the entire amount of his strike price, being the difference between the value of the options received and the strike price (no flat-rate calculation). Additionally, social security contributions are owed by both the employee and the employer (and holiday payment on variable amounts will need to be payed).
- B. Between the granting and the exercise of the option, the beneficiary is no shareholder of the company and will get no voting rights nor right to any distribution (dividends). If the options grant the beneficiary the right to acquire newly issued shares, the beneficiary is allowed to attend the general meeting and to have an advisory vote.
3. The beneficiary decides whether or not to exercise the options.
- A. The beneficiary buys the existing shares or acquires the newly issued shares and pays the underlying price as determined in the stock option plan.
- B. The beneficiary can then choose to keep the shares or resell then and realise a capital gain. The stock option plan often allows:
- the company (or an affiliate) can buy off the underlying shares upon exercise of the option (call option).
- the beneficiary to sell off the underlying shares upon exercise of the option (put option) to the employer.
- the beneficiary to exercise its option anticipatively if some specific events occur, called ‘change of control’, such as a change of management in the company, a merger or sale of the company.
- C. The plan determines which rights the beneficiary keeps in case he leaves the company before the moment the options can be exercised (the so-called 'bad leaver' and 'good leaver' clauses).
Imagine an enterprise issuing 10,000 shares is worth 1M EUR. Every share is then worth 10 EUR.
On 1 October 2021, an employee is granted options on 100 shares. The options can be exercised between 1 January 2025 and 30 September 2026.
If the employee accepts the proposition before 1 December 2021, he will have to pay 48.15 EUR. This amount is calculated as follows:
- The taxable base is 1,000 EUR. This is the total value of the shares related to the option.
- This amount is multiplied by 9%, resulting in an amount of 90 EUR.
- 90 EUR is then multiplied by the applicable personal tax rate. This is usually 50%, to increase with the average rate of additional municipal taxes of 7%, to calculate on the previous calculated tax amount. This results in a total tax of 48.15 EUR.
Between the end of 2021 and the start of the exercise period, the following two scenarios can happen:
- The value of the company has decreased. It is unlikely the beneficiary will be interested in exercising his options as he won’t be able to realise a profit gain and thus lose the taxable amount he paid at the beginning (subject to exceptions (and under conditions) such as the fiscally neutral warranty of a surplus value of an amount equal to the tax paid on the moment he accepts.
- The value of the company has increased. The shares are now worth more (e.g., an increase of 75% so the shares are now valued at 1,750 EUR). The beneficiary will be interested in exercising his option and if he sells his shares, his will realise a capital gain of 750 EUR. Minus the tax of 48,.15 EUR, his net gain will be 701.85 EUR.
Are you interested in issuing a stock option plan within your organisation? Don’t hesitate to contact our Tax & Legal team.