Aija Lasmane, Sorainen partner; Māris Liguts, Sorainen counsel
An initial public offering (IPO) is the process by which a company offers its stocks to the public for the first time on a stock exchange in order to raise additional capital. This is an important milestone in a company’s growth and often attracts a lot of attention from investors. The purpose of the IPO is to provide the company with the additional financial resources needed for its further development.
Stock options are among the most common ways companies motivate employees: by offering them the opportunity to become stockholders in the company. Stock options are a legitimate opportunity to pay income to employees with a significantly lower tax burden, which benefits employers and employees – especially with the current high labour taxes.
Income from the exercise (implementation) of employee stock options has been exempt from personal income tax (PIT) and mandatory state social insurance contributions (MSSIC) since the end of 2012, when the special regulation was initially introduced.
On 12 January 2021, amendments to the Law on Personal Income Tax (PIT Law) and to the Commercial Law entered into force, allowing individuals to obtain a tax exemption after holding stock options for just 12 months.
Employees can purchase company stock at a strike price, determined at the time of granting the stock options, after the end of the specified stock-options-holding period. If the stock price in the market is higher than the price at which the employee has implemented the stock options, the employee can make a significant profit from the sale of stock in addition to the remuneration received at the company.
Employees who have implemented their stock purchase options during the company’s IPO must consider "lock-up" or share disposal restrictions. A "lock-up" is a restriction on a company’s stockholders (including employees) selling their stock in the company for a certain period after the company's IPO; this is to protect new investors from the price volatility that could result from a large volume of stock being sold on a stock exchange. This time limit varies in practice – from several months to two years – but employees are free to sell their stock on the stock exchange after the lock-up period.
In addition, if an employee joins the stockholders' agreement as a result of implementing stock options, which provides for some share restrictions or special management procedures, then after the IPO, such restrictions are reviewed and either cancelled or significantly changed so that they are adapted to the law's requirements.
Income from the implementation of employee stock options
Stock options granted to employees represent the right to buy the company’s stock at a specific price, subject to the fulfilment of certain conditions. The purchase price of a stock specified in the stock purchase options agreement may be lower than its market value so that an additional benefit may arise from the exercise of an employee's stock options. In general, such a benefit is subject to payroll taxes (Article 8, Paragraph 2.5 of the PIT Law) as it is considered a benefit that the employee receives based on the employment relationship. However, if certain conditions are met, income from the exercise of the employee stock options is exempt from PIT (Article 9, Paragraph 43 of the PIT Law). The employee is then free to make use of the acquired stocks. If a natural person sells their stocks, they must pay PIT on the capital gain.
Conditions for the application of the favourable PIT regime
In order to provide employees with an exemption from PIT when implementing stock options, five conditions must be met:
Stock options may also be granted in respect of stock that is not publicly traded. In such cases, the market value of the stock on the date of exercise of the stock options shall be determined as the value of the stock stated in an independent written opinion, including the valuation methodology used, provided by a person included in the list of valuers of property investments under the Commercial Law. However, determining publicly traded stock's market value is simpler and more transparent. Therefore, combining a stock public offering with a subsequent grant of stock options to employees should certainly be considered.
Article In Latvian: https://www.db.lv/zinas/sakotnejais-publiskais-piedavajums-un-akciju-opcijas-cels-uz-uznemuma-izaugsmi-un-darbinieku-motivaciju-518459
An initial public offering (IPO) is the process by which a company offers its stocks to the public for the first time on a stock exchange in order to raise additional capital. This is an important milestone in a company’s growth and often attracts a lot of attention from investors. The purpose of the IPO is to provide the company with the additional financial resources needed for its further development.
Stock options are among the most common ways companies motivate employees: by offering them the opportunity to become stockholders in the company. Stock options are a legitimate opportunity to pay income to employees with a significantly lower tax burden, which benefits employers and employees – especially with the current high labour taxes.
Income from the exercise (implementation) of employee stock options has been exempt from personal income tax (PIT) and mandatory state social insurance contributions (MSSIC) since the end of 2012, when the special regulation was initially introduced.
On 12 January 2021, amendments to the Law on Personal Income Tax (PIT Law) and to the Commercial Law entered into force, allowing individuals to obtain a tax exemption after holding stock options for just 12 months.
Employees can purchase company stock at a strike price, determined at the time of granting the stock options, after the end of the specified stock-options-holding period. If the stock price in the market is higher than the price at which the employee has implemented the stock options, the employee can make a significant profit from the sale of stock in addition to the remuneration received at the company.
Employees who have implemented their stock purchase options during the company’s IPO must consider "lock-up" or share disposal restrictions. A "lock-up" is a restriction on a company’s stockholders (including employees) selling their stock in the company for a certain period after the company's IPO; this is to protect new investors from the price volatility that could result from a large volume of stock being sold on a stock exchange. This time limit varies in practice – from several months to two years – but employees are free to sell their stock on the stock exchange after the lock-up period.
In addition, if an employee joins the stockholders' agreement as a result of implementing stock options, which provides for some share restrictions or special management procedures, then after the IPO, such restrictions are reviewed and either cancelled or significantly changed so that they are adapted to the law's requirements.
Income from the implementation of employee stock options
Stock options granted to employees represent the right to buy the company’s stock at a specific price, subject to the fulfilment of certain conditions. The purchase price of a stock specified in the stock purchase options agreement may be lower than its market value so that an additional benefit may arise from the exercise of an employee's stock options. In general, such a benefit is subject to payroll taxes (Article 8, Paragraph 2.5 of the PIT Law) as it is considered a benefit that the employee receives based on the employment relationship. However, if certain conditions are met, income from the exercise of the employee stock options is exempt from PIT (Article 9, Paragraph 43 of the PIT Law). The employee is then free to make use of the acquired stocks. If a natural person sells their stocks, they must pay PIT on the capital gain.
Conditions for the application of the favourable PIT regime
In order to provide employees with an exemption from PIT when implementing stock options, five conditions must be met:
- the minimum period for holding stock options (the period from the day the stock options were granted until the day when an employee is entitled to commence the implementation of the stock options) is not less than 12 months
- during the minimum period for holding the stock options, the employee is in an employment relationship with the capital company which granted the stock options to the payer, or a person related to it within the meaning of the Law On Taxes and Fees has granted the stock options to the payer
- within two months of the expiry of the period during which employees could have applied for stock options or during which stock options were granted (if the stock options exercise plan does not provide for applications for stock options), the employer submits information on the stock options plan to the State Revenue Service
- the stock options is implemented no later than six months from the day when the employment relationship was terminated between the payer and the employer (the capital company which granted the stock options to the payer or a person related to the employer within the meaning of the Law On Taxes and Fees)
- the capital company which granted the stock options to the payer, or a person related to it within the meaning of the Law On Taxes and Fees, has not granted any loans to the payer which remain unpaid by the moment of implementation of the stock options
Stock options may also be granted in respect of stock that is not publicly traded. In such cases, the market value of the stock on the date of exercise of the stock options shall be determined as the value of the stock stated in an independent written opinion, including the valuation methodology used, provided by a person included in the list of valuers of property investments under the Commercial Law. However, determining publicly traded stock's market value is simpler and more transparent. Therefore, combining a stock public offering with a subsequent grant of stock options to employees should certainly be considered.
Article In Latvian: https://www.db.lv/zinas/sakotnejais-publiskais-piedavajums-un-akciju-opcijas-cels-uz-uznemuma-izaugsmi-un-darbinieku-motivaciju-518459
