In a recently published decision, the Ruling Commission has stated that the tax due upon granting of stock options can be compensated for by the employer on a tax-free basis if the employee would incur losses when exercising the stock options (Ruling no. 2017.805 dated 12 December 2017). This hedging technique should allow employers to achieve a higher acceptance ratio for the offered stock options.
Context
The granting of stock options, as regulated by the Act of 26 March 1999 concerning the 1998 Belgian Action Plan for Employment and containing various provisions (the "Stock Option Act"), is still a commonly used remuneration instrument.
Stock options falling within the scope of the Stock Option Act and which are accepted in writing within 60 days after the date of the offer are taxable at the grant date (this is the 60th day following the date of the offer). The beneficiary receives a benefit in kind, which is – based on a five-year duration – fixed at a flat rate of 18% of the value of the underlying shares (or 9% if the so-called "reduced valuation conditions" are met) (the "Taxable Benefit"). This benefit in kind is subject to personal income tax.
For the beneficiary of the stock options, however, this upfront taxation is not without risk. After all, the tax upon granting of the options constitutes the final tax, even if the options never come "in the money", the value of the underlying shares thus remaining below the level of the exercise price, and the options therefore never being exercised. In practice, several hedging techniques have already been developed in order to limit the risk for the beneficiary and to achieve a higher acceptance ratio for the stock option plans.
Tax-free cash payment to compensate for the tax charge
The Ruling Commission was asked whether the company granting the stock options may reimburse the aforementioned tax charge to the beneficiary by means of a tax-free cash payment, if the latter would incur losses when exercising the stock options. This was in connection with a "cascade offer", where first a normal offer was made and subsequently, in case that offer was not accepted, an offer with cash payment was made in the same offer letter.
The beneficiaries would receive a cash payment where:
- the options were not exercised; in that case the compensation would be equal to the tax paid; or
- upon exercise of the options, the value of the shares increased, but by an amount lower than the tax due at the grant date (and the beneficiary therefore still incurred a loss); in this case, the compensation would be equal to the loss incurred.
This hedging technique has the consequence that, in a negative scenario in which the value of the underlying shares did not (sufficiently) increase, the beneficiary could still recover his/her tax charge at the expense of the company that granted the stock options.
However, article 43, §8 of the Stock Option Act stipulates that if a stock option plan contains provisions intended to confer a guaranteed benefit on the beneficiary of the option, this guaranteed benefit must be taxed as professional income to the extent that it exceeds the amount of the taxable benefit that is determined on a flat-rate basis at the time of granting the option.
The Ruling Commission considered that the aforementioned cash payment constitutes a "guaranteed benefit" within the meaning of article 43, §8 of the Stock Option Act, but that this benefit is in any case limited to an amount lower than the Taxable Benefit, and therefore can be granted free from tax (and free from social security contributions).
In this ruling, the Ruling Commission confirms that article 43, §8 of the Stock Option Act allows tax-free compensation in cash to the extent of the Taxable Benefit. Furthermore, the rather complex "cascade structure" would not be necessary.
Cash payment is tax deductible
The Ruling Commission also confirms that the cash payment borne by the granting company constitutes a tax-deductible professional expense in the meaning of article 49 ITC92, since the "guaranteed benefit" is linked to the professional activity of the beneficiary. Moreover, no tax form is required to be drawn up.
No take-back of the reduced rate
Unlike the case of hedging through an adjustment of the exercise price, the Ruling Commission confirms that the granting of a "guaranteed benefit" by means of a cash payment does not have an impact on the application of the reduced rate provided for in article 43, §6, 1st paragraph of the Stock Option Act.
The Ruling Commission points out that the granting of a "guaranteed benefit" by means of a cash payment does not detract from the fact that the beneficiaries of the stock options are still exposed to the risk that the value of the underlying shares would decrease after the granting (cf. article 43, §6, 1st paragraph, 3° of the Stock Option Act). The possibility of applying the reduced rate is, of course, of major importance for the attractiveness of the hedging technique.
Conclusion
In brief, with this decision, the Ruling Commission seems to have given the green light to a hedging technique utilising cash payment, without loss of the reduced rate. This ruling is understood to be part of a fundamental policy and therefore constitutes an important precedent for similar cases.