The problem of double taxation of financial instruments granted as part of incentive schemes.
On 13 April 2016 a questionable ruling was passed by the Supreme Administrative Court (hereinafter: SAC) in a case with reference number II FSK 668/14, in which the court ruled that the exercise of stock options and restricted share units received from a company as part of an incentive scheme creates the employee's income. The employee's income is created again when the employee sells the shares. However, he or she will not be able to reduce it by the cost equal to the proceeds from converting the options to shares. In the Tax Alert below we would like to familiarise you with the discussed ruling which practically leads to double taxation of the same income.
The case in question concerned a taxpayer who was granted options for shares and Restricted Share Units (hereinafter: RSU) based on participation in a share scheme organised and financed by the company. As a result of the exercise of these financial instruments the taxpayer acquired the company's shares, thus receiving a taxable income. The dispute with the tax authority related to whether the deductible costs attributable to the taxpayer's income from subsequent sale of those shares may include the previously taxed income received at the moment of the exercise of the instrument. According to the tax authority, taxable income from the purchase of shares cannot constitute the cost at the time of their sale, as the exercise of the derivatives and the sale of securities are separate categories of income.
In the cited ruling the SAC shared the view of the tax authority and of the first instance court, ruling that the taxpayer who exercises the options for shares and then resells the securities thus obtained may not include the already taxed income from their acquisition in the costs of sale. According to the SAC, the exercise of the option for shares and RSU granted as part of an incentive scheme generates an employee's income. The employee's income is created again when the employee sells the shares. However, he or she will not be able to reduce it by the cost equal to the proceeds from converting the options to shares. In accordance with the Personal Income Tax Act (hereinafter: PITA), taxation of income from the exercise of derivatives and income from the sale of shares are two separate transactions for which the tax base is defined in a different manner. This case will require the application of article 30b of PITA which regulates the taxation of income derived from the sale of securities and directly indicates which provisions should be applied in the case of the sale of securities. Therefore, the taxpayer will not be allowed to include the previously taxed income from the exercise of derivatives in the deductible costs.
The above approach practically leads to a distortion of the concept of incentive schemes by double taxation of the income that was already generated at the time of the conversion of options for shares and RSU to securities, and its value was not recognised as deductible costs attributable to the income from the sale of securities. Up to the present, the courts have ruled that income is not generated at the time of receiving and converting the options for shares. This may be concluded from, i.a. the ruling by the Provincial Administrative Court in Gliwice of 10 December 2015, ref. I SA/Gl 784/15 or the Provincial Administrative Court in Warsaw of 28 January 2015, ref. III SA/Wa 1049/14.
In our opinion, although the discussed ruling seems to be based on the literal wording of the regulations, at the same time it leads to double taxation of the income from the exercise of derivatives. Moreover, the very taxation of the exercise of the options by acquisition of the shares may cause controversy. Although in accordance with article 17 paragraph 1 item 10 of PITA, income from the sale of derivatives and the exercise of the rights thereof is considered to constitute income from capital, at the time of the exercise of the options the income is of a virtual nature and does not result in a measurable economic benefit of the purchaser. Actual income will only appear at the time of the payment of dividend or the sale of shares. In previous rulings the courts saw the problem of double taxation in the case of incentive schemes. This ruling breaks from the uniform jurisprudence that was beneficial for the taxpayers.
Although the ruling only applies to schemes based on options for shares and RSU, we would like to sensitise you to the need to carefully analyse the implemented incentive schemes including those that are still at the planning stage. Regardless of the impact of the ruling on the jurisprudence and the approach of tax authorities, taxpayers still have an opportunity to take advantage of safe and tax-optimal incentive schemes.
If you have any questions or doubts, do not hesitate to contact us.
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