On 4 December 2020, the Parliament enacted new legislation on employee share issues in unlisted companies. The new provision in the Income Tax Act is applicable as of 1 January 2021 and it provides an alternative valuation method for tax purposes. In many cases the new valuation method is advantageous and it reduces valuation related tax risks. The enactment of the new legislation was slightly delayed but the anticipated new tax regime has now been confirmed.
New rules allow net asset based valuation
If the conditions for the application are met, the value of the shares in an employee share issue may be calculated based on the share’s mathematical value i.e. generally by dividing the net assets of the company by the total amount of the company’s shares. As long as the subscription price of a share is equivalent, or higher, than the share’s mathematical value, the benefit received by the employee is tax exempt. If the employee disposes of the subscribed shares later on, any profit will be taxed as a capital gain.
Under the earlier rules, in an employee share issue a company may provide only up to 10% discount from the fair market value of the share as a tax exempt benefit when the shares are offered to the majority of the personnel (shares can be offered to employees in group companies as well). However, the earlier provision applies to both listed and unlisted companies and, in practice, listed companies have more commonly utilised this possibility. The new provision increases the attractiveness of employee share issues for unlisted companies. The earlier rules will stay in force in parallel with the new rules and they could become applicable where the conditions set for the application of the new rules are not met.
Conditions for the application
The conditions set out in the new provision, and in the preparatory works, are as follows:
- The shares can only be offered to the employees of the company issuing the shares (employees of group companies do not qualify).
- The shares must be offered to the majority (>50%) of the personnel in the company issuing the shares and under similar conditions. However, the number of shares offered may vary depending on the value of each employee’s work contribution.
- The shares cannot be offered to the members of the Board of Directors (or similar body) who are not employed by the company. Managing directors however qualify despite not having an employment relationship with the company.
- The employee (or their family members) may own no more than 10% in aggregate of the total shares/votes in the company.
- The issuer must be an unlisted limited liability company, which carries out business activities and majority of its assets are used in the business activities.
- The issuer must be from an EEA country or from a country with functioning exchange of information for tax purposes.
- The issuer must also be registered as an employer and in the prepayment register (alternatively, in case of a non-Finnish issuer, is able to demonstrate that it does not have tax neglects).
The new rules are aimed at facilitating employee ownership in private companies. The alternative valuation method provides companies whose fair market value is higher than their book value a tax efficient way to incentivise their employees. In any case, the new provision often simplifies employee share issues since determining the mathematical value is typically much more straightforward than determining the fair market value.
The new provision, as opposed to the current one, requires that the company issuing the shares employs the employees subscribing for the shares. This criterion was widely criticized during the legislative process but it was not removed. Reviewing the possibilities to utilize the new provision in a specific group structure is essential. The adopted single company based approach may create opportunities for new types of employee incentives in certain group structures and in connection with transactions.
Additional coverage on this topic may be found in our earlier D&I Alert from June.
When planning an employee share issue, also company law and employment law aspects need to be considered, in addition to the above discussed tax aspects. We are happy to discuss these topics further