ANOTHER French-Qualified RSU Regime on the Horizon

If it seems that most of my blog posts are dedicated to France, then you are correct.

For this, we can blame the many changes that have been adopted to the French-qualified regime for RSUs over the last few years, most recently discussed in my post from April 2017.  And, alas, another change is on the horizon. Continue reading

Tax-Qualified Plans – Blessing or Curse?

When granting equity awards, one of the most important questions is the tax effect of such awards.  Granting awards that have a negative tax impact on the employee or the company is counter-productive and should lead companies to consider other ways to incentivize their employees.  On the other hand, should companies maximize the availability of favorable tax treatment for equity awards in certain countries?  This is not an easy question to answer.

Favorable Tax Treatment – The Company vs. the Employee

When we talk about favorable tax treatment, it can mean different things depending on the country and the qualified-tax plan.  The most basic distinction is whether the treatment is favorable for the employee, the company, or both.

  • For employees, favorable treatment often means that taxation can be deferred (usually until the shares are sold), the taxable amount can be reduced or characterized more favorably (e.g., as capital gain, rather than employment income), social taxes can be mitigated or avoided, or a combination of the foregoing.
    For the company, favorable treatment usually means that employer social taxes can be reduced or avoided, tax withholding/reporting obligations can be eliminated, or a tax deduction becomes available.
  • Companies will need to consider which of the above are most important to them.  In my experience, it is usually a combination of employer social tax savings and employee tax savings that prompt companies to implement a tax-qualified plan.

The prime example for this is France, where a tax-qualified plan can reduce the very high employer social taxes (up to 46%) that are due on non-qualified awards, but also allow for a tax deferral and potential tax savings for employees.  Of course, French-qualified awards are famously complex, due to the many changes the French legislator has adopted over the last few years (described in more detail in my prior blog post here).

By contrast, in Israel, a trustee plan (Israel’s version of a tax-qualified plan) benefits almost exclusively the employee, but has become so common that companies are almost forced to adopt one, due to competitive pressures. More recently, however, several of our clients have adopted trustee plans in Israel for the main reason of obtaining a local tax deduction, which has become more important in the wake of the Kontera decision, so there is now also a dual reason for such plans in Israel.

The Cost-Benefit Analysis

Before companies decide to implement a tax-qualified plan, they should undertake a careful cost-benefit analysis.  In working with private companies, I have observed that they tend to almost reflexively adopt a tax-qualified option plan in the UK or a French-qualified plan.  This is usually based on advice from local advisors who claim that these plans are common place for companies offering awards in their jurisdiction and that, to remain competitive, awards have to be granted under these plans.

While it is true that tax-qualified plans in these countries can be especially beneficial for private companies and their employees, this advice often omits the administrative burden and cost of maintaining such plans.  Virtually all tax-qualified plans (with France and the UK being no exception) come with various special conditions (such as minimum vesting and holding period requirements) and ongoing filing obligations (such as special annual reporting requirements).  And while the initial preparation and implementation of the tax-qualified plan can be handled by an outside advisor, ensuring that the special conditions are met and completing the ongoing filings typically falls on the company which, in the case of many private companies, may not have sufficient resources to deal with these issues.

Another important consideration is the treatment of qualified awards in a corporate transaction.  This is again especially relevant for private companies which are more likely to be acquired before awards can first be exercised or vest.  If an acquisition disqualifies the awards from the favorable treatment, the qualified plan essentially would have been implemented for naught.

Of course, companies don’t have a crystal ball and whether or not an award could be disqualified depends on the type of acquisition, the treatment of the awards in the acquisition, whether holding periods have been satisfied at the time of the acquisition and many other factors.  Still, dealing with qualified awards in an acquisition is usually cumbersome and, in many cases, it will be necessary or advisable to obtain tax rulings to preserve the qualified status of awards.  For example, in Israel, it seems that any modification of an existing award granted under a trustee plan requires the approval from the Israeli Tax Authority to maintain trustee plan status.

Embarking on a New Tax-Qualified Plan? Answer These Questions First!

As companies decide whether or not to implement a tax-qualified plan in a particular jurisdiction, they should ask themselves the following questions:

  • What is the benefit of the tax-qualified plan?  If the benefit is purely, or mostly, for the employee, how does this affect employees in other countries who may not be able to receive the same tax benefits?  Are the employer social tax savings significant enough to warrant the implementation and maintenance cost of the plan, as well as the administrative burden?
  • Has everyone weighed in on the decision to implement a tax-qualified plan?  Operating a qualified plan will most likely have a significant effect on the stock plan administrator who will need to administer special terms, such as holding periods, and comply with ongoing requirements.  It can also have corporate tax and accounting consequences which should be socialized with the right people within the organization.
  • Who should pay for the implementation and maintenance of the plan?  If the main benefit of the plan is employer social tax savings, perhaps it is appropriate to allocate the cost to the local entity.
  • Do we have the administrative capacity to administer the qualified plan?  In this respect, it is important to understand all of the requirements and any ongoing filing requirements.  I would also consider creating a detailed checklist that can be used to track the requirements and obligations, which can be especially useful if there is turn-over at the company.
  • What does the future hold?  If a company is about to implement a new equity incentive plan, does it make sense to implement a qualified plan under the “old” plan, given that most qualified plans are tied to the parent plan and have to be re-done when a new plan is adopted?  If a corporate transaction is probable, what is the impact of such a transaction on a qualified plan?

At the end of the day, as always seems to be the case with global equity awards, the answer of whether a tax-qualified plan should be implemented is highly fact-specific and depends on the particular circumstances of each company.  The best advice is to not jump into implementation of a qualified plan, but carefully consider all of the benefits and requirements and seek input from multiple stakeholders.

To Learn More

In case you are planning to attend the 2017 GEO National Equity Compensation Forum in Rancho Palos Verdes from September 13-15, I invite you to attend the presentation on this topic that I will participate in, together with Jennie Anderson from Microsoft and Wendy Jennings from Cisco.  Jennie and Wendy are among the most experienced stock plan administrators in the industry and will no doubt have great tips when it comes to tax-qualified plans!  If you have not registered yet, please see our invitation here for a special discount offer.

Oops, the French Did it Again……

Less than 18 months after the latest amendment to the regime for tax-qualified RSUs in France, another amendment became effective on December 30, 2016.  This amendment is the third amendment to the regime in five years, meaning that companies may (in theory) have to administer tax-qualified RSUs that are subject to three different income tax and social tax regimes.  The three different qualified RSU regimes are as follows:

  • French-qualified RSUs granted after September 28, 2012 (“Pre-Macron RSUs“)
  • French-qualified RSUs granted under a plan approved by shareholders after August 7, 2015 (“Macron RSUs“)
  • French-qualified RSUs granted under a plan approved by shareholders after December 30, 2016 (“Modified Macron RSUs“)

For companies that have granted tax-qualified RSUs in the past, the question is whether they will want to continue to grant qualified RSUs after the latest changes.  Similarly, companies that have granted non-qualified RSUs in France or that are starting to grant RSUs in France for the first time will want to evaluate whether they can and want to grant tax-qualified RSUs under the new regime.

Background

Granting equity awards to employees in France can be expensive because of the high employer social taxes.  In particular, any income realized from a non-qualified equity award (e.g., spread at option exercise, FMV of shares at vesting of RSUs) is subject to employer social taxes at a rate of up to 46%.  The 46% rate is comprised of different social insurance contributions, only some of which are subject to a cap.  This means that even awards granted to highly compensated employees will remain subject to employer social taxes at a rate of approx. 25%(while the employees will have reached the contribution ceilings for the other contributions with their other compensation).  If a company grants awards on a broad basis in France, makes large awards to some employees or if the stock price increases significantly after grant, accordingly, the French employer is looking at a big employer social tax liability.

Many companies have been trying to mitigate employer social taxes by granting tax-qualified awards.  Several years ago (before it was possible to grant French-qualified RSUs), no employer social taxes whatsoever applied to French-qualified options.  Recognizing the loss of significant tax revenue, the French government started to impose employer social taxes on tax-qualified awards, but the timing of the taxation and the tax rate have changed significantly over the years.  Some of the changes have made it very difficult for companies to determine whether granting tax-qualified awards is, indeed, beneficial for them.

Determining Which Tax Regime Applies

Before we look at the possible tax benefits of granting tax-qualified RSUs (versus non-qualified RSUs), let’s first discuss under which regime companies may be able to grant qualified RSUs.

Strangely, this depends on when the plan under which the RSUs are granted was last approved by shareholders.  If the plan was last approved on or before August 7, 2015, qualified RSUs can be granted only under the Pre-Macron Regime.  If the plan was last approved after August 7, 2015 and before or on December 30, 2016, qualified RSUs can be granted only under the Macron Regime.  If the plan was last approved after December 30, 2016, qualified RSUs can be granted only under the Modified Macron Regime.

Because it is unlikely that companies would take their plan to shareholders just to be able to grant qualified RSUs under a particular regime (or obtain approval just for a French sub-plan), the application of the different regimes is somewhat random*.

Employer Social Tax Treatment Under Different Regimes

As mentioned, the timing and rate of the employer social taxes varies significantly depending on the applicable regime and can be summarized as follows:

Non Qualified RSUs Pre-Macron RSUs Macron RSUs Modified Macron RSUs
Rate Up to 46% (same as for salary) 30% 20% 30%
Taxable event Vesting date Grant date Vesting date Vesting date
Taxable amount FMV of shares at vesting FMV of shares at grant or fair value as determined under IFRS 2 (at election of employer) FMV of shares at vesting FMV of shares at vesting

It is important to note that, if the employee forfeits the RSUs before vesting (typically because the employee terminates prior to vesting), no employer social taxes will be due under any of the regimes, except the Pre-Macron Regime.  For RSUs granted under the Pre-Macron Regime, the employer has not been entitled to a refund for the employer social taxes paid at grant (which has been one of the reasons why it has been so difficult to evaluate whether such RSUs can result in employer social tax savings when compared to non-qualified RSUs).  However, this might change due to a challenge that is currently pending with the French Constitutional Court.

If successful, employers will be able to apply for a refund (likely both for previously granted awards and for future awards).

Employee Tax Treatment Under Different Regimes

The employee tax treatment also varies quite a bit depending on the applicable regime, as follows:

Non Qualified RSUs Pre-Macron RSUs Macron RSUs Modified Macron RSUs
Annual vesting gain not exceeding €300,000 Portion of annual vesting gain exceeding €300,000
Taxable event / Taxable amount Vesting date/FMV of shares at vesting Sale of shares/Gain divided into Vesting Gain (FMV of shares at vesting) and Capital Gain (sale proceeds minus FMV of shares at vesting)
Income tax Taxation as a salary income

Taxed at progressive rates up to 45%

Taxation as sui generis gain

Taxed at progressive rates up to 45%

Taxation as a capital gain

Taxed at progressive rates up to 45%, but application of rebate on entire gain (i.e., vesting and capital gain) if shares held for certain period: 50% if shares held at least 2 years; 65% if held more than 8 years

Same as Macron RSUs Same as Pre-Macron RSUs
Social taxes Up to 23% (same as for salary) of which approx. 20% is tax deductible 8% of which approx. 5.1% is tax deductible + 10% specific social contribution 15.5% on entire gain of which 5.1% is tax deductible

The gist of the above is that RSUs granted under the Pre-Macron regime are not very beneficial to the employee, even compared to non-qualified RSUs.  For Macron RSUs (and for Modified Macron RSUs, provided the employee does not realize more than €300,000 in annual gains), the tax treatment can be dramatically better, but only if the employee holds the shares for at least two years after vesting.

Main Requirements under Different Regimes

Various requirements have to be met to qualify for the special tax treatment under any of the French-qualified RSU regimes.  The most significant ones are as follows:

Non Qualified RSUs Pre-Macron RSUs Macron RSUs Modified Macron RSUs
Minimum Vesting Period None Two years One year One year
Minimum Holding Period None Two years from relevant vesting date Two years from grant date Two years from grant date

For Pre-Macron RSUs, this means shares generally cannot be sold any earlier than after the fourth anniversary of the grant date, as opposed to two years under the Macron and Modified Macron Regimes (exceptions may apply in the case of death or disability).  This makes the Macron and Modified Macron Regimes a lot more attractive for employees.

However, several additional requirements apply that can be difficult to administer for the issuer (e.g., closed period restriction at sale, accelerated vesting at death).  These requirements are the same under all of the different qualified RSU regimes.

Conclusion

Given all of the complexities related to the tax treatment and the requirements of qualified RSUs, it is almost impossible to say whether it is a good idea to grant qualified RSUs in France.  So much depends on the company’s circumstances, not least on the regime under which the RSUs can be granted.

However, I would generally caution companies to grant qualified RSUs, unless they have a strong stock administration team that can properly administer these awards and keep track of the many changes that have occurred.  If qualified RSUs are granted, but then not correctly administered (e.g., holding periods are disregarded), companies risk disqualifying the RSUs which can have disastrous tax consequences for both the employer and the employees (and be way worse than if the company had granted non-qualified RSUs).  Companies should also consider that disqualification can occur if awards are adjusted due to corporate transactions, with the same negative tax consequences.

Furthermore, I am not convinced that we have seen the last of the changes to the qualified RSU regimes.  As France prepares to elect a new President and usher in a new government, it is very possible that more tax reforms are on the horizon (especially if Mr. Macron wins the election…..).

On the other hand, I recognize that some companies have granted qualified RSUs for years and that changing to non-qualified RSUs can be a difficult “sell” to employees (and maybe the French employer).  Similarly, companies that are fortunate enough to be able to grant Macron RSUs may be happy to shoulder the burden of administering French-qualified RSUs in return for a flat 20% employer social tax at vesting.

So, again, every company should carefully consider whether it makes sense to grant qualified RSUs.  And, in any event, we all must stay tuned for further changes!

*That said, we are aware of a few companies that have either timed their shareholder approval to be able to rely on a specific regime (typically only possible for private companies) or that have sought shareholder approval for a French sub-plan (even though no amendments were made to the general plan).