Insights | September 1, 2023

The SAC hands down two positive rulings concerning employee share offerings by unlisted companies

In late June, the Finnish Supreme Administrative Court (SAC) laid down two rulings concerning employee share offerings by unlisted companies. The new rulings provide clarity on the definition of a "majority of the employees" and the basis on which the shares can be allocated among the employees.

According to ruling SAC 2023:65, the SAC held that the shares could be offered to the employees at net asset value without tax consequences in cases where the number of shares offered to each employee was dependent on the duration of their employment. In case SAC 2023:66, the SAC found that the allocation of the subscription rights among the employees on the basis of an appraisal process was appropriate, and the shares were regarded as being offered to the majority of the employees in accordance with the rules on employee share offerings by unlisted companies.

The new rules on employee share offerings by unlisted companies since 2021

Under the rules that entered into force from the beginning of 2021, an employee share offering by an unlisted employer company does not constitute a taxable benefit for the employees if the subscription price corresponds to at least the shares’ net asset value (with some adjustments). This rule is often very beneficial since the net asset value is relatively easy to define and may fall below the fair market value and/or the price paid by investors.

The share offering and the employer company need to fulfil certain criteria, which we have explained in our previous article that can be found here.

Shares must be offered to the “majority of the employees”

One of the prerequisites for the tax exemption is that the shares are offered to the majority of the employees. First, this means that the right to subscribe for shares in the company must be granted to more than 50% of the employees. In addition, the subscription rights should be allocated among the employees on appropriate grounds.

The criterion to offer shares to the majority of the employees does not require that the same number of shares are offered to each employee. Typically, the number of shares offered to each employee has been based on their annual gross salary. However, this is not the only criterion available, and it has been recognized that  other allocation criteria may be more suitable for unlisted start-ups.

According to the government’s proposal for the rules on employee share offerings by unlisted companies, the number of shares offered to the participating employees should be based on objective and uniformly defined criteria. What this means in practice is far from clear. In this regard, the SAC’s recent rulings are welcome and important precedents.

Cases SAC 2023:65 and SAC 2023:66

In case SAC 2023:65, the SAC held that the shares were regarded as having been offered to the “majority of the employees” when the number of shares offered to each employee was dependent on the duration of their employment. The SAC did not refer to the objectivity of this criterion, but considered that relevant factors to be taken into account were that no category of employees was favored or discriminated against, and that no category of employees only had the right to subscribe for a nominal number of shares compared to other categories of employees.

In case SAC 2023:66, the employees were divided up into 20 categories that were entitled to subscribe for different numbers of shares based on their roles and the value of their work performance to the company. The employees were categorized by their superiors based on feedback from other employees, and through company level calibration meetings attended by all members of management and chaired by the CFO. The final proposal was made by the leadership team to the company’s board of directors, which made the final decision.

Appropriate allocation criteria applied equally

The Finnish Tax Administration claimed that the subscription rights were not allocated to employees based on objective criteria (in accordance with the requirement presented in the government’s proposal). However, according to the SAC’s ruling, this did not prevent the tax exemption applying. The SAC emphasized that the allocation criteria were appropriate, and they were applied equally to all employees, which fulfilled the “majority of the employees” criterion.

In its reasoning in the ruling in this case, the SAC referred to the purpose of the rules, which is namely to incentivize personnel to own shares in the employer entity as well as to increase the company’s value by tying the employees to the company. The rules were not misused contrary to their purpose, for example by the company offering shares only to members of management or certain individual employees.

Indeed, the employees were divided into groups that had rights to subscribe for different numbers of shares based on an appraisal process that was applied equally to all employees. It is worth noting that companies commonly pay bonuses to their employees based on similar appraisal processes. Consequently, it would have been difficult for the SAC to come to a conclusion that such a process is not appropriate.

No need to separately justify the number of shares offered

In case SAC 2023:65, the Tax Administration argued that the number of shares offered to the employees should correspond to the value of each employee’s work performance. The SAC did not agree with this approach. Differences in the number of shares offered per category of employees did not have to be separately explained.

It is true that in case SAC 2023:66 the difference in the numbers of shares offered to employees in each category was significant: while employees in the lowest category were offered 500 shares, employees in the highest category were offered 13,000 shares. However, since the value of the shares was significant and not nominal even in the lowest group, the tax exemption was applicable and no taxable benefit arose for the subscription price that corresponded to the net asset value.

Takeaways

To summarize: based on the new rulings, the tax benefit can be considered available to the majority of employees, even if the employees are entitled to subscribe for different numbers of shares, provided that the allocation is based on appropriate criteria that are applied equally to all participating employees. The basis for this allocation can include for example the employee’s role, work contribution to the company, duration of employment, or gross salary.

The ability for companies to allocate shares on the basis of an appraisal process is important and interesting. However, the details of the process should be scrutinized to ensure they are objective. Due to the significance of the potentially adverse tax consequences, the company should ascertain in advance that the criteria to offer the shares at net asset value are met. For this purpose, the appraisal process should be described carefully to the tax authorities.

Some employees may be excluded

Another issue considered in case SAC 2023:66 was whether the provision could be applied to the employees participating in the appraisal process even if shares were also offered to employees who did not participate in the appraisal process based on their individual circumstances. The SAC considered that the exclusion of some employees from the tax regime did not prevent its application to the rest of the employees.

In case SAC 2023:66, the SAC mentioned that, out of a total of 230 employees, shares were offered to 217 employees only two of whom did not fulfil the criteria and were excluded from the tax regime. The SAC only referred to the number of employees and not the number of shares offered. Consequently, the decision left open the question of the number of shares senior management would be able to receive without jeopardizing the whole offering.

The cases are relevant to other share offerings as well

If shares are offered to the employees of a listed company or if a parent company’s shares are offered to the employees of its subsidiaries, the tax exemption referred to above (if the subscription price corresponds to the net asset value) is not applicable. However, a maximum 10% discount on the issue price compared to the fair market value of the share is tax exempt provided that the shares are offered to the majority of the employees.

The concept of a “majority of the employees” is similar when considering whether the employees can receive the 10% discount under the former rules without tax consequences (e.g. in an IPO) and when applying the tax exemption to share issues at least at net asset value based on the new rules. In this regard, the SAC’s rulings in SAC 2023:65 and SAC 2023:66 are also relevant to companies other than unlisted stand-alone companies.

We would be happy to tell you more about the new rulings and how to provide incentives to your employees efficiently.