This year, on January 12, 2021, changes to the Personal Income Tax Law and the Commercial Law came into force, which expanded the possibilities to grant stock options to employees. These changes put Latvia at the top of the world ranking, alongside Estonia and Lithuania, winning the title of most favourable country for stock options for employees.
What exactly are stock options?
Currently, a growing motivation tool is stock options or share purchase rights (hereinafter “stock options”) which enable a company to attract highly qualified employees. It stimulates employees to work more productively (increase business value) in the interests of the company, thus increasing the value of the company’s shares.
A stock option is a type of investment that allows an employee to buy a certain number of company shares at fixed price. In other words, they have the right to buy shares in the company. For example, suppose the company you work for offers stock options that will allow you to buy 100 stock options later at the price on the day you received the options. You can hold stock options until some future date when the value of the company will increase and then make a profit. Additionally, positive aspect from the employee’s point of view on this is 0% risk of loss. Stock options do not impose an obligation to exercise them.
The table below summarizes the most important information.
|Applicants||Employees, members of the board and council, employees of affiliated companies.|
|When can be granted||Not earlier than after 12 months (period from the date of granting the options until the day when the employee is entitled to start exercising the options).|
|Price||The company can choose a starting price even at face value. There is no need for a formal evaluation analysis.|
|Maximum share to be allocated||The total nominal value of shares may not exceed 10% of the company’s paid-up share capital.|
|Employee rights||The employee is free to dispose of the acquired shares. By acquiring shares, the employee acquires all the rights of a participant (receipt of dividends, voting rights, rights to liquidation quota). Non-voting shares may be issued. An employee who terminates his employment must use his options within 6 months of leaving. If a participant wants to sell its rights, the other participants have pre-emption rights.|
|Employee tax (when payable)||Payroll tax is payable if the options are not held for at least one year.|
|Employee tax (rate)||The sale of shares is subject to income tax on capital gains (currently 20%). The after-sales valuation must be based on an independent valuation organized by the company (if not publicly traded).|
|Taxation of employers||No tax is payable if the options are exercised more than one year after they are granted.|
Section 9 paragraph 43 of the Law on Personal Income Tax specifies the cases in which income tax is not payable on income from the exercise of options:
- if at least 12 months have passed since the share option was granted (previously 36 months)
- during the minimum holding period of the options, the employment contract between the employee and the capital company that has granted the options is valid. A corporation may also be an associate of the option grantor. The exception is the employee’s retirement age.
- the employer has submitted the information specified by law to the SRS
- stock options must be exercised within six months of the date of termination of the employment contract. The exception is the employee’s retirement age. In this case, the rights are exercised within the term specified in the option exercise plan
- there is no debt between the capital company and the employee.
Share – share, capital share or other right to receive dividends
The amendments to the law expanded the definition of shares, which allows offering share options also to employees of LLC companies
Exercise of share purchase rights (options) – purchase of shares at the price specified in the agreement, or receipt of shares free of charge
Stock options give the employee the right to purchase the company’s shares at the price (or free of charge) agreed on the date of the agreement. This allows to attract professionals to promising start-ups who are unable to offer high salaries, but can offer options that will generate large revenue later.
Nominal value – statutory value. The value of a share is not less than one cent. Parts of one category have the same nominal value. The share gives the right to participate in the management of the company, distribution of profits and distribution of property in case of liquidation.
Exercise of share rights (gain of income) – the day when the ownership rights to shares are transferred.
What do you need to know about the information that has to be submitted to the SRS?
Stock options are also no exception and information on their granting must be provided to the State Revenue Service.
Income from the exercise of share purchase rights is the market value of shares on the day of exercise of share purchase rights minus the acquisition value of shares.
The market value of shares is determined as follows:
- for public – fixed weighted average share price
- for non-publicly traded shares – the value specified in the independent written opinion, which shall include the valuation methodology.
The valuation may be carried out by a person on the list of property valuers or by a person who is entitled under national law to provide such an opinion. The opinion is valid for 12 months from the date of its preparation.
Within two months after the application period options or their granting, the employer must provide the SRS with information on:
- participating companies
- qualifying criteria for employee participation
- conditions for the purchase of shares
- the minimum holding period for share options
- opportunities to exercise share options in the event of termination of the employment contract
- the right to dispose of the rights granted or to exercise them in the event of the death of the staff member concerned
- conditions for the exercise of the right
- employees who will purchase or receive shares
If amendments are made, the information must be submitted to the SRS within two months.
Employee stocks and stock options
Stock options are not the only way to offer shares to an employee. In essence, the two types are similar, but there are some nuances that distinguish them. Let’s try to clarify how employee shares and employee stock options differ.
In both cases:
- when shares are granted for a fee, payment is made by an employee, but when allocating free of charge, the company issues shares at the expense of the company’s retained earnings or special rezerves
- applicants are employees, members of the board and council, employees of affiliated companies
- the total nominal value of shares may not exceed 10% of the company’s paid-up share capital.
|Employee stocks||Employee stock options|
|Staff shares are non-transferable. Upon termination of the employment contract, the shares become the property of the company.||The shares shall not be disposable, unless otherwise provided in the articles of association or the regulations for the issue of personnel share options|
|The company will allocate personnel shares to its employees||The company gives employees the right to acquire its shares|
|There is no time limit for the allocation of staff shares||Stock options can be granted no earlier than after 12 months|
|The employee has the right to receive dividends and other statutory rights. If the shares are granted for a fee, there is a right to a liquidation quota.||Upon acquisition of shares, the employee acquires all the rights of a participant. Non-voting shares may be issued|
|Property rights exist only for the duration of the employment relationship||In the event of a sale, the other participants have a pre-emptive right|
|If the shares are granted free of charge, no taxes are payable. If the shares are granted for a fee, the capital gains tax is payable on the disposal||The sale of shares is subject to capital gains tax|
|Capital gains are calculated by deducting from the disposal price the acquisition value and the value of investments in the asset during their holding||The capital gain is calculated by deducting the acquisition value of the shares from the market value of the shares on the day of exercising the share purchase rights|
|At the time of dividend distribution, the employer pays CIT||No tax is payable if stock options are exercised more than one year after they are granted|
|If the shares are granted for a fee, the company pays the former employee the remuneration that it would have had if the company’s property had been distributed in the event of liquidation, according to the current situation||An employee who terminates the employment contract must exercise the opportunities within 6 months after the termination of the employment contract|
Employee shares are regulated as a one-time and systematic remuneration of an employee, therefore, as provided in Article 8 (2) of the Law on Personal Income Tax, personal income tax is payable on income. Such an incentive tool can be afforded by large companies whose shares are clearly predictable in value and have won their place in the market. Usually, staff shares reward senior employees.
In turn, stock options are a great option for new businesses. A new business is unlikely to be able to offer high salaries to employees in the beginning, which makes it difficult to attract highly qualified specialists. As you know, good employees are an equal sign for the successful development of the company. When offering stock options, a highly qualified specialist will also be interested in working for a new company, even with a lower salary at the beginning, if it is expected that later, as the company grows, it will be possible to receive a significant reward from the shares.