For the purposes of payroll tax, an employee’s remuneration comprises everything received in connection with their employment. This means that share options in the employer’s company granted to employees are also subject to payroll tax.
Option
An option grants the employee the right to acquire shares in the employer’s company at any time. An employee option is usually subject to the condition that the employee must still be in the employer’s service at the time of exercise.
At the time of exercise, the employee may acquire the shares by paying the exercise price, but he or she is, of course, also free to choose not to do so. In most cases, the option lapses if it is not exercised within a specified period.
Time of collection
Payroll tax is not payable at the time the employer grants the option. It is only when the employee exercises the option that payroll tax becomes payable on the benefit actually realised at that time.
In the past, the situation was the reverse. When the employee option was granted, its value had to be determined and, on that basis, the benefit taxable at that time. No income tax was payable at the time of exercise. It goes without saying that this led to disputes over how the value of the entitlement should be determined at the time the option was granted. The lower that value, the greater the tax benefit.
Advantage
The benefit subject to payroll tax is the difference between the value of the share acquired and the exercise price payable by the employee. This payroll tax is paid by the employer, but the employer recovers the tax from the employee.
Example: In 2017, an employee was granted the right to acquire a share in the employer’s company in 2019, at an exercise price of 150. In 2019, a share is worth 225. The employee exercises the option and pays the exercise price of 150, as determined in 2017. Payroll tax is payable on: 225 - 150 = 75.
If the exercise price had been zero, the taxable benefit would be: 225 - 0 = 225. However, if the exercise price is equal to the value of the shares, the employee pays: 225 and the taxable benefit amounts to: 225 -/- 225 = 0.
Start-ups and scale-ups
Employers often use employee share options or employee shares to strengthen the ties between key employees and the company. For young (innovative) companies, an additional advantage is that the granting of employee share options and the delivery or issue of shares does not come at the expense of the company’s cash flow.
One problem with start-ups and scale-ups using employee share options is that income tax must be paid when the options are exercised. The (often young) employees do not have the means to pay this income tax at that time. Their salary, part of which is paid in the form of employee share options, is not sufficient for this purpose. Furthermore, they are usually not yet able to sell shares to use the proceeds to pay the tax.
To resolve this issue, State Secretary Snel of Finance has announced that he is considering postponing the date on which payroll tax is levied to a date later than the date on which the option is exercised. If this measure is introduced, it is likely to come into effect on 1 January 2021.