Employee Shareholding: New Regulations Provide Better Opportunities for Employers to Reward Employees

The latest round of tax reform in 2023 has brought the topic of employee shareholding to the forefront, i.e., the inclusion of employees in the ownership structure of the employer. Although this type of reward was possible before, the latest amendments to the Income Tax Act have put this topic in focus as the tax rate on such income has been reduced, which has immediately increased employers’ interest. However, before deciding on this step, employers need to understand how this now works from a tax perspective and what the most important aspects of implementing such a reward model are.

Namely, if we provide an employee with any benefit in kind below market price, a tax obligation will arise based on income from dependent work, unless the tax regulation explicitly states otherwise. For example, the free allocation of shares to employees is considered a taxable benefit in kind. If shares are sold to an employee below market price, the difference (i.e., discount) is considered a taxable benefit in kind.

Equal Treatment

Until this year, we had unequal tax treatment of the allocation of shares (d.o.o.) and the allocation of stocks (d.d.) to employees. The allocation of shares was considered ‘income from dependent work’, applying tax and contribution rates as on salaries, while the allocation of stocks was considered ‘income from capital’, applying a tax rate of 20 percent (plus applicable surtax), without contributions.

From 2024, this inequality has been corrected, and in both cases, such a benefit in kind is considered ‘income from capital’ and is taxed at a fixed rate of 24 percent, without contributions. This change has prompted many employers to consider the possibility of introducing employee shareholding in their company. It is important to emphasize that the matter is more complicated than just the tax rate.

Market Price of Shares

First of all, it is necessary to emphasize that the nominal value of shares is practically irrelevant for tax purposes. The tax regulation is clear when it states that the value of any benefit in kind, including shares, i.e., stakes, is determined according to their market value. The market value of shares, i.e., stakes, can be determined in several ways, and one of the more common, and perhaps the most reliable, is the engagement of certified appraisers.

Conversion from Net to Gross

We have long waited for the legislator to correct the inequality in the taxation of the allocation of shares (d.o.o.) and the allocation of stocks (d.d.), and we have waited even longer for the legislator to correct an illogicality in the calculation of tax on benefits in kind in general, which includes the allocation of shares, i.e., stocks.

Namely, the market value of the benefit in kind is always considered net for the purposes of calculating tax, which needs to be converted to gross, regardless of whether the tax burden is borne by the employee or the employer. Thus, we have had situations where the actual tax burden could exceed one hundred percent of the market value of the shares (e.g., when it came to the free allocation of shares in a d.o.o. before the last amendments to the tax regulations, i.e., when the rules for taxing ‘income from dependent work’ were applied).

From 2024, this actual tax burden amounts to 30.89 percent of the market value of the shares (thus, it is not 24 percent, which is the nominal tax rate, but it is also not approximately one hundred percent, which it could have been before the last tax amendments).

Our tax regulation assumes that the employer will always pay tax on benefits in kind. However, there are situations where employees receive option plans, i.e., acquire shares directly from abroad, in which case they personally bear the tax burden, and the tax regulation still forces them to make the conversion from net to gross as if the employer had paid the tax. This can easily be corrected by amending the Income Tax Regulation, and we believe that this problem will also be resolved.

Dividend and Capital Gains

After acquiring shares, employees can earn dividends, as well as capital gains after selling shares. Dividends are taxed at a rate of 12 percent, as are capital gains, with the stipulation that capital gains are not taxed at all if the employee has owned the shares for at least two years before selling them.

A New Era, New Models

Most successful employers are well aware of how much quality employees mean to them and how difficult they are to find and retain. Significant effort is invested in creating a motivating work environment, clear and challenging goals, and appropriate compensation packages for employees. These are dynamic processes that often change under the influence of the market, competition, growth, inflation, legal changes, and various other factors. Such mechanisms for retaining and motivating key employees have become imperative for many sectors, with the IT sector still standing out the most in this regard.

Terms you may hear in practice include employee shareholding, option plans, ESOP (i.e., employee stock ownership plan), and similar. The primary goals of such models are the long-term retention and motivation of key or all employees. Employees have the opportunity to participate in the future profits of the company and the increase in its value, which gives them a strong interest in contributing to the company’s core goals in the long term. Even potential investors want to see that key employees are motivated to stay with the employer in the long term, primarily through ownership stakes or option plans, which ultimately increases the value of the company. Owners of family businesses may also be interested in such models, as they often recall this topic when they anticipate selling the company or retirement. Employees are generally the bearers of a significant portion of the company’s value, and owners are aware of this and want to reward them.

Risks of Employee Shareholding

In addition to the clear benefits that arise from including employees in the ownership structure, there are also some risks that can be mitigated or eliminated through detailed planning of the entire employee shareholding model. In practice, it has been shown that it is relatively easy to plan how employees will acquire shares in the company and under what conditions, but the potential separation from the employee is planned for a long time.

If a separation occurs, it must be clear what happens to the shares that the employee has acquired – whether the employee retains them, whether they can sell them to anyone, or whether they must first offer them to the employer (at what price, within what timeframe), etc. It is also important to define what happens when making important decisions for the company (e.g., when selling the company to an investor). For each of these risks, there are various solutions and best practices.

The application of employee shareholding in practice is by no means simple. There are many aspects to consider when thinking about the employee shareholding model in practice. Each model is generally based on the same principles, but it also differs and is tailored to the specific employer. In addition to tax experts, legal experts are also needed in selecting the model, and the entire process takes three to six months.