On 13 April, a circular letter (Dutch/French) was issued by the Belgian General Tax Administration that puts an end to a discussion that had been going on for some time with respect to the reduced valuation of stock options or warrants granted to persons who use a personal service company to deliver services.
While the informal practice of applying the lower of two valuation methods for the benefit in kind is now outlawed, the Minister of Finance implicitly tolerates the practice for the past.
1. The generally beneficial upfront taxation of stock options and warrants received by Belgian individuals
In Belgium, stock options or warrants are a frequently used employee benefit. On the one hand, they constitute an attractive incentive aligning the interests of personnel and shareholders and on the other hand, they allow to reduce the tax and social security burden on remuneration and fees paid to employees, directors/managers and consultants.
Stock options or warrants granted in the framework of a taxable professional activity carried out in Belgium are in principle taxable as a benefit in kind in the personal income tax or non-residents tax.
With respect to non-listed stock options or warrants, the law of 26 March 1999 provides a beneficial valuation of the benefit in kind. Generally speaking, the benefit is equal to a lump-sum 18% of the value of the relevant stock at the moment of the grant of the option or warrant. If some conditions are fulfilled, the benefit is reduced by half, to 9% of the value of the stock.
Finally, no social security contributions are due on stock options or warrants eligible for the above-mentioned beneficial taxation.
However, not all that glitters is gold. The abovementioned tax treatment is a gift only where the value of the stock increases and eventually a capital gain exceeding the lump-sum benefit is realized on the acquired shares. If this is not the case or if the options or warrants are forfeited before they can be exercised (for instance because of termination of the employment or consultancy agreement), the upfront taxation comes as a net loss for the beneficiary.
2. Personal service companies and stock options
It is not uncommon for Belgian managers and consultants to establish a limited liability company, generally referred to as a personal service company (“PSC”) or “management company”, which then delivers services to the client. To the extent the company’s profit is sufficiently high in order to cover the additional expenses and is not immediately forwarded as remuneration to the individual in question, this practice allows to exploit the difference between the tax rates of the corporate income tax and the personal income tax as well as the fact that no social security is due on payments to the PSC. Ultimately, the goal is to distribute the company’s profits to the individual’s private wealth at a low dividend withholding tax and free from social security contributions. Moreover, it allows to set up interesting private pension schemes.
As the service agreement is concluded between the client and the PSC and there is strictly speaking no relationship between the manager/consultant and the client, stock options or warrants should be granted to the PSC. As the law of 1999 does not apply to beneficiaries that are companies, the beneficial valuation cannot be applied and the actual value of the option or warrant is taxable corporate profit. However, that shouldn’t lead to a major problem, as it is perfectly possible for the PSC to immediately forward the stock option to the manager/consultant, thereby deducting again the acquisition value of the option. In sum, this back-to-back operation is tax neutral for the PSC and still allows to apply the beneficial lump-sum valuation of the benefit in kind at the level of the individual behind the PSC.
3. The issues: direct grants and application of the 9% lump-sum valuation
A longstanding informal practice existed whereby options or warrants were granted directly to the person behind the PSC. In the framework of this practice, the question arose what valuation rate had to be used in such situation. The 18% or the 9% rate? One of the conditions for the use of the 9% rate is that the option or warrant relates to stock of the company to the benefit of which the professional activity is exercised by the beneficiary or to the benefit of companies that have a direct or indirect participation in the former company. Bearing in mind that the options or warrants typically relate to stock of the client or a parent company of the client, this condition is not fulfilled at the level of the individual director/consultant but only at the level of the PSC. The conclusion is that the 9% rate cannot be applied, but the 18% rate must be used instead.
Confronted with this inconvenience, the Belgian General Tax Administration was contacted on a case-by-case basis. At several occasions, the tax administration confirmed the use of the 9% rate, but only where the options/warrants are granted to the “permanent representative” of a PSC that is appointed as a director, manager (zaakvoerder/gérant) or member of the management committee, management board or supervisory board of the company to the benefit of which the professional activity is exercised. Indeed, in that case, according to Article 61, paragraph 2 of the Belgian Companies Code, the permanent representative must meet the same conditions and shall be liable according to civil and criminal law as if they would carry out the mandate in their own name and on their own behalf, without prejudice to the joint and several liability of the legal person they represent, and the latter may only dismiss its permanent representative by appointing a new one.
At the same time, the Belgian Service for Advance Decisions in Tax Matters, the so-called Ruling Commission, issued binding tax rulings which explicitly required the intervention of the PSC in the grant of the options or warrants (the described back-to-back operation) and denied the application of the 9% rate.
4. Circular letter 2017/C/21 of 13 April 2017
At the end of 2016, the financial press echoed the informal practice, referring to the 9% valuation as an unexpected gift for PSCs. This led to public condemnation of the practice by a number of tax advisers, the president of the Ruling Commission and finally also by the Minister of Finance, which announced to have his administration issue a circular letter, which was published yesterday.
It first reiterates the principle that reduction by half of the valuation of the benefit in kind (the 9% rate) requires that the option or warrant relates to stock of the company to the benefit of which the professional activity is exercised by the beneficiary or to the benefit of companies that have a direct or indirect participation in the former company. Then, it confirms that from a legal and tax viewpoint, the PSC delivers the services to the client and the manager/consultant exercises its professional activity to the benefit of the PSC and not to the benefit of the client. Therefore, the condition for reduction by half of the benefit is not fulfilled, whether or not the PSC is a board member of the client.
While it emphasizes the different nature of the relationship between PSC and client and between PSC and manager, the circular letter does not explicitly require the intervention of the PSC (the back-to-back operation) in the grant of the options/warrants. This may indicate that the tax administration would continue to tolerate direct grants. It is unclear whether the Ruling Commission will align its position to that of the central tax administration. Future ruling decisions will probably shed light on this.
Finally, the circular states that it only applies to stock options or warrants that are granted after the date of its publication (13 April 2017), which may be interpreted as grandfathering the application of the 9% rate for options or warrants granted to managers/consultants using PSCs at the latest on 12 April 2017. Beneficiaries with PSCs that have been granted options/warrants in the past years and that have applied the reduced valuation should now be able to sleep on both ears.