(French Administrative Supreme Tax Court, Sep. 26, no.365573, M. et Mme Gaillochet)
In its decision on September 26, 2014, the French Administrative Supreme Tax Court (Conseil d'Etat) ruled that, given the facts of the case, the capital gains made from the sale of shares acquired from exercising a call option granted by investors to an executive could not be treated as capital gains from a sale of shares. Instead, it had to be treated as wages.
An executive had been granted, by certain investor shareholders, a call option to acquire shares of the company, at a later date and under conditions. In order to benefit from this call options, the executive had immediately paid an cash amount. The executive could exercise his call option subject to his continuous active presence in the group for at least 5 years. The number of shares subject to the call option depended on the internal yield rate of the investment made by the investors. Several years later, the executive exercised his call option, paid the exercise price then, the next day, sold his shares and provided a guarantee in relation to the shares sold as others investors selling shares did. The taxpayer reported the capital gains made from the sale of the shares in the category of capital gains from share sales, which was subject to a flat-rate tax.
The tax authorities found that the execution of the call option and the exit terms at the time of the sale of the shares were subject to his duties as an executive. Therefore, the capital gains upon the sale could not be considered as the remuneration for a capital investment with risk-taking given the token amount paid at the time the call option was granted to him. In addition, the authorities considered that guarantee granted had no connection to the call options, but only to the sale of the shares, and was therefore not a supporting argument for the taxpayer in demonstrating he had acted as any shareholders would have done.
This decision was expected because the French Administrative Supreme Tax Court was ruling for the first time on how to categorize capital gains made within the framework of a management package in the form of call option to acquire shares. In her opinion, the Public Rapporteur, Mrs. Cortot-Boucher, compared these call options, granted pursuant to a private agreement between an executive and an investor, to stock options granted by a company (or by one's group of companies) to its employees in order to become an employee shareholder at a price set in advance. She argued that, technically, there are two separate gains: firstly, a gain from exercising the call option which must be categorized to be taxed, and, secondly, a gain from the sale of the shares, consisting of the shares increasing in value, if applicable, since their acquisition, which is taxed as capital gains from a sale of shares. Consequently, she noted that, if the options were not granted pursuant to the relevant provisions of the French Commercial Code, the gains at exercise of the option must be taxed as wages. Moreover, the Public Rapporteur concluded that the gains at the exercise or at sale of the shares could not be categorized as non-commercial profits (which could have been another way to characterize the income from a tax standpoint) because the gains did not result from an activity that is distinct from the employment activity as an officer. In the specific case, the terms of the options were however different than those of an employee stock options, both as regards to the person granting the options and as regards to the immediate payment to be granted such an option as well as the exit terms.
For some authors, the French Administrative Supreme Court made a completely erroneous reading of the situation because no employee income can exist since the option is granted by a third party, not the employer company, and the executive took an investor's risk by paying a price to the granted the call options, which could have been lost under certain circumstances.
In other authors' opinions, in this decision one should see only one possible assessment of management packages by the French Administrative Supreme Court, based on the factual circumstances, resulting in characterizing the capital gains as compensation to be taxed as wages. With other facts, they could have been deemed investment income or maybe if the financial risk taken as an investor (i.e. if the immediate payment for the options) is more significant, as capital gains from a sale of shares.
In our opinion, this is not a precedent decision involving systematically a characterization of management packages as wages. We believe one has to view this decision as an assessment depending on the factual circumstances. It is to be hoped that the decision would have been different had it involved acquisitions of securities, shares or share purchase warrants (BSA), under specific, actual conditions where an executive takes a risk by investing alongside third-party investors.
Indeed, although the tax authorities seem to think, “Once an employee, always an employee”, it still has to be proven based on the facts.