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Tax aspects of an incentive program in a limited liability company

February 7, 2024
Author Filip

One form of remuneration for key personnel, in addition to the traditional forms used in this regard (employment contract, management contract), is an incentive program. Despite the fact that it is not a popular method, it is worth considering because of the direct link between the interests of employees and the growth of the organization, as well as the favorable tax consequences associated with this solution..

Is it possible to organize an incentive program in a limited liability company?.

Incentive programs are usually associated with joint stock companies (or simple joint stock companies). This is due to the ease of trading shares. Tax aspects are also not negligible, as incentive programs organized in joint-stock companies can enjoy favorable PIT taxation under certain conditions. Preferential taxation then consists in no taxation of the value of shares taken up as a result of the incentive program (i.e., no income from gratuitous benefits at the moment of taking up shares).

However, it is worth bearing in mind that an incentive program may also be organized in a limited liability company. The instrument subject to acquisition under the program is then share options, which under certain conditions stipulated in the program regulations (in particular, the expiration of the so-called vesting period, i.e. the vesting period) may be subject to conversion into shares in the limited liability company or a related entity.

What are the tax aspects of participation of individuals (Polish tax residents) in an incentive program organized by a limited liability company?

The inapplicability of preferential tax treatment to participants in an incentive program organized using options for shares in a limited liability company raises the question of how to tax the resulting gain. In this regard, it is important to note three key moments that may have tax consequences:
1) Acquisition of share options,
2) Conversion of share options, and
3) Disposal of shares.

Each of these moments should be analyzed separately.

Tax consequences of acquiring share options.

In the vast majority of cases, the acquisition of share options should not be treated as an event that results in free benefit income. This is due to the nature of options, which, according to the rules governing incentive plans, are usually non-transferable instruments and therefore devoid of market value. The benefit, which could be viewed as taxable income, is purely hypothetical in nature here.

The tax consequences of converting options into shares.

The matter becomes more complicated whenthe option is exercised and shares in the entity organizing the incentive program are taken up as a result. There is no doubt that when the option is exercised, tax income arises on the part of the individual taking up the shares. This income will be equal to the market value of the shares taken up, and will be reduced by the costs paid in this regard by the individual for the expense of taking up the shares (as a rule, these will be symbolic amounts, e.g. PLN 1 per share).

The key issue, therefore, is to determine the appropriate source of income in PIT. This issue depends on the individual circumstances of the case. In general, however, it can be said that share options should not be treated as securities (in particular, they do not constitute financial instruments), and for this reason the income from their exercise should not be treated as income from capital sources.

This qualification means that income from the exercise of options can in practice be treated as:
1) Income from an employment relationship,
2) Income from personally performed activities,
3) Income from so-called other sources,
4) Income from business activities.

The nature of the legal relationship linking the option holder to the program organizer will determine which source the income from taking up the option should be classified under.

Without going into the details, one can venture to say with a high degree of certainty that the most profitable choice will be option No. 4, i.e. qualifying the income from the exercise of the option as a business activity. This will be the case, in particular, if the eligible person acquired the stock options as remuneration granted to him under a service contract (the so-called B2B contract).

A particularly interesting case in such a situation will be a lump sum from registered income. This is because, according to the interpretations of the tax authorities, the income arising upon the exercise of the option should be subject to a 3% flat rate. At the same time, the solidarity levy does not apply in this regard, as income taxed at a flat rate is not subject to it.


Tax consequences of the disposal of shares acquired in connection with the exercise of options.

Another moment when tax income arises is the sale of shares. Here another interesting tax issue arises. Although it is not explicitly stated in the regulations, this is because at the time the shares are sold to an individual, there is a right to recognize expenses equal to the tax income that arose at the time the option was exercised. In other words, the negative tax effect arising at the time the option is taken is nullified at that point.

Tax income, on the other hand, is the price obtained from the sale of shares. As a rule, income in this regard should be included in income from capital gains (taxable at a 19% PIT rate). Income earned in this regard will count towards the solidarity contribution tax base.

It is worth noting that effective taxation of income from participation in an incentive program can be significantly lower than in the case of traditional forms of remuneration based on employment contracts / management contracts / resolutions of appointment. In particular, in the case of properly structured incentive programs in a limited liability company, there is no burden of ZUS and health premium.

How to secure the tax treatment of participation in an incentive program .

Incentive programs based on stock options are still not a very popular solution for rewarding and hiring members of key personnel in an organization. Arguably, this is due to the fact that in the past this form of remuneration has been used for tax abuse and was even the subject of so-called tax warnings issued in August 2017.

Currently, however, the Director of National Tax Information is issuing interpretations in factual situations involving incentive programs based on stock options, so it should be considered that this form of remuneration does not constitute prohibited tax avoidance. Otherwise, in this regard, decisions would be issued refusing to issue interpretations due to suspicion of illegal tax avoidance.

In conclusion, incentive programs are an interesting alternative for rewarding and employing members of key personnel in an organization. Given the lack of well-established practice, if a decision is made to implement a share option-based program, care should be taken to carefully prepare the legal documents governing participation in the program (including the rules of the incentive program). It is also a recommended action to obtain individual tax interpretations for program participants and, in some situations, for the entity that organizes the program.

Filip Biegun
Tax advisor
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If you are interested in the content of this blog post and would like to discuss tax issues in your organisation, book an appointment for a free consultation.

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