Employee Stocks Options as Bonus Payment

There are many compensation options that companies like to give to reward their highly paid employees. One of these options is the granting of employee stock options

It serves to strengthen employee’s ties to the company and provide additional motivation for the company’s success.

Stock options explained

A stock option is a security that allows the holder to buy or sell shares in a company at a predetermined price. Since these options can also be traded on the stock exchange and the security’s price performance depends on the performance of the underlying stock, it is also referred to as a derivative (derived security).

As a rule, so-called call options, i.e. stock options that entitle the holder to purchase a security, are issued to employees as bonuses. 

Articles can often be found in the press about top managers who make use of their options when leaving the company or when the share price reaches a high.

Option models

The employer grants the employee option rights to acquire shares in its own company or an affiliated company at a specific date and a predetermined price. 

Stock option models are structured differently depending on the interests involved:

  • The employee is prohibited from making any use of the option right until the exercise date.
  • The options right can be sold at any time, thus creating marketability. In most cases, a pre-emptive right of the employer is agreed upon or skimming off of the prematurely achieved capital gain in favour of the employer is stipulated.
  • The employee does not necessarily receive the right to purchase shares at the time of exercise, but the company keeps open the option of granting only a cash settlement.
  • The Company pays a cash settlement on the predetermined price for the acquisition of the shares.

How employee stock options work: Grants and vesting

Grants are how a company grants share (stock) options. In your grant, you will find all the details of your share plan, including:

  • The type or types of stock options you receive.
  • How many shares you receive
  • The exercise price (the purchase price of the shares, usually based on the market value of the shares at the time of grant)
  • The vesting schedule (when you can exercise your shares)

The process by which you become entitled to exercise your options is called vesting.

Generally, you must pass a “vesting threshold” – where companies require you to have completed a specified amount of time (normally at least one year) – before you can exercise your options.

Generally, you can only exercise options on vested shares; if you leave the company, any unvested rights revert to the company’s options pool when the options expire after you leave. 

However, some companies allow options to be exercised early, which may have certain tax advantages depending on your situation.

Why are employee stock options so attractive as a bonus payment?

For employees, stock options offer an interesting salary component. Anyone who is a bit risk-averse and has already speculated on the stock market will be delighted with such options. After all, they allow employees to earn disproportionately from the success of their own company.

However, the amount of shares that can be bought is limited and is usually dependent on salary. In addition, the stock options may be subject to a blocking period and may not be exercised or sold immediately.

From a business perspective, stock options are more favourable than direct cash payments. Since the company usually still holds an enormous proportion of its shares, it does not have to spend any money to compensate its employees, so to speak. Stock options are easy to explain and also serve as an attractive salary component for those new to the stock market.

How are stock options taxed in Spain?

The taxation of employee stock options in Spain is rather complicated, but it is an important aspect to consider when implementing a stock option plan. A company’s granting of stock options to its employees to retain and enhance employee loyalty is not yet very common in Spain.

The grant by a company to its employees of options over their shares without remuneration is not a taxable event unless the options are freely transferable, which is very rare.

Therefore, in most cases, taxation is deferred until the option is exercised and the shares are acquired. The taxable amount is the difference between the fair market value of the shares on the expiry date and the amount paid by the employee (exercise price). This amount is included in the employee’s personal income tax as non-cash compensation.

After the acquisition, the subsequent sale of the shares will result in a capital gain (loss) equal to the difference between the market price of the shares on the date of acquisition and the sale price.

This capital gain or loss will be included in savings and taxed at a reduced rate applicable to savings. However, it cannot be set off against other ordinary income in the case of a loss.

If you have any questions regarding employee stock options topic, please contact our tax advisors in Barcelona by telephone or email.

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