More and more companies are establishing variable remuneration systems through stock options in order to link their executives and employees to the company’s success, thus increasing the value of their shares.
This enables to link variable remuneration, usually that of senior executives, to the stock market value of the Company’s shares –in the case of listed companies–, or to the share value (as is usual in emerging companies).
A stock option is a right granted by a company to its employees to purchase a specific number of shares or stock of that company at a set price (called a strike price) during a specific period of time (called a vesting period). If, during this period of time, the stock price has increased and the value exceeds the set purchase price, the employee will be willing to exercise his/her right to purchase the shares at the set price, and then sell them, if he/she so wishes, on the market for a higher price, thus getting income from the shares.
In order to define the stock options taxation, three different moments in time must be identified:
1. Grant of the option: The mere grant of the call option does no generate income for the employee.
During the holding period of the right to purchase shares of the entity at a set price, the Personal Income Tax shall not apply, and the economic prospect shall not be deemed as a right to be included in the Wealth Tax base nor in the 720 form if the call option relates to a foreign entity. The mere economic prospect does not involve taxation in Spain.
2. Exercise of the option (purchase of shares): During the period in which the employee has the right to exercise the call option, if the Company’s stock price is higher than the agreed price, the employee may be interested in exercising his/her right and purchase the shares.
The difference between the market price and the option price, for tax purposes, is considered as remuneration in kind in the Personal Income Tax of the taxpayer, inasmuch as they are part of the employee’s remuneration for his/her employment.
Such remuneration in kind is subject to an exemption in the maximum amount of EUR 12,000 per year, provided the following requirements are fulfilled:
- That the offer is carried out under the same terms and conditions for all the company’s employees or, where appropriate, its Group or sub-Group companies.
- That the employees together with their spouses or family members up to the second degree of consanguinity do not have, either directly or indirectly, a stake in the company in which they provide services or in any Group company exceeding 5%.
- That the shares are held at least for 3 years from the date of execution thereof.
Additionally, it is possible to reduce the entire income by 30%, as irregular income, provided that the following requirements are fulfilled:
- Income with a generation period exceeding two years, therefore, in the case of stock options the period between the grant of the call option to the employee and the exercise thereof must be more than two years;
- That, within five tax periods preceding that in which the options are exercised, the beneficiary thereof has not received other employment income generated for a period exceeding two years.
- Maximum amount of EUR 300,000.
3. Transfer of shares: Once the employee holds the shares, he/she may transfer them at any time, thus receiving capital gains or losses to be included in the taxable amount of savings for the difference between the stock price on the sale date and the stock price on the day of execution or purchase of the stock options.
In order to know when it is advisable to exercise an option and its subsequent sale, please find below the following example:
- Eduardo, resident in Spain for tax purposes, has been granted by the Company a stock options plan in January 2020 for his work performed in the Company in Spain, the plan being the following: he has a period of 5 years to purchase for the amount of EUR 10 (price per share as at the date on which the grant is made) a maximum of 10,000 shares. His annual base salary is EUR 120,000.
- In January 2023, the market price per share is EUR 15 per share, and it is expected that this value will increase.
Eduardo asks his tax advisors when it would be convenient to exercise this right, taking into account the reasonable bullish market prospects, and the taxation in his case.
His tax advisors, anticipating that the share price will rise, recommend exercising the option now and holding the shares until their price rises, and then, selling them.
- Taxation in the year in which the option is exercised:
- Purchase price: 10*10,000= EUR 100,000
- Value of the shares at the time of purchase: 15*10,000= EUR 150,000.
- Difference to be included in the general taxable base: EUR 50,000.
- Taxation at a general rate of 46.5%: EUR 23,250.
- Taxation in the case of sale: If in 2024 the share price is 20, and he expects that the price will not rise or he prefers not to take a risk and sell the shares, taxation will be as follows:
- Value of acquisition: EUR 150,000.
- Value of sale: EUR 200,000.
- Gain: EUR 50,000, to be included in the taxable amount of savings.
- Taxation: EUR 10,380.00.
- TOTAL TAXATION:
- TOTAL INCOME: EUR 100,000.
- TOTAL TAXATION: EUR 33,630.
If he had exercised the option in 2024, taxation would have been approximately EUR 46,500 (general taxable base).
III. INTERNATIONAL ASPECTS
Today, in a globalised world where changes in tax residence are a common practice, there can be a situation in which a taxpayer changes his/her tax residence during the period between the grant of the stock options and the exercise thereof.
The fact that the remuneration for the work effectively carried out in a country is paid at a later time, is not a reason for the source country not to tax such income, therefore, the internal regulations of each country must be observed, and if a convention for the avoidance of double taxation exists, it should be analysed whether the requirements provided for in Article 15 of the double taxation conventions are met.
Tax advisors must review the article relating to employment income of the convention signed between the country in which the taxpayer has been a tax resident -the source country-, from which he/she will receive the shares, and the country in which he/she currently resides -country of residence-.
The commentaries on the model of the Organisation for Economic Cooperation and Development (OECD), establish some criteria for this type of remuneration:
- Income generated until the exercise of the option is classed as employment income. Once the employee becomes a shareholder (by exercising the option), income will be classed as capital gains.
- It is essential that the options have been granted as a result of the work effectively performed in the source country, during a certain period of time in which the employee was a resident in that country, and by the company residing in that country.
- It is important to note that the source country may decide when to tax this income according to its internal regulations, and that date may not match with the vesting date of the country of residence, therefore this issue must be carefully analysed.
- Although the employee no longer effectively works in the company, or even if he/she has retired, articles regarding “other income” or “pensions” cannot be applied.
Even though the provisions of each convention must be observed, in general, shared authority is established, removing double taxation through the implementation of the mentioned procedures, progressive exemption or ordinary taxation.
See binding consultation of the Directorate General for Taxation, (hereinafter, DGT), number V1486-19, of 20 June 2019.
The DGT provides for in this respect in its binding consultation V1907-17, of 18 July 2017.
 By way of simplification, in this example we assume that the requirements to apply the above-mentioned exemption of EUR 12,000 and the irregular income, are not fulfilled.
Without considering other tax issues beyond the Personal Income Tax, such as Wealth Tax implications.
In that sense the Central Economic Administrative Court has ruled in its resolution 8267/2008 of 3 February 2010.
It is recommended to obtain a tax residence certificate for the purposes of the DTC signed with Spain.