The Voivodship Administrative Court in Warsaw, in a judgment dated June 12, 2015 (case file no. III SA/Wa 3043/14) ruled that income on account of participation in employee incentive programs arises upon the disposal of shares allotted to the employee, not at the time the employee exercises rights under the option scheme, or in simple words, obtains the shares to which s/he is entitled under the scheme.
The taxpayer worked for a Polish limited liability company (“PolCo”), which is part of an international capital group and has participated in an option scheme (“Program”) operated by the German-based ultimate parent company (“DECo”). All Program participants were granted a free-of-charge non-transferrable, conditional right to prospectively acquire DECo shares free of charge and to acquire free of charge one additional share for each three additional shares purchased by the employee. The right to acquire (subscribe for) DECo shares arose from resolutions adopted by the General Meeting of DECo.
To ascertain tax liabilities ensuing from Program participation, an employee applied for an individual tax ruling to confirm that by exercising the conditional right, i.e. acquiring the shares, the taxpayer does not per se earn any taxable income.
According to the taxpayer, he will only generate income on account of Program participation upon disposal of the shares (rather than allocation), and the prospective income ought to be treated as ‘cash equity income’ (dochód z kapitałów pieniężnych). The taxpayer cited Art. 24 Sec. 11 of the PIT Act, which stipulates that income representing the difference between the market value subscribed for by persons eligible to do so under the terms of a General Meeting resolution and the expenses incurred to subscribe for them is not taxable at the time of share subscription.
The tax office ruled that the taxpayer’s submissions were incorrect and that the taxpayer ought to report income on two occasions, i.e. not only upon the disposal of the shares subscribed, but also at the time the employee exercises rights under the Program and acquires DECo shares free of charge. According to the tax authorities, the acquisition of shares by the taxpayer under the Program is not subject to the tax exemption cited by him, as the shares had not been acquired pursuant to a General Meeting resolution, but DECo’s commitment under the Program. The resolution of the General Meeting of the German company provided for the taxpayer’s right to acquire (subscribe for) shares in a German company, not the acquisition of DECo shares.
In setting aside the tax ruling on appeal, the Voivodship Court ruled that the exemption under Art. 24 Sec. 11 of the PIT Act, also applies to foreign companies limited by shares domiciled in other EU or EEA member states and does not constitute a definitive tax exemption but merely postpones the timing of the tax liability in connection with the acquisition of shares to the moment they are disposed of. The Court also held that considering that the Company submitted that the shares had been allocated under the terms of a Program approved by a resolution of DECo shareholders, the exemption may be applied to shares subscribed for and acquired under the Program.
The commented judgment seems to be in line with the line of administration of justice by administrative courts. That said, in some cases, the tax administration insists that shares allocated to employees under incentive schemes ought to be taxed twice: upon the free-ofcharge acquisition of shares (on account of a free-ofcharge benefit earned by the employee), and again upon the sale of the shares by the employees. We find this approach unacceptable.
Undoubtedly, the Voivodship Administrative Court was right in pointing out that the taxpayer’s rights would have been infringed if the exemption under Art. 24 Sec. 11 of the PIT Act had not applied. We concur with the Court’s conclusion to the effect that the tax exemption also needs to apply to shares acquired under an incentive scheme, considering that the scheme had been approved by a General Meeting resolution. Although tax exemptions must not be interpreted expansively, we cannot agree with an opposite situation, where the exemptions are interpreted so narrowly as to deny taxpayers the rights they are eligible to.
Additionally, it must be pointed out that if we were to agree with the stance taken by the tax office, we would undermine the purpose of the regulation at issue, i.e. to avoid double taxation (of free-of-charge share acquisition and the subsequent sale of the shares) of the taxpayer on account of only one benefit obtained. For this reason, we support the Court’s determination, as it seems to have duly ruled that the deferment of taxation in time enables the taxpayer to avoid double taxation while at the same time not leading to tax evasion per se. The ultimate benefit is earned upon the sale of the shares and for this reason the taxable income needs to be assessed at that point in time.