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Comparative of taxation between stock options and phantom shares

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phantom shares vs stock options

Comparative of taxation between stock options and phantom shares

Companies are wondering which solution is the most useful for remunerating employees with shares and thereby attracting and, above all, retaining talent in their workforces.

However, the entry of employees into the share capital generates various conflicts that conflict with the general interest of the founding shareholders. This is why phantom shares are currently being used as an alternative solution.

The purpose of this article is to compare the advantages and disadvantages that both figures, stock options and phantom shares, have for the company. 

Stock options are the delivery of call options on a certain number of shares of the company to a beneficiary, such as an employee. Such delivery is conditioned to the fulfillment of a series of terms and conditions that are duly stipulated in the grant agreement. It may be made at par value or at the current value of the shares. Usually, the beneficiary will be able to exercise his acquisition right progressively and/or after a certain period of time, subject mainly to certain conditions and subject to a lapse period. Once the stock option has been exercised, the beneficiary acquires the shares and becomes a partner of the company.

On the other hand, Phantom Shares are payments in which the beneficiary receives a cash incentive whose amount is linked to the increase in value of the company, and whose accrual is linked to the occurrence of certain events previously agreed with the company. Consequently, the beneficiary is given notional securities to which a reference value is given, which could be either the nominal value or the current value of the shares. Assuming payment in cash at the previously agreed time, for the difference between the initial value of the company’s shares at the time of delivery and their final value. The economic result would be the same as that of the stock options but, unlike what happens with the delivery of stock options, the beneficiary would not acquire shares, and would not become a partner of the company.

How will the beneficiaries be taxed for personal income tax purposes?

In the case of Stock Options, according to the doctrine of the General Directorate of Taxes (“DGT”), the granting of a non-transferable stock option only constitutes an expectation of obtaining income for the beneficiary, which will materialize when the beneficiary receives the shares after the previously agreed conditions have been fulfilled. In this sense, until such materialization occurs, no income is deemed to have been generated for personal income tax purposes and the obligation of the granting entity to pay income on account does not arise.

When the beneficiary exercises his purchase option: the delivery of such shares will be considered as income from work in kind, since it implies the acquisition of an asset free of charge or at a price lower than the market value. This income will be the result of the difference between the market value of the shares acquired and the exercise price of the option, being attributable to the tax period in which it is payable to the beneficiary and its payment on account will accrue with the delivery of the shares.

However, it should be borne in mind that the payment on account may or may not be passed on by the company to the beneficiary, so that if it is not made it will result in a higher remuneration.

The yield obtained with the delivery of shares or participations may be exempt in certain circumstances.

When the beneficiary transfers his shares: he will be taxed in Personal Income Tax as a capital gain, for the difference between the transfer value and the acquisition value.

Regarding Phantom Shares, when they are granted, they are not subject to taxation, since they are only expectations of collection. It will be at the time of a liquidity event, or sale of the company, when a bonus will accrue to the beneficiary for the price received by the holders of the ordinary shares. Upon receipt of the amount, it will be when it must be taxed as a monetary income from work in the IRPF, with the corresponding withholdings on account, if the company so decides, being made previously, if the company so decides.

Will it be possible to apply some fiscal benefit to reduce its taxation?

Finally, we must specify that there is the possibility that the beneficiary of the stock options or phantom shares can apply a 30% reduction, in relation to the work income received and associated to the same, as long as a series of requirements established by the Personal Income Tax Law are fulfilled. Among others,

  • Income with a generation period of more than two years,
  • Imputed in a single tax period,
  • Not having applied the aforementioned reduction, in income with a generation period of more than two years or qualified by regulations as irregular income, in the five previous tax periods,
  • The amount of the full income, subject to reduction, does not exceed 300,000 euros per year.

To answer these or other questions that may have arisen after reading our post, do not hesitate to contact us.

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