On 29 November 2017, the Luxembourg tax administration published its new circular letter on stock options. It has raised the market value of freely negotiable options (warrants) which are not listed on the stock exchange to the value of 30% of the underlying from 17.5% in the past.
The tax treatment of warrants has been intensively debated over the last months by political parties and business actors. On the one hand, incentive schemes for top earning and highly qualified employees are necessary to attract and retain talent in the country; on the other hand, a system which discriminates among employees may be potentially difficult to justify on the grounds of equal treatment of taxpayers.
As a compromise, the Luxembourg finance minister announced, when presenting the 2018 finance bill, that the tax treatment on warrants would be increased to bring it in line with the tax treatment of extraordinary income. Basically, extraordinary income, such as non-speculative capital gains, is taxed at half the usual rate applicable to the taxpayers’ ordinary income. A similar system also applies to extraordinary employment income, in case the item of income pertains to more than one fiscal period.
In practice, it is difficult to reconcile the rules of the circular on stock options, which determine a tax base for the advantage resulting from the grant of the warrant with those of the income tax law, which set a specific rate for the taxation of extraordinary income. To achieve this result, the authorities have proposed to raise the valuation of the advantage resulting from freely negotiable stock options. For options granted before the end of 2017, the advantage is set at 17.5%. As of 1 January 2018, it will be raised to 30%. This means that, currently, the advantage resulting from the grant of warrants is taxable at a rate of approximately 13% and, as of next year, the average tax burden on the grant of warrants will amount to approximately 21%, which corresponds to half of the top individual income tax rate.
The circular letter also includes certain other rules in relation to stock option plans, which were included in the past in service notes and in ministerial responses in front of the Luxembourg Parliament.
In particular, the taxable advantage resulting from warrants cannot exceed 50% of the total annual remuneration to a given beneficiary. This limit is appreciated for each beneficiary and not for the plan as such.
Warrants can only be attributed to executives, as determined by labour legislation. Basically, this category covers employees who have a remuneration which significantly exceeds the average salary paid by a given employer, and provided this salary is the counterparty of managerial functions, of a large autonomy in the organisation of work and of the absence of fixed working hours (hence without specific remuneration of overtime).
The warrant plan has to be designed so that the option price does not exceed 60% of the value of the underlying securities.
Finally, the circular letter addresses filing obligations. For options granted in 2016 and 2017, the employer has to inform the tax administration about the existence of the option plan prior to 31 January, respectively 31 March 2018. In the absence of information, the stock option tax regime cannot be enjoyed anymore for the future.
The Circular letter specifically states that, as of 2018, the communication to the tax administration has to be made at the time the advantage is put at the disposal of the employee, and not at the time the stock option plan is created.
This communication to the authorities has to be made via electronic means.