An Employee Share Option: An effective way to retain the employee. Legal regulation and taxation in different EU countries.

10 min.

15. February 2023

Share options are rising as a popular way to incentivise and reward employees. This is noticed not only among start-ups but also among companies operating in other fields. Moreover, businesses around the world are also looking for financial incentives related to share options, such as phantom shares.

Employee Share Option Scheme: How Does it Work?

An employee option scheme is an equity compensation plan where business owners offer shares of their company to employees of their choice. The share option is a right to acquire a specific amount of the company’s shares after some time in the future at a pre-agreed price or free of charge. The employees who have this instrument are entitled to exercise their share options, i.e., to buy the shares after a specified period of time at the price fixed at the date when the options were received regardless of the prevailing market price or get them free of charge. Then, if the employee decides to sell the shares later, significant earnings are recorded.

The employer may provide that the granting and implementation of share options would be subject to certain goals, such as performance indicators or sales results. In other words, the employee will have a right to use his/her share options when the set goals and agreed indicators are met.

Some companies choose to offer share options to the key employees ensuring that the company’s strategy is executed by the team that has a long-standing history with the company while others offer share options to all employees. The common goal of both parties of the share options agreement is to motivate the employee to take a long-term approach, thus increasing the value of the employer as the company and aligning the interests of the parties. Share options are of personal nature and are inseparably related to the employee as the member of the particular company. The company wants to have longer employment relations, therefore, usually an essential condition is to set a long period after which the employees can exercise their right to acquire shares in the company.

The alternative to the share options are so-called phantom shares where the actual shares in the company are not granted but the cash bonus provided to the employee is linked to a change in the value of the company. The phantom shares are becoming more popular among FinTech companies in Lithuania, who, first of all, choose options to encourage employees who work longer or hold higher positions. This encourages the employee to become involved in the growth of the company’s value, although he/she doesn’t become a shareholder of the company.

Advantages of Employee Share Option

Helps you to attract high-quality talent. Most companies are painfully aware of the difficulty in attracting talented staff. While stock options are seldom substitutes for compensation increases, as part of a solid benefit program, they help make employment packages more attractive. Offering meaningful share options both attracts better, more talented employees and helps keep them for the long term.
Keeps staff motivated. Employees can reap some of the financial benefits of a successful business. This can result in employees making far more money above and beyond their annual salaries. Partial owners of a company have a vested interest not only in their own performance, but in the long-term success of the whole company. Individual employees will directly benefit from the success of a company and will feel a sense of ownership.
Offers tax advantages. The only significant costs to the company are the lost opportunities to sell some stock at market value (since employees usually buy at a discounted rate) and the expense of administering the plan. An Employee Share Option can be a very attractive option, particularly because of the tax benefits available and the simplicity of the rules, resulting in lower costs of implementation. Instead of depleting cash resources to pay people top rates and large bonuses, why not incentivise them via shares or options?
It’s highly flexible. Companies have flexibility in deciding how many stock options you can grant to employees. They can also choose to offer additional shares for people with seniority or special skills.

The applicable taxes are an important aspect in granting of the share options. The general rule is that if the shares are granted to the employee based on the share option, the difference between the fair market value of the shares and the price paid by the employee for the shares may be subject to taxes. In such cases, personal income tax and social security contributions are applied.

However, certain tax exemptions could apply to facilitate the conditions for start-ups and the whole business.

Legal Considerations of an Employee Share Option in different jurisdictions

Below you can find the summary of taxation and regulatory framework in different countries, such as Lithuania, Poland, Slovakia, Estonia, Latvia.

Country	Regulatory Framework	Taxation
Lithuania	Currently, the procedure for granting share options and concluding such agreements is not regulated in the Lithuanian legal system. Therefore, to have more detailed regulations in this area, amendments to the Law on Companies of the Republic of Lithuania are proposed.	The general rule is that the fringe benefits from share options is taxable as salary. The employer has the obligation to pay the applicable taxes. Applicable tax exemption is applied for income tax and social security contributions if a share option is held (but not exercised) by an employee for at least 3 years. The fringe benefits from share options are exempt from personal income tax provided that a share option agreement is concluded after 1 February 2020. It is important to note that taxation is applicable not at the moment of granting the share option but only when the share options are exercised. The capital gain which the employee derives from the sale of the acquired shares is subject to the personal income tax. The Law on Personal Income Tax of the Republic of Lithuania does not define the mechanism for calculating the fair market value. In principle, fair market value is an economically reasonable price agreed between independent persons. The State Tax Authority shall consider the price of the asset or service declared by the taxpayer to be correct until it is established otherwise.
Poland	Currently, the procedure for granting share options is not covered by corporate law. It is however possible both in limited liability company and joint stock company under existing legal frame. In limited liability company the options can be introduced in relevant agreement and resolutions In joint stock company options are introduced by using subscription warrants and conditional capital increase.	• The general rule is that the non-pecuniary benefits resulting from employment are taxable as salary. The employer has the obligation to pay the applicable taxes and social security contributions. In case of joint-stock companies the share options issued under option incentive scheme are not subject to taxation. The profit which the employee derives from the sale of the shares acquired as result of option incentive scheme is subject to the flat personal income tax of 19%. This rule however applies only to option incentive scheme in the meaning of Act on Personal Income Tax.
Slovakia	Currently, the procedure for granting share options is regulated in a very limited way, only for so-called “simple joint stock companies” (for employees or freelancers under specific conditions), and for joint stock companies (for employees on preferential terms). Slovak corporate law does not exclude (but also does not regulate) the acquisition of shares in other forms (phantom shares or share in LLC´s), as this possibility is foreseen by the Income Tax Act.	The general rule is that income (pecuniary and also non-pecuniary) resulting from employment is taxable as salary, as well as benefits with some statutory exceptions. The employee has the obligation to pay the applicable taxes, social security and health care contributions (levies). The difference between the fair market value of the share and the price at which the employee acquired the share is subject to taxes and levies. Subsequently, income from sale of the share by the employee, after deduction of expenses, incl. paid purchase price and amount of non- pecuniary income taxed by the employee, is also subject to taxes and levies; this applies if all incomes from sale of shares in respective financial year exceeds EUR 500.00 (up to this amount, it is a tax-free income). With respect to shares traded on a regulated market, Slovak Income Tax Act provides income tax exemption, if period between acquisition and sale exceeds one year.
Estonia	Currently, the procedure for granting share options for employees is not covered by law. It is however possible both in limited liability company and joint stock company under existing legal frame.	The granting of share options on the employer’s company is considered a fringe benefit. All types of fringe benefits are taxable as a salary. The employer has the obligation to pay the applicable taxes. Under the Income Tax Act of Estonia, share options have a tax exemption on certain conditions, on the basis of which options with an exercise time of at least three years are not considered fringe benefits. That means there must be at least three years between granting the option and acquisition of the assets underlying the option. The capital gain which the employee derives from the sale of the acquired shares is subject to the personal income tax.
Latvia	Since 13.07.2017, the corporate law in Latvia regulates issuance of stock options (personnel options) which give the right to officers and employees of a given company to acquire its stock. Personnel options may not be alienated unless it is otherwise provided for in the articles of association or the regulations for issuance of personnel options. The total amount of the stock which may be acquired by using personnel options may not exceed 10 per cent of the paid-up equity capital of the company at the time of taking the decision to grant personnel options.	Income from the implementation of a stock purchase option is a non-taxable income if the following conditions are complied with: the minimum period for holding of a stock purchase option (a period from the day of granting of the stock purchase option until the day when an employee is entitled to commence the implementation of the stock purchase option) is not less than 12 months; during the minimum period for holding the stock purchase option, the employee is in an employment relationship with the company which has granted the stock purchase option; the employer has submitted required-by-law information to the State Revenue Service; the stock purchase option is implemented not later than within six months from the day when the employment relationship with the company which granted the stock purchase option has been terminated; the company which has granted the stock purchase option to the employee has not granted a loan to the employee which has not been repaid by the moment of the implementation of the stock purchase option. If the above conditions are not met, the income from the implementation of a stock purchase option is taxable. The rate depends on the amount.

ECOVIS International is leading global consulting group operating in more than 80 countries worldwide. Excellent local knowledge and the unique international expertise of the interdisciplinary network of ECOVIS professionals make ECOVIS different from other service providers. ECOVIS is one-stop shop for all legal, tax, audit, corporate and business-related matters in the jurisdictions where ECOVIS operates. If you intend to introduce an employee share option scheme and apply related employee retention and motivation benefits, please do not hesitate to contact us. We will advise on the best way to design and properly implement such a scheme.

The content of this article is intended to provide a general guide to the subject matter. If you need assistance regarding the specific situation related with employees’ shares option, or any other question related with this topic, please consult the experts of ECOVIS.