Heiko Lohuis and Charles Willigers from Loyens & Loeff report on German and Dutch changes to taxability of employee stock options.

Germany: taxability of employee stock options

The moment of taxability of and the allocation of benefits from non-listed employee stock options has been decided through two recently published rulings from the German Supreme Tax Court (Bundesfinanzhof or BFH).

The benefit from an employee stock option is not taxable at the moment the option is granted, the BFH has decided.

However, at the moment the option is exercised, the benefit can be taxed.

Uncertainty previously existed in German tax practice about the moment stock options would be taxable.

There had been an argument that an option already has a certain value at the moment it is granted and therefore should be regarded a taxable benefit at that moment.

Options can also not be transferred, or exercised, within a time frame of three years, the BFH also decided the two previous cases.

Under these circumstances, the employee does not receive a benefit from his/her employer at the moment the stock options are granted.

Based on the given facts, the employee did not receive anything more than just a mere chance to receive a benefit. Therefore, this chance is not enough to constitute a taxable benefit, and the benefit is actually received at the moment the option is exercised.

The BFH did not decide on the question whether the benefit from an option should be taxable at the moment it becomes transferable, as this is before the moment when they can be exercised. Therefore, still no certainty exists about this specific issue.

The BFH also decided on the international allocation of the profit from an option where an has employee worked in different countries.

The BFH states that in general it can be assumed that an option is granted as a remuneration or incentive for future activities for the same employer.

If after granting of the option, the employee has performed his activities partly abroad, a pro rata allocation to these activities abroad has to be made.

Following the allocation rules of a tax treaty, if applicable, an exemption from German taxation for this pro rata part must be granted.

This is also the case if the employee has terminated his/her activities abroad and has returned to Germany at the moment the option is exercised.

Netherlands: choosing the moment of benefit taxability

Employees now have a choice when it comes to the the moment of taxation of the benefit from employee stock options, thanks to a (long-awaited) change in tax law, effecitve January 1, 2001

Usual taxable moment

Under Dutch tax law the 'usual' taxable moment of stock options is the date when the grant of the options becomes unconditional (the vesting date).

By ministerial regulation a formula has been determined on the basis of which the taxable benefit is calculated as a percentage of the value of the underlying shares.

The benefit is the total of the intrinsic value plus the expectation value and has a minimum value of four percent of the value of the underlying share at the taxable moment.

The intrinsic value is the difference between the fair market value and the exercise price.

The expectation value is the deemed increase of the value during the remaining term of the option.

Exercise or disposal within three years

When the options are exercised or disposed of within three years after the grant, the actual gain will be taxed.

If an amount had already been taxed when the grant became unconditional, only the additional benefit will be taxed (ie exercise gain minus taxable benefit upon vesting).

However, if the previously taxed benefit was higher then the actual gain, no tax refund will be given.

Choice of taxable moment

The new tax legislation on stock options applicable as of the tax year 2001 introduces a choice with respect to the taxable moment.

It is now possible to defer taxation until the date the options are actually exercised. Thus the actual gain will be taxed and not a calculated 'deemed' profit.

However, in case the exercise value is established below the fair market value at the moment the options are granted, the difference will be taxable when the options become unconditional.

No deferral of this gain is possible, only the expectation value can be deferred.

When the options are finally exercised the real gain will be taxed, less the previously taxed value.

However, if the latter amount is higher than the real gain, no tax refund will be given for the difference.

For example:

• date of grant 1/1/01; fair market value 100; exercise value 90
• date of vesting: 01/01/02; fair market value 110; expiring after three years
• date of exercise: 30/06/2003; fair market value 140

Taxable amount/moment

• without deferral: 26% of 110 = 28,6 on 01/01/02
• with deferral: 100 - 90 = 10 on 01/01/02 and 140 - 90 = 50 - 10 = 40 on 30/06/03

The choice to defer tax must be notified by employer and employee together to the wage tax inspector before the taxable moment, ie before the options vest/become unconditional.

In order not to miss the chance to make the choice, both employer and employee must be aware of the moment the tax liability of the options arises, so the choice must be made before that date.

Employers should update their manuals for the option schemes and include this new possibility and its particular conditions.

Since the employer has a leading role in this (the notification must be sent to the wage tax inspector), he/she should inform the employee in time if he wishes to defer tax payment.

However, employees should also keep the due date in mind in order to avoid missing the possibility to defer tax.

Option grants from other group companies

In international employment situations it often occurs that employees are granted options not by their local employer, but by the foreign parent company of the group.

Very often the local employer is not aware of this, or if he knows about it, has no information on it.

From a Dutch tax perspective, the option grants are regarded as a benefit from the Dutch employment and as such taxable in the Netherlands.

The employer should withhold wage tax on the benefit and if that does not happen, the employee should declare the benefit in his income tax return.

The State Secretary of Finance was asked how the choice for deferral of the taxable moment could be made in such situations.

He replied that the Dutch employer is assumed to be aware of the situation, so a timely notification can be made to the tax inspector.

In practice, this means that it if the employee wishes to defer tax, he/she should inform the Dutch employer of the option grant by the parent company.

Employee insurance schemes

The above-mentioned choice regime is only applicable for the wage tax withholding, for the employee insurance schemes no deferral of the taxable moment is possible .

This makes no difference if already the maximum premiums are due on the salary itself, but if the maximum is not yet reached, employee insurance premiums will be due on the taxable benefit from the options at the vesting date.

Tranches of options granted before 2001

Some option schemes (especially US) vest in tranches with one-year intervals. If the first tranche vested before 2001, it is not possible to defer tax for subsequent tranches vesting as of 01/01/2001.

However, after questions were raised in Parliament, the State Secretary announced he is willing to make deferral possible for these tranches.