Government plans fundamental taxation changes for employee stock options
Currently, stock options granted to employees (including management) are taxed under the general regulation on fringe benefits of the Income Tax Act, where no special regulations have been laid down. Under the planned amendment, the moment of calculation and payment of fringe benefits will at all times be moved into the future – a fringe benefit being defined as income received from exercise or transfer of the option, regardless of whether the option was transferable at the moment of issue. This means that granting of stock options, which has so far been subject to taxation in the case of transferrable options, is no longer considered a fringe benefit. As mentioned, the positive news is that exercising a stock option is not a fringe benefit as long as it is exercised more than three years after issue or later.

Until today the occasional practice has been to grant employees working in subsidiaries an option to acquire shares in the (foreign) parent company. Sometimes the reason lies in the group’s option policies or some other decision of principle that foresees keeping sole ownership in subsidiaries and expanding the circle of shareholders on the level of the parent company exclusively. Often, however, such practices emerge in order to avoid granting benefits subject to taxation by employers to their employees in which case the transfer of subsidiaries’ shares by parent companies is also used. Under the draft regulation, options provided by any entity in the same group as the employer are also taxed as fringe benefits whereas tax is payable by the employer, not the formal provider of the fringe benefit.

The wording seems somewhat raw at the moment but the planned amendments would make the stock option taxation regulations much clearer and to some extent more entrepreneur-friendly. When the relevant provisions have taken effect, any new stock options may be issued taking into consideration the terms required for tax exemption. Options are widely used as management incentives and often linked to long-term contribution and financial indicators achieved over several years, which would enable the three-year norm to be met. At the same time, entry into force of the amendment would also be a good time for reviewing and adjusting existing option schemes that may reveal new tax liabilities.

According to the draft, the amendments will come into force as of 2011. Discussions in the Parliament (Riigikogu) may bring changes in the proposed taxation principles but we will keep the readers of „Deal with LMHB“ in the loop of events.