New withholding tax on share-option gains

Scope of application of the system

The new section 182 A (c) of the French Tax Code states that tax will be withheld at source on “profits of French origin” made from share options, free share allocations and BSPCEs, when the shares are sold “by people who are not domiciled in France for tax purposes in the year of the sale”. Each part of this text raises a question:

• The notion of a profit of French origin:

To this day, no legal definition of this notion exists in the context of profits from share options. On the issue of salaries, the withholding tax in article 182 A of the FTC also applies to revenue of French origin, defined as salaries in payment for professional activity exercised in France. How can this definition be applied to share-option gains? The answer should normally be given in the tax circular to be published on the taxing of share-option gains in an international context. The various draft circulars in circulation for a number of years repeat in effect the principles laid down by the OECD comments on this point. A this titre, the position of the French tax authorities would be that the acquisition gain made by beneficiaries of options is only taxable in France on that part of the profits derived from an activity performed in France. In accordance with the position of the OCDE, the acquisition gain would be considered as acquired during the “vesting” period (or period of acquisition of rights over the options) applicable under the plan. The acquisition gain would therefore need to be linked with each of the countries in which the employee performed his professional activity during the vesting period, applied pro-rata according to the time spent in each country. The withholding tax under the new section 182 A (c) would therefore be applicable on the part of the acquisition gain relating to the exercise of an activity in France. For example, if the employee spent two years in France over a total vesting period of four years, half of the gain would relate to France and would therefore be taxable there.

• The question of the tax residence of the beneficiary:

The law states that the tax will be withheld at source if the beneficiaries of the gains are not resident in France for tax purposes for the year of sale. How is this to be applied when the beneficiary has changed tax residence during the course of the year? It would be more logical to base it on the date of the sale to determine when the withholding tax is actually applicable, especially since there might be several sales in the same year. Unless such an interpretation is adopted, the law would seem difficult to apply.

How the tax is withheld

Again, several questions arise on reading the rest of section 182 A (c), where it states that the tax must be withheld by “the person who pays out the sums derived from the sale of the shares”, and that the specific rates laid down in the schemes for options, free share allocations and BSPCE are applicable, unless the scheme for taxing wages and salaries has been opted for.

• The person responsible for the withholding of tax:

The responsible for withholding the tax is the person who pays out the sums derived from the sale of the shares or, if the plan does not qualify, who confirms the advantage granted or (in the case of free share allocations) hands over the shares. In practice, it will therefore be the company, or much more frequently, the bank (French or foreign) which has been made responsible for handling the plan, which must levy the tax. Remember that if the tax is not withheld, or not sufficiently, or more than a month late, a fine of € 9,000 and 5 years' imprisonment are applicable. The question of who is responsible for the payment is therefore a weighty one… Therefore banks are now in an uncomfortable position if they are appointed as responsible for withholding and paying in the tax. But they may not necessarily have the information required to implement this tax (particularly concerning the division of the employee's activities during the share vesting period). So, if the sanctions mentioned above are imposed, banks are very likely to pursue the French companies issuing the options or employing the beneficiaries whenever faulty information is to blame for the absence or inadequacy of the tax withheld. The companies involved will have to institute efficient systems for providing information to the banks managing the plans, and the efficacy of these systems will be all the more crucial when the plans are managed by foreign banks…

• The rate of the tax withheld:

The law states that the tax must be withheld and paid to the relevant tax centre before the 15th of the month following the date the sums are paid, at the rates stated by the special regime applicable to each option, each free share allocation and BSPCE. The exception is if the taxation as salaries has been opted for (if the plan does not qualify within the meaning of French law, the withholding tax still applies). Given that the tax must be paid in the year the sums are received, and that the option of asking for it to be taxed like pay or salary does not take effect until the year when the income is declared, i.e. the year following the payment, how should the person responsible for withholding the tax decide what rate to apply? Since the decision lies in the hands of the beneficiary alone, it seems difficult to allow the bank to apply the special regime on its own authority. Besides, as the rates of tax imposed on profits from options vary according to the amount of the profit, it will not be possible to determine the rate actually applicable to the overall acquisition gain (30% or 41%, respectively on sums below or above € 152,500) before the end of the year of sale, an additional difficulty arises when the shares held by one beneficiary are distributed between several banks. In this type of situation, the tax authorities will have to propose some practical solutions for applying the law, sometimes requiring a particularly flexible interpretation of it…

One final point: Article 57 of the Amending Finance Bill for 2010 states that the withholding tax is applicable to gains realised from 1 April 2011 onwards. There are two ways of interpreting this provision: either the law is referring to profits “taxable” from 1 April 2011 onwards, in which case the gains made from options taken up and shares definitively acquired before 1 April 2011 would be taxable at source, so long as the sale of the shares occurs after that date; or the law only refers to profits actually “realised” after 1 April 2011, i.e. only the options taken up and the shares finally acquired from that date onwards. This second solution appears more in line with the letter of the law. However, when it comes to options, given that the taking up of the options and the sale of the shares are very often simultaneous, businesses and banks will have very little time to put practical methods in place for applying the withholding tax, and the many uncertainties described above are not likely to make matters any simpler…