The Directorate of Taxes reconsiders its position on the Kruse Smith incentive scheme
On 1 January, the Directorate of Taxes issued two statements of principle on the tax treatment of incentive programs in employment relationships. One of the statements assessed the so-called Kruse Smith model, in which the Directorate of Taxes concluded that the model could no longer be used as a basis for taxation as previously assumed.
By Morten Platou & Olav K. Eidsaa
On 28 March, the Directorate of Taxes changed its position in a new statement that can be read here. Thus, the Kruse Smith model reappears as an incentive model.
If an employee acquires shares in the employer for a consideration that is lower than the market value of the shares, the employee is taxed for the benefit of the discount at the time of acquisition. The benefit is taxed as earned income. In the Kruse Smith judgment (Rt. 2000 p. 758), the Supreme Court considered whether the acquisition of shares at nominal value (7% of the shares' fair value) should be taxed as a benefit gained from earned income. The shares were purchased on the condition that the discount at the time of acquisition had to be repaid upon later realization of the shares. If the consideration for the shares did not cover the discount at the time of acquisition, the discount at the time of acquisition only had to be repaid as far as the consideration extended. The Supreme Court concluded that no lower price had been paid at the purchase of the shares and that a sufficient financial risk had been taken for the return on the shares to be regarded as capital income (and not earned income). The Supreme Court did not take a direct position on the question of how the discount at the time of acquisition should be handled. However, the Supreme Court commented that the discount at the time of acquisition had to be regarded as a loan on which interest had to be calculated, to avoid taxation on the benefit of a tax-free loan.
Following the Supreme Court's decision, the tax authorities have issued several advance rulings based on the Kruse Smith model. The tax authorities have also stated that interest must be calculated on the discount at the time of acquisition and that any subsequent waiver of the discount at the time of acquisition entails a benefit for the employee, which is to be taxed as earned income. In practice, the model has proved to be a good solution where employees want to acquire shares in the employer company, but where the risk and liquidity burden for the employee has been an obstacle.
The practice relating to the Kruse Smith model has been more or less uniform since 2000. It was therefore surprising when the Directorate of Taxes issued a statement of principle on 1 January stating that employees who acquire shares according to the Kruse Smith model should be taxed at the time of acquisition. The Directorate of Taxes' view was that the discount at the time of acquisition could not be regarded as a loan for tax purposes, as long as the loan does not have an unconditional repayment obligation. The statement was not consistent with neither the Supreme Court ruling in the Kruse Smith case nor the subsequent administrative practice.
The statement of principle issued on 28 March replaces the statement issued on 1 January. With the statement of principle, the Directorate of Taxes changes its position. The following can be extracted from the new statement of principle:
- If the employee acquires shares at a discount at the time of acquisition, where the discount at the time of acquisition is to be repaid upon realization of the shares (according to the same model as in the Kruse Smith judgment), the discount at the time of acquisition must be considered a loan for tax purposes. Hence, the acquisition does not trigger taxation at the time of acquisition.
- Since the discount at the time of acquisition is considered as a loan, interest must be calculated on the loan to avoid taxation on the benefit of a tax-free loan. The loan will often be regarded as granted in an employment relationship. Hence, an interest rate below the standard interest rate stipulated in the regulations to the Tax Act will constitute a taxable benefit for the employee. If the loan is not granted in an employment relationship, the interest rate must be set at the market interest rate to avoid taxation.
- Dividends or gains on the sale of the shares shall in principle be taxed as income from capital, provided that the employee has taken a sufficient financial risk when purchasing the shares.
- If the discount at the time of acquisition is forgiven, the employee will be taxed for the benefit associated with remission.
- If the employee purchases the shares via a limited company, dividends or gains on the shares shall in principle be allocated to the limited company and taxed according to the participation exemption. Benefit in the event of a too low interest rate on the discount at the time of acquisition, or benefit in the event of remission of the discount at the time of acquisition, shall be allocated to, and taxed by the employee.
- The tax treatment for the employee will be the same regardless of whether the employer sells its shares to the employee, or whether the employee purchases shares from another shareholder. It does not matter whether the shares are in the employer company or another company in the group. However, some company law barriers become important when choosing a procedure, which the Directorate of Taxes does not address in the new statement.
Schjødt's tax department has assisted many clients with the establishment of various incentive programs following the Kruse Smith model and has obtained several advance rulings from the Tax Authorities regarding the scheme. We believe it is positive that the Directorate of Taxes has published a new statement of principles, which is in accordance with the Supreme Court's decision in the Kruse Smith judgment and the Tax Authorities' long-standing practice.