From 1 January 2005 options may be taxable under more than one tax system and payroll administrators need to note the date options were vested. Deloitte offers some advice.

Payroll administrators need to pay attention to the date options were vested

On 14 December 2004, the tax plan for 2005 was adopted in the Netherlands. The plan provides for a definite amendment of the fiscal legislation, including the tax regulations for options. The regulations have been harmonised with those of other countries, especially Anglo-Saxon countries.

The new tax legislation for options has provided for a transitional regime. From 1 January 2005, options may be taxable under more than one tax system, and payroll administrators have to pay particular attention to the date options were vested for proper payroll accounting.

To help you deal with the new legislation we have summarised below the new tax legislation for options and the transitional regime. We have also provided a flow chart with information on how options should be accounted for in payroll accounting from 1 January 2005.

New legislation

Theoretically, the new tax regulations for options effective on 1 January 2005 are quite straightforward. Options have to be accounted for in payroll accounting —such as payroll tax and social security contributions— when exercised or alienated.

From 1 January 2005, the withholding of social security contributions must also take place on the date of exercising or alienating the options. The taxable value is equal to the effectively realised gain from exercising the options.

This is the difference between the fair market value of the purchased shares and the price paid for the shares (exercise price).

The price paid by the employee to the employer for acquiring the option right may be deducted from the realised gain. In our view, exercising expenses such as broker fees may also qualify for deduction from the exercising gain.

Former regulations may take precedence over new regulations

The new tax regulations for options take effect on 1 January 2005. However, the former regulations may take precedence over the new regulations. This is the case for options divided into 'tranches' (parts of divisions), some of which have become exercisable (have become unconditional or were vested) before 1 January 2005.

Future tranches under the same option agreement are taxed under the former regulations that were applicable to stock options in the year 2004. Thus, options that vest in tranches after 1 January 2005 may also be taxed under the previous regulations.

The previous regulations provided that options are taxable on vesting, except if the employee postponed taxation from vesting to exercising (based on deferral regime that was applicable to stock options). If so, payroll tax has to be withheld at the moment of exercise, in the same way as under the new tax legislation for options.
 
Let us consider an option agreement with one tranche of the options that vested in June 2004 and subsequent tranches that will vest in June 2005 and June 2006. In this case, the previous tax regulations apply to the tranches' options that vest in June 2005 and 2006.

The transitional regime also applies to social security contributions. If the previous tax regime applies, social security contributions may become due on vesting, regardless of any choice made for deferral of the moment of taxation of stock options.

Alertness is required

From 1 January 2005, the transitional regime applies as well as the new tax regime. Payroll administrators may find it difficult to decide which regime applies. We have devised a flow chart to clarify the taxation rules for options. Before referencing the flow chart, it is important to check the details of the options to assess whether they are due for taxation. 

Required details

To assess whether and when the options of an individual employee have to be accounted for in payroll accounting from 1 January 2005, the granted options have to be studied in detail. For each vesting, the flow chart may be referenced while taking into account the following details of the options.

• The date the options were granted (effectively, the date the offer of options was accepted);
• The vesting schedule for the options (U.S. options are generally divided into tranches becoming due for exercising at different times during the total life of the options);
• Whether or not the employee agreed with the employer to postpone taxation from the date of vesting to the date of exercising.

The flow chart provides information about the payroll and social security effects of options by determining the dates of (1) granting, (2) vesting, (3) exercising and (4) sale of shares.

Where wage withholding tax is stated — payroll tax and national insurance contributions are due. Where SV (Dutch abbreviation for Social Security) is stated — only social security contributions are due.

January 2005

Nino Nelissen is a partner in the Deloitte International Assignment Services practice in Amsterdam.  He can be reached at +31 (0)20 58 5926, or via e-mail at (ninelissen@deloitte.nl).  Martijn Bedaux is a Trainee in the Deloitte International Assignment Services practice in Amsterdam.  He can be reached at +31 (0)20 582 5609, or via e-mail at (mbedaux@deloitte.nl).

Subject: Stock options in the Netherlands