Stock options – the timing of the tax benefit

The Italian Tax Agency responding to a request for an official interpretation on the tax treatment of options (no. 23 of 5 February 2020) has set out its view of the moment in which stock options become taxable in the hands of employees working in Italy.

This particular stock option plan  saw the grant of options to management of companies belonging to a UK group, including an Italian group company, to participate in an incentive plan. Under the plan, management are granted the option to purchase shares of the UK holding company at a price potentially lower than the market price.

The plan in question had three stages:

1) the grant of the option right at a fixed the strike price (i.e. the price payable when the shares can be exercised;

2) vesting – the date after which and subject to conditions management may exercise their right to buy the shares

3) exercise – the date on which management actually exercise their right to purchase the shares.

In their ruling the Tax Agency identify stage 3) – the actual exercise of the rights – as the relevant date for tax purposes.

The taxable base is the difference between the “normal” (i.e. market”) value and the price paid by the employee at the time of exercise.

This decision is based on the general principle that an individual is only liable to tax generally on employment income (whether it be salary in money or benefits in kind) at the moment the benefit leaves the employer’s “financial sphere” and enters the employee’s “sphere”.

In this case it was clear that up until the moment of exercise the employee only had a future hope of obtain a benefit, depending on stock market movements.  Until vesting under the stock option plan participants are not allowed to dispose of the option rights to third parties.

The only permitted assignment  under the plan rules is to a surviving spouse and children in the vent of death of the employee   or to a bona fide trust set up for the benefit of the spouse/children and the plan made provision restricting the option rights for “bad leavers” i.e. employees whose contract of employment terminates otherwise than by the expiry of the relevant incentive period or reaching pension age.

The Tax Agency response is not controversial and confirms widespread practice in multinational groups.  It also confirms the general principal that employment income is taxable on a “received” basis.   It is necessary therefore to review the plan and determine whether restrictions on assignment of plan benefits prior to exercise truly exist.  If an employee were able to borrow money on the basis of accrued but unexercised benefits or if the employer were to be given traded stock options (i.e. options that can easily be disposed of to third parties), the analysis would be different.

Unfortunately, the Ruling does not deal with international movers (senior management are increasingly mobile), as the original request did not regrettably ask for clarification on this issue. On a strict interpretation of the concept of “received” basis, an employee working in Italy for a number of years, accruing benefits under a scheme but not actually exercising rights before they leave to go to work in another country, is not liable to Italian tax on the benefit so accrued.    On the other hand management moving to an Italian payroll from another group company with accrued benefits will be taxed in Italy when they exercise any stock option rights.  It is difficult to see how any other solution could be workable given that stock option benefits depend ultimately on market movements which are not in synch with relative periods of employment in one country or another.  Some groups do work out a notional cost to the business of providing options for the purposes or re-charging that cost to the local employer entity, and this could be used to determine the apportionment of the employee benefit.

It is possible, on the basis of another recent Tax Agency circular (albeit applicable to a different context), that the Tax Agency might prefer an apportionment on a daily basis between time spent working in Italy and time worked outside. Again, each case needs to be looked at on an individual basis.  Against the argument in favour of time apportionment is the apprehension that accrued taxable income may escape the charge to Italian tax where an employee moves abroad after a period of working in Italy.  It is likely the Agency would only accept an apportionment argument if they were satisfied that tax was being paid on the same income elsewhere.

It should be said that the Italian “receipts” based approach makes Italy country an attractive destination for senior management with extensive unrealized stock award when coupled with and 70% exemption for newly arrived impatriates and the possibility of time apportionment.

Colin Jamieson

April 2020