Rescission of tax-privileged share-based employee schemes

Date 21 nov. 2011

 

Introduction

In continuation of its budget proposal for 2012, the government stated that the rules regarding the tax privilege of certain share-based employee schemes may possibly be rescinded. The following schemes are concerned:


Section 7A of the Danish Tax Assessment Act regarding the allotment of free shares/warrants, according to which employees, as part of a general employee scheme, may receive free shares and/or warrants.

 

Section 7H of the Danish Tax Assessment Act, according to which it, within certain limits, is possible to conclude individual agreements with single employees on the allotment of share-based instruments.


For the employee, the tax-privilege of both types of schemes comprises that the employee is not taxed at the time where the shares are received or where the warrants are exercised, but only at the time where such shares are sold, just as taxation will only take place at the (lower) tax rate applying to equity income as opposed to normal earned income. To a certain extent, the tax-privilege is counterbalanced by the fact that the company holds no right of deduction for the value of the allotment with respect to the individual schemes. 


However, it is the intention to preserve the rule of Section 28 of the Danish Tax Assessment Act, which is not a tax privilege scheme, but which only comprises a postponement of the time of taxation in connection with the receipt of certain options/warrants.


This article contains a short review and analysis of the proposal and its consequences to current and future schemes.


Regardless of the fact that no concrete bill has been introduced, companies with share-based incentive schemes should discuss the contents of these schemes with their advisors with a view to assessing the consequences of a potential law reform to the schemes, including whether it is necessary or appropriate to change them.


It cannot be ruled out that the bill will be given legal effect from the time of its introduction or even earlier still, for which reason such a discussion should take place as soon as possible.


Furthermore, the fact that no concrete bill is under consideration makes it necessary to monitor developments closely, since there, inherently, may be changes in a potential bill compared to what has been specified in the proposal currently available. 


The Contents of the Rescission

November 2011, the government published its proposal for the 2012 budget. In this proposal, the government contemplated an abolition of Section 7A and 7H of the Danish Tax Assessment Act. This will imply that the tax privilege used in connection with companies’ remuneration of employees through incentive programmes up till now will be abolished.


This will have the consequence that all allotments of employee shares will be taxed as earned income, taxed at a marginal rate of 56%. However, Section 28 of the Danish Tax Assessment Act is preserved, according to which purchase and subscription rights are only taxed at the time where these rights are exercised. 


The background for the proposed abolition of the favourable tax rules for employee shares is the government’s opinion that all parts of an employee’s pay should be taxed in the same uniform manner. The rule in Section 28 of the Danish Tax Assessment Act is preserved partly because it is difficult to assess the value of the purchase and subscription rights at the time of allotment, and partly because the employee will be taxed normally on his pay when these rights are exercised. Furthermore, the rule only implies a postponement of taxation.


Since the new rules will imply that the employee will be taxed normally on his pay in all cases, it will, at the same time, imply that the company will receive a corresponding deduction which is impossible under certain incentive programmes under the current rules.


The Rescission’s Consequences to existing Incentive Programmes

The specific consequences for existing programmes of a potential abolition are dependent upon how the transitional rules are drawn up.


One possibility is that the time of allotment will decide whether employees are covered by the existing or the new rules, regardless of whether final right to the allotted instruments has been acquired at this time. If this is the case, it will imply that all existing programmes where allotment has taken place, or where allotment will take place before the new rules come into effect, will still be able to benefit from the rules of Sections 7A and 7H of the Danish Tax Assessment Act. 


Another possibility is that the time where the right is acquired will be decisive, as was the case at the latest amendment of Section 7H of the Danish Tax Assessment Act. If so, taxation will therefore be dependent upon whether the employee has acquired final right to the allotted purchase or subscription rights before the new rules come into effect with the result that the existing set of rules will apply to such allotments. In such case, if the employee has not acquired final right to the allotted instruments, the employee will instead be taxed normally, as on his earnings, on the allotment. An employee has acquired final right to purchase and subscription rights if there are no conditions to be met, for example financial targets, before the employee may exercise the allotted rights.


The Need to change existing Incentive Programmes

Since there is a certain possibility that the time where the right is acquired will be decisive, it should be considered whether time-of-right-acquirement should be expedited in existing incentive programmes, naturally subject to whether the incentive programme allows changes to be made, since some changes may be so material that they imply that the employee has renounced the programme. At the same time, the commercial preconditions must be considered in connection with a potentially expedited time-of-right-acquirement.


Against this background, it is our recommendation that existing programmes be discussed with the company’s advisors with a view to clarifying the concrete different options.


The Possibility of establishing new Incentive Programmes

Since Section 28 of the Danish Tax Assessment Act is preserved, it will also be possible to allot warrants/options to employees without this triggering taxation in the future. However, it is important to be aware that taxation pursuant to Section 28 of the Danish Tax Assessment Act will take place either when these instruments are transferred (for example sold) or exercised.



If you have any questions or require additional information on incentive programmes, please contact partner, adjunct professor Jakob Bundgaard (jbu@mwblaw.dk), Attorney Henning Hedegaard Thomsen (hht@mwblaw.dk) or Junior Associate Kim David Lexner (kdl@mwblaw.dk).

 

The above does not constitute legal counselling and Moalem Weitemeyer Bendtsen does not warrant the accuracy of the information. With the above text, Moalem Weitemeyer Bendtsen has not assumed responsibility of any kind as a consequence of a reader’s use of the above as a basis of decisions or considerations.