Employers are always on the lookout for creative ways of rewarding their employees. They hope in this way to retain good staff, increase employee commitment or present themselves as attractive employers. With this package of measures, also known as “the employee participation plan”, many of these goals can be achieved.
Employee participation plans come in all shapes and sizes. There are participation plans for shares, employee stock options or bonus schemes that are tied to the value of the company. Sadly, misconceptions about employee participation abound, particularly in relation to tax. Below we list the 5 most common misconceptions about employee participation:
1. The only motivation behind employee participation plans is to pay less tax!
If the employee participation plan is intended solely to replace regular salary, then the tax burden should be a key consideration in its design. Where the employee participation plan has other aims, such as long-term staff retention, it may be necessary to disregard the importance of tax optimisation to achieve those aims. Practice has shown that if the employee participation plan is offered to a larger group of employees it is very important that the plan is not too complicated. Employee plans must therefore be in line with the intended goal, and taxation is one of the topics that must be kept in mind in the design of the plan.
2. Employees only pay tax if they 'profit' from an employee participation plan
The grant of shares can be considered as wages in kind if the employee pays nothing or too little for the shares. Payroll tax must therefore be paid even though no remuneration was received in cash. This can give rise to liquidity problems for employees. However, the employer can opt to absorb the payroll tax itself.
3. Employee stock options are taxed upon granting to the employee
An employee stock option is the right vested in an employee to acquire shares in his employer’s company at a pre-determined price within a certain period. Although an employee stock option may represent a certain value, this does not result in the levy of payroll tax.
Payroll tax is only due on the difference between the value of the acquired shares and the acquisition price upon the exercise of the employee stock option(s). The exercise of employee stock options also can give rise to liquidity problems for the employee, as the tax due must be paid in cash, while the employee has received 'only' shares. This liquidity issue is generally resolved by the fact that the employee is entitled to sell (part of) the acquired shares immediately to his employer.
4. The grant of (depositary receipts for) shares and/or employee stock options always results in tax benefits
As is the case under 2 above, the grant of (depositary receipts for) shares and the exercise of employee stock options can be considered as payment of wages in kind. However, the employer may not charge these costs to its own taxable profit. It is therefore possible that an employee participation plan, from a tax perspective, proves more expensive than awarding regular salary (whether or not in combination with a performance-related bonus).
As employees are often able, on exercising their stock options, to immediately sell back part of the acquired (depositary receipts for) shares to their employer, it may be more advantageous from a tax perspective to structure the employee participation in the form of a bonus, which is deductible for the employer. By tying the bonus to the increase in the value of the shares in the employer, it is possible to safeguard the value of the employee's award.
5. The taxation of employee participation plans is identical in all countries
Employee participation plans come in multiple guises. While in some countries there appears to be a strong preference for employee stock options, in other countries (conditional) share plans are popular. The design of the plan is often determined by the tax laws of the country where the employer is established. As the tax laws relating to employee participation plans vary across all countries, it can be very disadvantageous for employers or employees to offer the same plan to employees in different countries. It is recommended, therefore, that the plan, and the manner of its implementation, be tailored for each country.