Italy has introduced both an unfavourable and favourable change to its tax regime for stock options.
The unfavourable and retrospective change is that gains on all options exercised on or after 25 June 2008 are liable to income tax as a fringe benefit, with income tax rates of up to 43% (where overall income exceeds €75,000). Previously gains on some options could be taxed as a capital gain at a rate of only 12.5%.
However, the favourable change is that, although income tax charges will automatically apply for options exercised on or after 25 June 2008, there will now be no social security charges, whenever the option was granted.
Old rules
There have been a number of changes to the taxation of Italian stock options in recent years.
Until 4 July 2006, the exercise of stock options did not give rise to an income tax or social security charge. A capital gains tax charge was payable on sale of the shares at a rate of 12.5%, which was very favourable.
However, the position was changed on 4 July 2006. An income tax and social security charge (of up to 10% for the employee) was imposed for options exercised after that date but it was possible to avoid these charges provided that the following conditions were met:
- Options were granted by the company in which the recipient was employed, by a company which directly or indirectly controlled the employing company, or by a company which was controlled by the employing company or was under the common control of such a company;
- The exercise price per share was at least equal to the market value of the share at time of grant;
- Shares and/or other rights held by the employee did not give the employee more than 10% of voting or participation rights;
- The option had been held for at least 3 years;
- The company’s shares were listed at the time of grant; and
- The employee held a minimum number of shares for at least five years following the date of exercise. The relevant number of shares had to have a value of at least the difference between the market value of the shares at the time of grant and the exercise price paid by the employee (i.e. the gain on exercise).
These conditions were relatively easy for UK listed companies to meet, although they would have to insert specific five-year holding provisions to achieve social security savings.
Where the above conditions were not met, the employee was subject to income tax and social security contributions on the amount of the fringe benefit (calculated as the difference between the market value of the shares on the day the option was exercised and the strike price of the option). In addition, the employer had to pay social security contributions and withhold relevant taxes from the employee’s salary in the month following the date in which the gain had become taxable. To assist with this, the Italian tax authority ruled that the employee had to:
- Inform the employer (or former employer) when options were exercised and also when shares were sold; and
- Provide the employer with sufficient cash to pay the relevant income tax and employee social security contributions on the gain if they exceeded the monthly salary.
New rules
The legislation has now changed so that income tax treatment applies for all options exercised on or after 25 June 2008. Accordingly, companies may wish to consider removing provisions in option plans that were only included to obtain benefits which are no longer available. Employees can now sell all their shares immediately on exercise without triggering additional tax which in some cases they previously would not have incurred if they had held the shares for five years. As the change is retrospective, companies should also inform their employees of the changes.
On the other hand, an important (and favourable) provision has been introduced for social security contributions. Option gains arising from options exercised on or after 25 June 2008 will no longer be subject to social security contributions (payable either by the employer or employee).
