On 15 June 2017, the Saeima adopted comprehensive amendments to the Commercial Law (these amendments entered into effect on 13 July 2017), which, inter alia, also governs matters regarding employee stock and personnel options.
Section 255 of the Commercial Law has been reworded; furthermore, the definition of employee stock has changed significantly. I will outline the key changes to be able to make comparisons.
First, from now on, employee stock will be stock which may not be disposed of, and this means that, upon the cessation of the status of employee, board member or member of the council, employee stock is transferred to the company’s ownership. According to the previous regulation, disposal of employee stock was allowed and provided for the rights of first refusal to the company. After the cessation of the status of the employee, board member or member of the council, or in the case of death of a stockholder, stock is transferred to the company. Transfer of employee stock to the company must accordingly be registered in the register of stockholders without the consent of the former stockholder. Employee stock is stored by the company regardless of its form (printed or dematerialised).
Second, the range of persons to whom such stock is granted, has become wider by including not only board members and employees, but also members of the council.
Third, employee stock was previously granted free of charge, while the new regulation also allows for the purchase of the stock for a charge. If employee stock is granted free of charge, it is financed from the retained profits or special reserve. If employee stock has been granted for a charge, then after the owner of the employee stock has ceased their status, the company pays the former holder of employee stock or his/her heirs remuneration, the amount of which must be equal to the amount, which the stockholder would obtain by dividing the company’s property in the case of liquidation thereof, if such were to take place at the moment of disposal of the stock.
Fourth, the rights of the owner of employee stock have been expanded, and the owner is now entitled to receive dividends – the right to vote, as well as in the case if employee stock has been granted for a charge, the right to receive the liquidation quota may also be considered.
The total nominal value of unused employee stock may not exceed 10 per cent of the paid-up equity capital of the company.
In general, the Commercial Law corroborates important qualities of employee stock – increases the volume of rights, as well as stipulates that property rights to employee stock are effective for the period of legal employment relations only.
With respect to the applicable taxes, the law “On Personal Income Tax” does not include any special procedure for the application of tax to employee stock, therefore employee stock is subject to the regulation laid down in the law “On Personal Income Tax” for the capital asset – stock. Pursuant to the provisions laid down in Section 119 of the law “On Personal Income Tax”, capital gains are determined by subtracting the purchase value and value of investments made in the capital asset during the holding thereof from the disposal price of the capital asset.
Since employee stock, which has been granted free of charge, is disposed of in the same manner, no capital gains are expected. Whereas, if employee stock is purchased for a charge and sold after cessation of the status, capital gains will be equal to the difference between the disposal value and purchase value of employee stock.
Employee stock options
The Commercial Law is complemented by a separate section (2481) regarding stock options, which governs regulations for the issuance and registration of employee stock options. Issuance of employee stock options is subject to the provisions of the Commercial Law regarding the issuance of convertible debentures. By analogy, as provided for convertible debentures, a register of employee stock options and holders thereof must be kept for the registration of holders of employee stock options.
The Commercial Law does not provide for the definition of stock options, however, in essence, stock options mean the right to purchase stock in the future at the price determined during the assignment of options (by selling or granting as compensation). In order to purchase stock, the owner of stock options is obliged to exercise this right by paying the agreed price in advance and requesting the company to issue stock according to the personnel options schedule.
The company is entitled to issue stock options conferring the right to acquire stock thereof to the employees, and members of the board or council of the relevant company or companies of the same group.
If, by the way of use of stock options, stock is acquired free of charge or for a charge, which is less than the nominal value of the stock at the moment of use of the stock options, the company issues stock at the expense of the retained profits of the company or pays for the stock using funds of special reserves.
Stock options may not be disposed of, unless the Articles of Association or Regulations for the Issuance of Options stipulate otherwise. The total nominal value of the stock, which may be acquired by using stock options, may not exceed 10 per cent of the paid-up equity capital of the company at the moment when the decision on the granting of stock options is adopted.
Issuance of stock options is subject to the provisions of the Commercial Law regarding convertible debentures (Section 245, Paragraph 2), according to which regulations for the issuance of debentures indicate:
- The number of debentures to be issued, the nominal value of one debenture and the total amount of nominal value,
- The price of debentures,
- The time period for the conversion of debentures,
- The interest which the company undertakes to pay to the debenture holder and their payment provisions (if such are provided for),
- The procedures and time periods for the payment of debentures,
- The procedures by which the debentures are exchanged for stock,
- The rights of debenture holders,
- Other provisions, which are not in contradiction to the law.
Regulations for the Issuance of personnel options additionally indicate:
- The purposes for the issuance of stock options,
- The range of persons who may acquire stock options,
- The number, nominal value, category of the stock intended for covering personnel options and the rights corroborated therein,
- The procedures for granting and transfer of stock options including the type of payment and procedures for payment (if any is intended),
- The amount of stock to be obtained as a result of the use of each stock option and the price of one unit of stock (if any is intended),
- The procedures and time periods for the use of stock options,
- Establishment of reserves, if upon the use of stock options the stock may be acquired free of charge or for a charge, which is less than the nominal value of the stock at the time of implementation of the employee stock purchase option.
The board maintains a record of the stock options and their holders in a register of the personal options in accordance with the procedure laid down in Section 247 of the Commercial Law. Additionally to the information provided for in Section 247 of that Law, the amount of stock to be obtained by each employee, member of the board and council is indicated in the register.
The board maintains a record of the convertible debentures and their holders in a register of debenture holders (Section 247). The following is entered in the register of debenture holders:
- Information regarding debenture holders,
- The number of debentures owned by each debenture holder, their nominal value and ordinal number if such has been allocated,
- Information regarding the conversion of the debentures.
Debenture holders, members of the board of directors and of the council and competent public persons have the right to become acquainted with the register of debenture holders. A debenture holder has the right to receive an extract from the register of debenture holders certified by the chairperson of the board of directors or a member of the board of directors authorised by the board of directors regarding the debentures owned by him or her.
Tax issues regarding stock options are dealt with in the law “On Personal Income Tax”. According to the norms of Section 8, Paragraph 25, income obtained from the implementation of the stock purchase option. However, income obtained from such stock purchase option is not subject to tax in the cases referred to in Section 9, Paragraph 1, Clause 43 of that Law. The conditions are as follows:
- The minimum period for the holding of the stock option (a period from the day of granting of the stock option until the day when an employee is entitled to commence the implementation of the stock option) is not less than 36 months,
- During the period for the holding of the stock option (period from the day of granting of the stock option until the day when an employee is entitled to commence the implementation of the stock option) the employee is in employment relations with the capital company, which has granted the stock option to the payer or a company related with which within the meaning of the law “On Corporate Income Tax” has granted the stock option to the payer,
- The employer has submitted the information referred to in Section 11, Paragraph 4 of the Law to the State Revenue Service.
Personnel options is a medium-term and long-term instrument for the connection of employees, the positive feature of which is the connection of employees (by not taxing the income from the implementation of the stock option), whereas, the possible deficiency is defragmentation (“dilution”) of the existing structure of stockholders.