Stock options as a tool to motivate key people

By granting stock options, certain employees are given the right to acquire in the future (after a ‘waiting period’ of several years) a certain number of shares of the company, at a price that was already set (or able to be set) when the options were granted.

If the employee concerned decides to exercise the share options granted, they will acquire a shareholding in the company. In most cases, however, the acquired shares are quickly sold back to the company itself because employees would like to see their years of commitment and dedication converted to money in the bank.

Overall, the annual conversion of the options may not exceed 20% of the total salary package. According to the Ruling Commission, rates greater than 20% constitute improper use of the tax benefit contained in the Share Option Act. For taxpayers who remain below this famous 20% limit, this is currently the only interesting instrument to achieve the above goals. As far as the social rules regarding share options are concerned, no social security contributions are due for an employee, whereas self-employed persons do pay social security contributions on the benefit obtained.

The company VOLT would like to give Allesandro, one of its key people, an incentive to not only stay on board, but also to take VOLT to the next level.

Therefore, Allesandro is granted stock options, giving him the right to purchase a certain number of VOLT shares within 6 years. The price is determined in advance, being 10,000 euros, the value of the specific amount of shares at that time. The lump sum benefit on which Allesandro is taxed, assuming that all the conditions for halving the percentage are met, is: 10,000 euros x (9% + 0.5%) = 950 euros.

Assuming a marginal personal income tax rate of 53% (50% + 6% municipal tax), this amounts to a tax of 950 euros x 53% = 504 euros.

Six years in the future, Allesandro decides to exercise his stock options because in the meantime the value of the underlying share package has doubled to 20,000 euros. Allesandro must only pay an amount of 10,000 euros, since this was already set 6 years ago. Allesandro will quickly sell this share package back to VOLT since the value of that share package is currently 20,000 euros. Capital gains on shares are tax-free, so Allesandro does not pay taxes on this.

In this case, Allesandro realises a profit of 20,000 euros – 10,000 euros = 10,000 euros, on which he already paid 504 euros in taxes 6 years ago. This ultimately results in a tax burden of 5.04%. 

Granting stock options has several attractive advantages:

• It gives the opportunity to attract employees, directors etc. with the necessary experience;
• This creates an incentive to take the lead, given the fact that the persons concerned share directly in the increase in value;
• Individuals to whom stock options have been granted will be much less likely to leave the company, since they can look forward to significant private income with a limited tax burden.

Nevertheless, it is advisable to handle the issue with caution. After all, everything stands or falls with the appreciation of the underlying shares during the vesting period. There is a risk that if the value of the underlying shares remains the same, or even decreases, the option will not be exercised, even though the personal income tax has already been paid when the share options were granted.

The granting of stock options is interesting in a scenario where the appreciation of the underlying shares is certain. This is possible at a company entering a growth phase. In practice, however, in many cases the 20% limit on the total salary package remains an obstacle to implementing the concept.