Serbia has recently amended the Companies’ Act to introduce a legal framework for employee stock option plans (“ESOPs“) in limited liability companies (“LLCs“). Although the Parliament passed the law on 23 December 2019, the relevant provisions enabling creation of ESOPs in LLCs will take effect on 1 April 2020.
LLC is the most popular corporate form in Serbia. Its capital consists of ownership quotas (shares) and one owner can have only one capital quota (share) in LLC.
Although the official explanations accompanying the bill emphasised that the purpose of the amendments was to enable employees and managers (as well as certain other categories of individuals closely connected to LLC, such as external consultants, sponsors etc.) to acquire shares, the law in fact opens ESOPs to any individual named as a participant in the scheme by the company.
Acquisition of shares in LLC pursuant to ESOP is explicitly exempt from the rules on financial assistance.
Reserved Treasury Share (RTS)
Shareholders of LLC wishing to set up an ESOP should first create a reserved treasury share (“RTS“). RTS is a treasury share owned by LLC and reserved for the sole purpose of implementing an ESOP, i.e. issuing options to acquire shares in the LLC. Owners can create RTS by contributing a portion of their respective fully-paid up ownership quotas to the LLC free of charge (payment by the LLC to the owner for this purpose is not permitted).
LLC may not sell or pledge RTS.
The process of RTS creation begins by a vote in the General Assembly on the resolution to create one or more RTS. A resolution to that effect requires two-third majority of the total number of votes. Dissenting shareholders cannot be forced to give up any portion of their stakes to create RTS.
RTS must be registered with the commercial register. LLC can have more than one RTS (an exception to the general rule that an owner can have only one share/quota in LLC). However, the total nominal value of all RTS may not exceed 40% of the total registered share capital of the LLC.
The maximum value of the Options issue may not exceed the nominal value of the underlying RTS. One RTS may be used for more than one issue of Options. A portion of the RTS that is not consumed for a single Options issue may be cancelled through the formal share capital reduction procedure or used for the future issues in which case it becomes “new” RTS.
LLC issues Options against RTS, as dematerialised and non-transferrable financial instruments.
Option entitles its holder to acquire, upon maturity, an ownership quota in LLC of pre-determined nominal value.
The maturity of an Option is set at the time of its issuance, in the resolution on the Options issue. The Option cannot not be exercised prior to its maturity.
Option can be exercised by payment to LLC of the option exercise price determined in the resolution of the Options issue. The law does not impose any limitations regarding the exercise price. It is unclear whether the exercise price must be paid in money or it could be paid in kind just like in case of acquisition of LLC share at the establishment or pursuant to a capital increase. In any event, in order to benefit from personal income tax exemption, the exercise price must be less than the market price of the corresponding LLC share at the time of the relevant stock option issue. It will be difficult to determine in practice the market price of share of LLC, because those shares are not publicly traded.
Stock options issued pursuant to LLC’s ESOP are strictly personal and non-transferrable, non-pledgable and uninheritable financial instruments. The successors of the deceased stock option holder are only entitled to the compensation of the market value of the LLC share which the deceases who had paid the exercise price prior to his death would have obtained as a result of the stock option exercise, had he not died in the meantime.
Issuance of stock options
The issuance of stock options is not considered a public offering. It is a special form of a private placement of financial instruments, which is arranged via the Central Registry, Depository and Clearing House of Securities in Belgrade (“CRS“).
The issuance of stock options must be covered by a resolution of the General Assembly, or, if so provided in the Memorandum of Association (“MoA“), by a resolution of the board of directors, supervisory board or, as the case may be, the issuer’s sole director.
A resolution on the issuance of stock options must contain the main terms of the issue and in particular the following:
- number of stock options being issued;
- description of the underlying RTS;
- details of individuals to whom the stock options are being issued;
- percentage of RTS that each stock option holder is entitled to acquire upon the exercise of the stock option;
- exercise price;
- payment term (which cannot be shorter than 15 days and longer than 30 days from the maturity of the stock option);
- issue date;
- maturity date;
- conditions under which the stock options may be cancelled prior to its maturity.
Each stock option issue gives the option holders of that issue equal rights with respect to the percentage of total share capital of LLC that they can acquire by exercising the option, exercise price, payment term, the issue and the maturity date, and the conditions for cancellation of stock option.
The law does not specify whether the maturity of stock option must be determined as a certain date, or it may be set as a determinable date (e.g. the end of a period triggered by the occurrence of a particular event). Given the absence of the requirement for a specific date, based on general legal principles, it should be possible to set the maturity date in the decision on the issuance of stock options as an event, i.e. as a determinable date.
The corporate resolution on the issuance of stock options is submitted to the CRS for registration in the name of individual holders. Details of the procedure of issuance, registration and deregistration of stock options should be regulated by the amendments to the Rules of Operation of the CRS.
Exercise of stock options
If the stock option is not exercised within the set deadline, or LLC wants to cancel it prior to its maturity, LLC must pass a resolution cancelling the issued stock option. Thereafter, LLC must request deletion of the cancelled options from CRS. Options are deleted from CRS also upon their exercise and conversion into LLC shares. All stock options issued on the basis of the same underlying RTS are deleted simultaneously.
The acquisition of shares in LLC pursuant to the stock options exercise is subject to the registration with the commercial register. All shares acquired against the same underlying RTS are registered simultaneously. If LLC does not file for registration, the stock option holders have the right to sue and request either the registration of the shares or compensation for the market value of the shares.
The law does not specify which documents must be filed with the commercial register in support of a request for registration of shares issued based on stock options. Arguably, the registration should be possible solely on the basis of evidence that the stock option holders have paid the exercise price to the LLC within the set deadline and the CRS’ confirmation that the stock options have been deleted from the CRS’ registry.
The existing shareholders have no pre-emption right in case of stock option exercise.
Forced acceleration in case of corporate reorganisations and voluntary winding up
Commencement of corporate reorganisation (mergers, divisions, transformations) or voluntarily winding-up accelerates the outstanding stock options which can be exercised by payment of the purchase price within maximum 40 days from the acceleration date, which is the day following the date of the relevant publication announcing the commencement of the reorganization/voluntary winding-up. Corporate reorganization or voluntary liquidation cannot be completed until the outstanding stock options are exercised and the unused portion of the underlying RTS cancelled through the formal share capital reduction procedure. In case of merger, it is not possible to exchange stock options issued by the merging company for the same type of options issued by the surviving company.
In case of compulsory liquidation of LLC, outstanding stock options are forfeited and their holders become creditors of the liquidation estate and the LLC shareholders for the market value of the shares that they would have been entitled to acquire, provided that the stock options had matured and the exercise price had been paid prior to the deletion of the company from the commercial register, or for the market value of the shares at the time of deletion of the company less the exercise price, if the exercise price had not been paid prior to deletion. It is unclear how the market value will be determined in this case in practice.
Personal income taxation under ESOP
According to Serbian Personal Income Tax Act (“PIT Act“), any in-kind benefit afforded by the employer or its related party to an employee in connection with the employment is regarded as salary and is therefore subject to payroll tax and social security contributions. Accordingly, acquisition of shares of LLC by the employees for less than market value is a taxable event. The tax base is the market value of the shares acquired in LLC, less the price paid. Payroll tax is in this case calculated and withheld by the employer.
However, acquisition of shares in LLC by employees pursuant to ESOP, in line with the amendments to the Companies’ Act discussed above, is exempt from payroll tax and consequently from social security contributions provided certain conditions are met. One of these conditions is that the employee does not sell the share acquired pursuant to the Option exercise before the expiry of two years from the acquisition date. If the employee sells the share during the two-year lock-up period, the obligation of the employer to calculate and pay on a withholding basis payroll tax and social security contributions is triggered. There may be an issue in practice regarding the fixation of the date as of which the employer is deemed to have become aware of the sale of the share by the employee. The withholding obligation is also triggered if the company redeems the shares/quotas from the employee at any time, even after the expiry of the two-year lock-up period. Furthermore, if the employee’s employment agreement terminates prior to the expiry of the two-year lock-up period as a result of the employee’s resignation, by agreement with the employer or as a result of dismissal by the employer, the tax exemption is lost and the obligation to calculate and pay tax and social contributions is triggered.
In case shares in LLC are granted to stock option holders who are not employees, the exemption from personal income tax does not apply. The acquisition of shares by non-employee would be subject to personal income tax at the rate of 20% and mandatory pension contribution at the rate of 25.5%, payable by LLC on the withholding basis. The tax base is the market value of the share acquired, reduced by 20% on the account of standard costs.
When an employee or other individual sells the share acquired by exercise of a stock option at a gain, such gain is subject to the capital gain tax. Capital gain is the difference between the selling price (or market value as assessed by the tax authority in case the selling price is lower than the market value) and the stock option exercise price (adjusted upwards for the official annual consumer price growth index), and the tax rate is 15%.