Stock Option Plans – To be or not to be (compensation)
By Isadora Varella, Maury Lobo de Athayde and Angelica Santos.
Stock-based incentives have always been a controversial topic in Brazil from the labor, social security and tax perspectives. Although there are different structures, such as Restricted Stock Units (“RSUs”) and Phantom Stocks, the main discussion in Brazil currently is if the Stock Option Plans (“SOPs”) are considered compensation or not.
SOPs are, in summary, offers made by a corporation to its employees, executives, and service providers of the right to purchase shares of the corporation (or of a company of the same group) under specific conditions (e.g., number of stocks available, price, vesting periods, etc.).
In this context, SOPs have a commercial aspect in principle. However, there are still discussions in Court about whether the amounts involved in SOPs should be reclassified as compensation, depending on the specific conditions offered to the participants, such as the purchase price and the conditions for the purchase of the stocks.
If SOPs are considered compensation, the additional costs for the company with employment charges and social security contributions in connection with the amounts involved in the SOPs could reach around 60%.
Discussions could involve the SOPs being considered part of the employees’ employment conditions, which can reduce the flexibility for the company to change the existing conditions of the plan. The employment implications also include discussion about rights at termination of employment, equal pay to equal work, among others.
The participant would also suffer a significant increase in the income tax burden, which could reach 27.5% depending on the amounts involved. Discussions also exist about the moment such income tax would be due, whether at the grant of the right to purchase the stocks, at the purchase of the stocks or at the sale of the stocks.
If SOPs are considered commercial transactions, they should be taxed as capital gains (if any) by the employees at a 15% to 22.5% rate (depending on the amount received and where is located the source of the payment – in Brazil or abroad). The income tax would only be calculated upon the stock being sold on the difference between the purchase price and the sale price of the shares. No social security contributions or employment charges would be due, and no other employment issues should exist.
Currently, there is a bill of law in Congress, which was already approved by one of the Parliament houses, specifically addressing stock option plans and indicating that such plans would have a commercial nature. Other types of stock-based compensation are not included in the wording of this bill of law.
The matter was also recently discussed in the Superior Court of Justice, which issued a binding decision that SOPs should be treated as commercial transactions and thus, income tax would not be due when the stock is purchased by the employee but only on the sale of the shares (as a capital gain). This decision only concerns income tax, but those arguments could also be used for discussions of social security contributions. Other Courts must follow this decision, but a case-by-case analysis is still recommended to verify whether the decision is applicable.
Other structures were also left out of the decision, which indicates that SOPs should not be considered compensation because they are (i) optional; (ii) not related to the work performed at the company and (iii) a commercial transaction (the stock is not given to the participants by the company) that could result in financial loss for the participants.
Labor Court decisions are usually in line with the understanding of this decision by the Superior Court of Justice, but the controversy will probably continue, as the tax authorities, on the other hand, usually have a stricter understanding of the matter, defending that SOPs should be considered as compensation.
In this context, there is plenty to see on this topic, mainly because the bill of law under review and the decision rendered by the Superior Court of Justice limited the analysis to the stock option plans, excluding other stock-based structures, which reopens the door to new discussions in administrative and judicial courts.
This bulletin is for information purposes only and should not be relied upon to obtain legal advice on any of the topics covered here. For additional information, please contact the leaders of the Labor and Tax team.
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