LeXcom Law firm

The referred decision relates to the situation of a French taxpayer who was granted stock options in 1995, as an employee of Total Final SA France. This employee was further assigned to Belgium from August 1st, 1999, until August 31st, 2000. During this period he exercised part of his options, the shares subsequently acquired being immediately sold.

Afterwards, the French tax authorities noticed that the tax residence of this employee had remained in France during such assignment period and that he omitted to declare the gains derived from the sale of the shares acquired upon the exercise of the options. The corresponding amount was therefore included in the taxable income of the taxpayer for the year of the sale as a salary (the 5 years holding period, in force at that time, having not been complied with by the employee).

The Court rejects the yearly taxation principle for the taxation of the acquisition gain

The first court and the court of appeals of Versailles both decided, in accordance with their line of precedents, to include in the taxable income only the part of the acquisition gain corresponding to the time effectively spent in France by the taxpayer during the year of exercise of the options. On the contrary, the French Supreme Administrative Court refused the reference to the yearly taxation principle for the allocation of the right to tax the acquisition gain between France and Belgium. The decision of the Court is based on the following grounds:

Classification of the acquisition gain as salary for the application of the tax treaty between France and Belgium

Taking into account, on the one hand, the classification as salary of the acquisition gain when the shares are sold before the expiry of the holding period (section 80 bis of the French Tax Code), and on the other hand, article 11 of the tax treaty between France and Belgium relating to employment income, the French Supreme Administrative Court considers that the gain is only taxable as a salary in France when the activity from which the grant of stock options derived was performed on the French territory. This interpretation of article 11 of the treaty between France and Belgium is in conformity with the OECD commentaries, which state “the Article allows the State of source [the one in which the activity is performed] to tax the part of the stock-option benefit that constitutes remuneration derived from employment exercised in that State even if the tax is levied at a later time when the employee is no longer employed in that State.”

Reference to the vesting period in order to allocate the right to tax the acquisition gain

With respect to the determination of the employment services remunerated through these options, the French Supreme Administrative Court states that when the stock option plan provides that the right to exercise the options is subject to the achievement of certain conditions, the activity from which the grant of options derived is the one performed between the date of grant and the date on which the beneficiary is allowed to exercise these options. The French Supreme Administrative Court is thus referring to the notion of “vesting”, which appears in the OECD recommendations and in many French and foreign plans. According to these principles, the right to tax the acquisition gain is thus allocated between the States in which the taxpayer performed his employment activity during the vesting period, on a pro rata basis, based on the number of days worked by the beneficiary on each territory respectively. Last, the French Supreme Administrative Court explains that in the specific situation where the exercise of the options by the beneficiary is not restricted in any way by the plan, the options are considered to be granted only with respect to the activity performed at the grant date. Taxation of the whole acquisition gain is in this particular situation allocated to the State on the territory of which the employee performed his activity upon the date of grant of the options.

Conclusion

The decision of the French Supreme Administrative Court is a significant step in solving issues raised by cross border situations with respect to incentives. It seems nevertheless important to note that his decision was held, under the former writing of section 163 bis C of the French Tax Code, in a case where the holding period of the options was not met. This acquisition gain was thus, in accordance with French law, taxable as employment income. As a consequence, the question of the tax treatment of this gain remains in cases where the holding period is met. Although the additional salary nature of the acquisition gain is hardly challengeable, since it results from the actual drafting of section 80 bis of the French Tax Code, when the holding period is met, the acquisition gain remains taxed as a capital gain on sale of securities, under particular conditions and rates. The deletion of the reference to section 150-0 A by the TEPA law, dated August 21st, 2007, weakens the classification of the acquisition gain as capital gain on sale of securities; however, the threshold applicable for taxation of capital gains remains applicable. In the absence of a decision of the French Supreme Administrative Court confirming that this approach also applies in the case the holding period is met, it seems that there is still a risk that the French tax authorities would not apply the solution of the decision dated March 17, 2010, if the shares are sold after the expiration of such period. They may indeed in such cases allocate to the State of residence of the taxpayer at the date of sale of the shares the right to tax the acquisition gain, thus applying the article of the OECD Model Tax Convention on capital gains.