Italy: Taxation Of Stock Options: A Summary Of Latest Developments

Last Updated: 16 March 2000

A newsletter prepared by Salvatore di Salvatore Graham & James LLP, Milan Office

Background:

In an effort to create an effective tax treatment capable of lessening possible concern over tax avoidance relating to Stock Option Plans («SOP’s») and to also structure a tax relief which rises in tandem with employee performance, Parliamentary Decree no. 505/1999, a newly enacted law effective as of January 15, 2000, draws a distinction between two different kinds of SOP’s for employees. Guidelines issued by the Tax Authority address specific questions raised by commentators (Circular Letter no. 247/E of December 29,1999 and no. 30/E of February 25, 2000).

Discussion:

This paper summarises the main issues relating to the new regulation.

As a general comment, a broad principle which governs employment income tax («EIT») is that any fringe benefit is considered taxable in the hands of the employee when the right is fully vested and the employer retains no exercisable right over it. Therefore, the tax relief may be allowed regardless of the specific right in question (i.e. either share or option rights) since the crucial distinction between the two must be sought under the above principle. However, a key difference should be emphasised with respect to a grant of transferable option rights. Under such circumstance, the employee acquires the relevant right at the time of the grant and the fringe benefit is taxable forthwith. Moreover, with respect to transferable option rights it is worth noting that the Tax Authority guidelines have shed light on the method as to how to determine Fair Market Value («FMV»). The method is set forth in Article 9 of Presidential Decree no 917/1986. Specifically, it provides that the fair market value is to be computed according to the average prices which apply to similar goods (i.e. paragraph 3 of Article 9). However, either the relevant stock-exchange value or a specific appraisal applies when option rights are converted into securities - option rights securitisation - (i.e. paragraph 4 of Article 9).

The provision:

Subject to the fulfilment of certain conditions, the legislation allows a tax relief whereby any increase in the stock value accrued over the period during which the stock is held by the employee is taxed at the rate of 12.5% (Capital Gain Tax rate) rather than the progressive EIT rate. In addition to the above, a further tax allowance applies to "SOP’s granted in favour of all the employees".

(i) The first provision is contained in the amended Article 48(g) of Presidential Decree no 917/1996. It applies to "SOP’s granted to all the employees" to the extent that they hold the purchased stock for a minimum of three years. Under the above circumstance, the employee may take advantage of an EIT-exempt benefit in kind up to ITL 4,000,000 when purchasing stock from the employer within any fiscal year. For instance, if the employee purchases stock worth ITL 10,000,000 he or she will be taxed only on the difference between the purchase price and the EIT-exempt amount (ITL 4,000,000) (i.e. ITL 6,000,000) for EIT purposes. One should bear in mind, however, that if the three-year period condition is not fulfilled, then the exempted amount (ITL 4,000,000) will be subject to tax at the ordinary rate in the fiscal year when the resale of the stock takes place.

(ii) Under letter g bis of the amended Article 48, "SOP’s granted to specific employees" may benefit from the EIT relief as long as the stock purchase price borne by the employee at least amounts to the stock’s FMV as determined at the time the stock was offered. Nevertheless, in case the above condition is not fulfilled, the benefit will be subject to the ordinary EIT for its entire amount. For instance, assuming the stock purchase price at the time of the grant is ITL 10,000,000 and the purchase is executed at a price amounting to ITL 9,900,000. If the stock’s FMV at the time of the exercise of the right is equal to ITL 11,000,000, then the progressive EIT will apply on the entire amount of ITL 1,100,000 rather than just ITL 100,000. Moreover, the tax relief applies subject to the condition that the employee holds no more than a 10% interest in the employer’s entity.

On a different note, unlike the former tax treatment which extended the relief only to newly issued shares, the new tax treatment does not contain the same restriction. Moreover, the stock may be granted by in turn (i) the relevant employer’s entity, (ii) other entities which directly or indirectly hold a controlling interest in the employer’s entity, (iii) entities wherein the employer’s entity holds a controlling interest, and (iv) a further entity holds controlling interest in both the employer’s entities and the entities which grant the stock.

The decree also provides for rules to be applied to the transitional period for SOP’s whereby relevant rights may arise as of January 1, 1998, provided that they are exercised by January 15, 2000. The provision applies without prejudice to the old rules where more favourable to the employee (for instance, this may be the case if old SOPs were issued without resorting to newly issued shares and therefore plans were not granted any relief under the old provision).

Capital Gain Tax:

Under the above-two provisions relating to SOPs, a 12.5% rate of Capita Gain Tax («CGT») applies at the time of the stock resale on the difference between the resale price and the purchase price increased by any other sum which was previously subject to tax for EIT purposes. With reference to the first kind of "SOP’s granted to all the employees", in case the stock is sold after the three-year mandatory period for an amount equal to ITL 14,000,000, CGT will apply only on the difference between ITL 14,000,000 and ITL 10,000,000, being ITL 4,000,000 exempt and having been ITL 6,000,000 already charged for EIT purposes (see (i) above). As far as "SOPs for specific employees" are concerned, the 12.5% GGT rate will apply on the difference between the stock’s resale price and the purchase price.

Conclusion:

As a logical consequence to the recent implementation of the new tax treatment for stock option plans for employees («SOPs»), further legislation is expected to cover SOP’s for exclusive agents, directors and broadly any other categories of collaboration offered in a coordinated and continuous way. Indeed, as reported by the specialised mass media, the Chairman of The Committee of Thirty (i.e. Italian fiscal body which deals with draft of new legislation) has suggested to introduce a similar tax relief for the above mentioned categories. According to same source, the amendment should be included in the forthcoming tax legislation connected with the budget law ("Collegato Fiscale").

THE CONTENTS OF THIS PUBLICATION ARE NOT INTENDED TO PROVIDE LEGAL ADVICE THAT PERTAINS TO SPECIFIC CIRCUMSTANCES, FOR WHICH YOU SHOULD CONSULT APPROPRIATE COUNSEL.

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