• For employers in the tech sector, incentives are becoming a priority to attract and retain talent
  • Incentives need to be structured for maximum effectiveness by companies
  • The key to presenting incentives to employees is for companies to understand the tax advantages of share options within their relevant jurisdiction

Attracting and retaining talent in today's competitive job market is critical to the success of many businesses. This is particularly the case for early-stage companies in the technology sector, which are fast growing but have limited cash.

Employee share incentives are becoming increasingly important in the tech sector, as they can be used both as a hiring tool and as a cost-effective way to retain and motivate employees. Many tech employees now expect equity to form a part of their reward package.

Share options

For a large number of early-stage tech companies across Europe, share options can deliver a motivational impact while minimising administrative and cost implications of the incentive. Share options will give the employee a right to acquire shares at a fixed price at the time of purchase and on future dates. In the UK, that future date is typically on the occurrence of a liquidity event such as a share sale or IPO (initial public offering) (as opposed to the typical US model that provides for vesting over a four-year period, with a one-year "cliff").

The grant of share options has a number of advantages over only awarding shares directly to employees. These include no upfront funding obligation and no income tax or social security obligations to pay on grant. They also include risk-free investments for employees (with no obligation for the employee to exercise the option to purchase the shares).

Granting options means that there will be no administrative, tax and cost implications involved with employees becoming minority shareholders. Moreover, international expansion is relatively straightforward because "options" are a well-known currency in the tech sector and can be replicated across jurisdictions. Also, an aggregate option gain from a share sale is often tax deductible and can be a useful asset for valuing a company.

More European countries now offer specific tax advantages to growth companies, and an incentive that can minimise tax leakage is particularly attractive.

The UK landscape

In the UK, small to medium-sized companies and groups that have UK-based employees have for many years had advantages over more mature companies, as they typically qualify to grant enterprise management incentive (EMI) options. This highly tax-advantaged form of share option results in the growth in value of the shares in the period from the time they are granted to the time they are exercised as they are taxed as capital and not income. The tax efficiencies affect not only the employee but also the employing company, which can benefit from employer social security savings that are not available for, by way of example, cash-reward incentives.

For companies that do not qualify for EMI (or that have grown too big for EMI), recent changes to the company share option plan (CSOP) mean that it is still worth considering share option incentives. These changes include to the individual limit on the market value of shares, which is now set at £60,000 (double the previous £30,000 limit). Also, for companies with more than one class of shares, the complex share class tests have been removed, opening CSOP up to a wider range of companies (in particular, some private equity-backed companies and many non-UK companies may now qualify for CSOP).

Swedish developments

Since 2018, Sweden has also had a beneficial tax treatment of share options to employees of small and newly started companies, through qualified employee share options. The rules, like EMI, ensure no income tax or social security is charged on exercise and, instead, provide that any growth in value is taxed as capital income at a future disposal of the shares. These rules were updated in 2022.

Spain's 'start-up law'

In Spain, a beneficial tax treatment for start-ups granting share options was published in December 2022, known as the "start-up law".

The first €50,000 per year of the benefit in kind are exempt from share options. Unlike similar smaller exemptions available in other circumstances, there is no requirement to offer stock options to all employees.

Any excess over €50,000 will not however be taxed at the time of acquisition of the shares. The benefit in kind will be taxed instead, on the first to occur of the company being admitted to trading on a Spanish or foreign market (the shares being transferred by the employee), or when 10 years have elapsed since the shares were acquired by the employee.

Germany's new legislation

Germany has implemented new legislation as of 1 January 2024 in relation to share options/shares granted by start-ups as well as growth companies.

If a company qualifies, employees can consent to not being taxed at the time of the exercise of the share options and the respective acquisition of the shares. The taxation is instead deferred to the first to occur of (i) the transfer of the shares, (ii) the lapse of 15 years since the shares were acquired by the employee or (iii) the termination of the employee relationship (deferred taxation). If the employer assumes liability for wage tax, deferred taxation only applies in case of and at the time of transfer of the shares. For the calculation of the tax base, the lower of the two fair market values – value at the time of deferred taxation and value at the time of exercise of the share options – is relevant. In leaver cases, any lower consideration received by the employee for the share transfer is decisive for the tax base.

Any growth in value of the shares between the time of exercise of the share options and the transfer of the shares still constitutes capital income at the level of the employees.

Differing qualification criteria

The UK, Sweden, Spain and Germany have chosen slightly different tests for which companies qualify, based on circumstances such as the number of employees, turnover, balance sheet and how long they have been established. Tech businesses operating across Europe will be interested to learn whether they qualify for the available tax reliefs in each country.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.