ESOP and employee shares

Employee actions in Slovakia

We handle employee stock and the entire ESOP comprehensively from the legal side (we draft and draft the rules for the ESOP) as well as from the accounting and tax-tax side. Thus, the client can receive a comprehensive service under one roof including:

drafting the so-called. ESOP contracts;
drafting the so-called. “drawer contracts”;
Tax-tax assessment and design of a specific ESOP structure;
suggestions to minimise the risks of a possible tax audit;
the actual execution of the corporate changes; or
Establishing an ESOP structure using a foreign company.

We have been working on this topic for a long time, both by providing services to our clients and by organizing conferences and online trainings on this topic. And since we are still a young company, ESOPs are also of interest to us on a practical level.

Taxation of employee shares

The basic problem that we see in Slovakia in relation to ESOP structures is the timing of taxation. The current Income Tax Act provides for the generation of non-cash income – taxation at the time of acquisition of employee shares by the employee. There are even views that this moment is a little earlier in the case of option plans.

In any case, this concept contradicts the basic principle of taxation, which is based on the so-called “tax on the taxpayer”. “ability to pay” of the taxpayer. In other words, the acquisition of employee shares is to be taxed at a point in time when neither the employer nor the employee has cash income on which tax and levies can be paid.

In practice, therefore, there are often situations where an entrepreneur looks for ways to avoid this moment of taxation. Our task in these cases is to look for legal ways to set up the ESOP structure in a particular case in order to divert the moment of taxation to the moment of actually received cash income, possibly to reduce the rate of taxes and levies and also to minimize the risks of a possible tax audit. Finding a legal and tax-efficient structure appears, from our perspective, to be key to the use of ESOP structures.

Based on our experience, it appears that in the opposite case the entrepreneur is choosing between only two options:

not to enter the ESOP structure; or
Create an ESOP structure in a fiscally contaminated manner (i.e., illegally).

Taxation of “employee shares” in contractors

“Employing” contractors is a very common phenomenon in startups. Apart from the fact that it may be abusive conduct under the so-called ‘shvarc system’ (Labour law, including the issue of the so-called shvarcsystem ), it may also have negative tax and levy implications in terms of “ESOP taxation”. This is based on the philosophical premise that a taxpayer’s income should be subsumed into the category of activities affected by that income. In critical situations, the acquisition of shares in a company by a contractor may result in income tax and health and social insurance arrears being assessed in the annual tax return.

The ultimate tax and levy impact of the ESOP structure in question will depend on a number of factors such as:

a form of cooperation between a contractor and a company providing/facilitating a stake in a company;
the degree of the contractor’s involvement in what is happening in the company;
contractor position outside the company;
the real value of the company or its current stage of development.

Provision of employee benefits in cryptocurrencies (e.g.: security token)

In practice, it is relatively common to see the issuance of tokens as a “stake” representing some value of the platform or company on which the employee or contractor is working. Not necessarily just security tokens, but also utility tokens or some derivative thereof that attracts the potential for capital gains in the future.

The tax-deductible implications of these arrangements will depend on the particular setup of the ESOP structure. For example, the issuance of tokens and their subsequent fate (e.g.: disposition on the secondary market) can also be replicated by a downstream legal “offline” regime. In that case, the tax and levy regime replicates that applied in that parallel legal “offline” world.

For example, a structure where a company issues tokens that are backed by so called. “phantom” contracts and the income from holding tokens thus follows the same tax and the levy regime as foreseen in the relevant treaties. The liquidity of these tokens on the secondary market may not change that.

Cryptocurrencies have brought a new diversity to the legal and tax world and our role as legal, tax and accounting advisors is to be able to attribute relevant and appropriate legal, tax and levy effects to this phenomenon.

Taxation of employee options

We often see that a company first grants or sells options to its employees. Subsequently, after certain conditions are met, the employee can “convert” the option into a real share in the company. In practice, there are also various derivatives of these options, such as:

selling an option to an employee for a nominal price;
granting the option to the employee free of charge;
sale/grant of an option to an employee by a foreign group company;
sale/grant of an option to an employee by a Slovak or foreign company;
sale/grant of an option to a contractor – a natural person by a Slovak or foreign company;
sale/grant of an option to a contractor – a legal entity by a Slovak or foreign company;
sale/grant of an ESOP option to an employee and/or contractor company by a Slovak or foreign company;
foreign employees/contractors;
the moment(s) of acquisition of the share.

Since our Income Tax Act does not provide addressable rules in identifying the tax and levy frameworks for these types of ESOP structures, we must look for analogies in foreign legislation and draw on related case law and basic philosophical concepts in tax law when analyzing the tax implications.

How to fire a bad employee/”contractor”? (Bad leaver and good leaver)

The diversity of the tax and levy treatment of employee shares is further enhanced by legal complexity. In a number of ESOP structures, we deal with a variety of “bad leaver” situations that require a more sophisticated approach from a legal and practical standpoint. Relevant tax and levy implications also need to be attributed to this element “under one roof”. In this context, it is necessary to bear in mind the still distorted decision-making practice in Slovakia. On the one hand, there is a kind of protective role for judges in employment disputes, which disadvantages employers; on the other hand, there is an element of time and cost.

Therefore, “bad leaver” situations need to be prepared for preemptively in a clear, straightforward and practically enforceable language and manner.

Examples of employee actions from practice

For more information on employee events and examples from practice, please visit our website Highgate Group.