The abysmal market performance these past few months has had catastrophic financial consequences for both investors and shareholders alike. However, another category of persons, often overlooked, has also been affected by the crisis – namely, employees, managers and others who have received stock options or warrants. The problem is well known: the recipients of stock options (or warrants) are taxed, pursuant to the Act of 26 March 1999, on the options upon grant. However, the current economic climate prevents them from exercising their options and selling the underlying shares to realise a tax-exempt capital gain. Moreover, option holders are unable to recover the tax they paid upon grant. This article discusses a number of measures that could be taken to solve this problem.
Extension of the exercise period for options
Most option plans are of a limited duration (between 5 and 10 years). Therefore, if the current financial crisis persists, certain option holders may never be able to exercise their options.
Recently, a number of solutions have been proposed to mitigate the effects of the financial crisis, without however increasing government spending. On 3 February, the Government submitted a bill intended to provide relief to option holders who had lost all hope of one day being able to exercise their options. The bill proposes extending by up to five years the exercise period for options. Of course, other solutions could also have been envisaged.
In order to offer option holders a reprieve from the present market turbulence, companies could consider amending the conditions of their option plans and extending the exercise period. However, such an amendment would have adverse tax consequences since, from a tax perspective, a change to the exercise conditions can be construed as a new offer and, consequently, a grant of new options which are taxable in the hands of the recipients (at a rate of 15% or 7.5% of the value of the underlying shares, as the case may be).
During the 2002 crisis, the legislature allowed Belgian companies to extend the exercise period for their options by up to 3 years with no additional tax burden. Given the extent of the current crisis, the Government now proposes allowing the exercise period for options to be extended by up to 5 years. This solution gives a new lease on life to the beneficiaries of option plans concluded between 1 January 2003 and 31 August 2008, provided the total tax value of the plans subscribed by the same beneficiary with the same company does not exceed EUR 100,000.
If the bill is approved by Parliament, companies will undoubtedly take care to adapt their option plans in accordance with company law and the provisions of their individual plan.
A lifeline has also been extended to employee warrants: the bill indeed provides that the prohibition set forth in Article 499 of the Company Code on extending the exercise period beyond 10 years does not apply in this case.
Directors, managers, consultants and other beneficiaries exercising a professional activity for the issuing company (or a group company) can also benefit from this provision.
Choice of tax upon grant or exercise
Another solution would be to allow recipients to opt to be taxed upon grant (in accordance with the current system) or to defer taxation until exercise. In the latter case, the beneficiary would pay tax only upon exercise of the options, namely when a capital gain is effectively realised. This solution, borrowed from the Dutch model, was examined by the Finance Minister during the 2002 market turmoil, but was ultimately rejected owing to the practical difficulties it would entail (contradiction with the current philosophy according to which the grant of an option constitutes as such a taxable benefit in kind, significant administrative management, imposition of social security contributions upon exercise, etc.).
Repricing of options
Reducing the exercise price of options is yet another possibility. However, once again, such an amendment to the exercise conditions could give rise to a new grant of options, with the adverse tax consequence explained above.
The legislature could however authorise an adjustment to the exercise price without adverse consequences for the beneficiaries, by taking as a reference the market price of the shares on 1 July 2008 (for example). This measure could be accompanied by a prohibition on disposing of the shares for a certain period of time (mandatory holding period).
Gratuitous offer of shares
Finally, offering shares free of charge could be an interesting solution to the current situation. Currently, employees are able to buy their company's shares at a reduced price. For listed shares, a reduction of up to 20/120 (that is, 16.66%) can be offered free of taxes and social security contributions, provided the shares are locked up for at least 2 years. Discounted shares can also be acquired free of taxes and social security contributions, provided very strict conditions are observed (minimum 5-year lock-in period, discount of no more than 20%, etc.).
The grant of options free of charge would be taxable. In order to mitigate the effects of the financial crisis, the legislature could however provide for advantageous tax (and social security) treatment – temporary or not – in return for the observance of certain conditions, notably related to the retention (i.e., continued employment) of the beneficiary. Thus, provision could be made for a lock-in period with an obligation to return the shares in the event the recipient resigns or is dismissed for just cause. Termination on ordinary grounds, on the other hand, would not trigger an obligation to return the shares, but the holding period would be maintained. If the beneficiary dies or retires, the shares would be immediately transferable.
In any case, the Government currently appears to prefer extending the exercise period, a technique already used back in 2002 and which has presumably been tried and tested. The adoption of such a measure would not weigh on the government's finances. Although this approach does not guarantee that option holders will be able to realise a profit (which remains highly uncertain due notably to the risks of dismissal, retirement and market unrest), it would give them, as in 2002, a brief reprieve, while awaiting an improvement in the economic climate.