Tax Exemption for Employee Stock Options
Despite regulatory hurdles, the number of Latvia–based employees that receive stock options is constantly increasing.
In the past, stock options were typically received by the employees of Latvian companies that belonged to large international groups, and tax rules for stock options that were introduced back in 2013 were tailored with large internationals in mind.
Now the situation has changed. The main demand for stock-options comes from start-ups, as, at their early stage of development, they are typically unable to pay high or even middling salaries. Meanwhile, a number of stories about freshly minted start-up millionaires have been widely publicized.
As a result, Latvian start-up companies are increasingly eager to use the stock option tool to attract and motivate employees. We also see a growing demand for stock option plans from other small and medium–sized companies, which have good chances for growth but are at the current time unable to increase their salaries.
Under the existing regime, an employee’s income from stock options is exempt from payroll taxes in Latvia provided that: (i) the stock options were granted pursuant to a stock option plan; (ii) the holding period of the options (the period between when the option was granted and when it was exercised, i.e., by acquiring shares) is at least 36 months; (iii) during the entire period from the date of grant until the date of exercise the individual remained employed either by the company that granted the stock option or by an affiliate; and (iv) the Revenue Service is notified about the grant of stock options no later than two months from the date of grant or the date at which the employee can apply for the stock options.
The majority of start-ups and small and medium–sized companies cannot currently benefit from this tax exemption, as the vast majority of them are incorporated as limited liability companies, and the Ministry of Finance and the Revenue Service have interpreted the law to mean that the exemption is available only where the stock options are issued by a joint stock company. This applies even where the issuer of options is incorporated abroad.
Changes Under Discussion
Start-ups began calling for a less rigid regime back in 2018 and the Ministry of Economy, which is responsible for start–up policy, eventually took heed. Following heated discussions and negotiation among the industry and the public authorities, ten Members of the Parliament filed a draft bill to amend the Personal Income Tax Act.
The draft bill aims to extend the tax exemption to options issued by limited liability companies as well. The minimum holding period would be reduced from 36 months to 12 months, the rationale being that nowadays a start-up can turn an idea into a product very quickly. In addition, although currently the tax exemption is lost unless the option is exercised while the employee is still with the company which granted the stock option or an affiliate, under the draft bill options could be exercised for up to six months after employment is terminated.
The draft bill has already been adopted by the Latvian Parliament in the first reading. In order to become law, the draft must survive two more readings.
However, because the Ministry of Finance objects, the draft’s prospects are unclear. The Ministry is arguing that limited liability companies will be tempted to abuse the exemption to avoid payroll taxes. Although in Lithuania and Estonia the tax treatment of stock options is very similar to the existing Latvian regime, the other two Baltic countries allow tax exemptions in cases of stock options issued by limited liability companies.
Therefore, the Latvian Ministry of Finance faces strong headwinds in its campaign against the relaxation of the stock options regime.
This Article was originally published in Issue 7.9 of the CEE Legal Matters Magazine.