13 October 2021
As part of its budget for 2022 (presented at the end of September), the Dutch government has proposed a change to the timing of the taxation of employee share options.
What are the current rules?
Under the current legislation, option plans are taxable on exercise, which can result in the employee having to sell shares to pay the tax. Although this is the standard moment of tax for option plans, issues can arise, especially for employees of private companies (e.g. start-ups), if the shares are not easily tradable, or if the shares cannot be sold, e.g. because the entirety of the shares being acquired are subject to a holding or lock-up period. This is mainly because it may not be possible to sell the shares in order to pay the tax, and the employee may not have sufficient cash available to pay the tax on exercise.
What are the proposed new changes?
Under the proposed new rules, if the shares are not tradable, employees will be able to choose whether to pay tax on exercise or to defer the taxable moment to the point when the underlying shares can be traded. If an employee defers the taxable moment, as long as transfer restrictions continue to apply, the shares will not be considered tradable and taxation will take place at the time the acquired shares become tradable. ‘Become tradable’ is defined as the moment on which any sale restrictions are lifted and the employee may sell the shares they acquired on exercise.
The value of the shares at the relevant taxable moment is used to calculate the tax that is payable. As a result, if the employee defers the tax point from exercise to when the shares are tradable, an increased amount of tax would likely be payable if the value of the shares increased during the deferral period. On the other hand, if the shares decrease in value over the deferral period, then a lower amount of tax would typically be payable. If the employee expects that the share price will increase after exercise, they may decide not to defer the tax point for this reason!
What are the impacts of the proposed changes?
The employee will retain the right to be taxed on exercise, even if the shares are subject to selling restrictions. However, the tax deferral automatically applies, so an election to opt out of the deferral must be made and recorded 'in a timely manner', and certainly before exercise. Note that, if the shares can be sold immediately on exercise, the shares will continue to be taxable upon exercise.
Restrictions apply to avoid long-term deferral of taxation. In particular, the deferral can be no longer than five years after the acquisition of the shares (for shares that are already listed) or five years after the IPO of a start-up or other private company.
When are the changes due to take effect?
The amendment is due to take effect on 1 January 2022. The new rules would apply to any options exercised on or after 1 January 2022 (regardless of when the options were awarded).
We are always delighted when rules are changed to make it easier for employees to benefit from share plans! This is an interesting change as, although it is common practice for options to be taxed on exercise, dry tax charges can be potentially problematic for employees of private companies where there may not be a market for the shares. We suspect that the change will be more useful to employees of unlisted companies for this reason, so this change is a welcome development for them. For employees of listed companies, the shares will likely immediately be tradable on exercise, unless for example they are all subject to a lock-up or other form of holding period. Companies may prefer employees to continue to pay tax on exercise as this may be easier for companies to administer for withholding tax purposes.
We don’t yet know the format of the election that employees will need to make to opt out of the automatic tax deferral, however we will keep an eye on developments and keep you updated. Companies should keep a look out for this, given the impacts it will have on the processes for and timing of the taxation of options. Once this change takes effect, there will be two different ways of taxing options that are subject to restrictions, so companies will need to identify and record whether an employee wishes to follow the tax deferral route or if tax is to be paid on exercise (as is standard), and apply withholding accordingly.
We would like to thank our partner firm in the Netherlands, Graham, Smith and Partners, for alerting us to this change.
If you have any questions on this alert, please do let us know.
Sharon Thwaites and Sonia Taylor