Option as a mechanism for motivating IT employees

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The financial motivation of employees is one of the topical issues today. Every year employers invent and develop new methods of employee motivation, which will help employees to get comfortable working conditions and wages.

The traditional motivation methods include:

  • benefits package;
  • bonuses based on achieved KPIs;
  • one-time annual bonus amounting to % of the company's profit;
  • other bonus systems developed by the company.

Every company strives to recruit professionals who will not just work to earn a wage but will put all their efforts into the development and growth of the business. Finding such specialists is not so easy, and keeping them in the company is even more difficult (especially if we are talking about the IT sector).

Today, the traditional ways of motivating IT specialists are not a surprise, so Ukrainian companies are trying to adopt new methods of motivation from their foreign neighbors.

IT companies in Europe and the U.S. have long practiced one of these ways - giving employees the opportunity to get a share of the company.

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What is an option and what is the purpose of such a mechanism in an IT company?

One way to get a share in a company is a share option agreement.

An option is a contractual right to repurchase shares at a reduced price in the future. Granting options to employees is often associated with the fact that the employer wants to be sure that the employee will not leave in a year or two and will work diligently to achieve the company's strategic goals.

For example, a startup is something new and uncertain in the market. A newly created company has an idea, but it has no permanent (or even any) income. That is why very often foreign startups cannot offer a specialist a salary that matches the level of large IT companies.

Therefore, for a startup to become a business giant (if we are talking about the IT sector), you need highly qualified specialists to help you achieve your goal. Specialists rarely "live long" on an idea alone. Like anyone, their needs must be covered by Maslow's hierarchy of needs, especially in terms of finances. A startup can't provide a high starting salary, but it can offer additional income in the form of a company share.

The company's benefit of providing an option:

  • one of the ways to attract highly qualified employees;
  • an incentive for the employee to work towards the company's development;
  • the employee will not leave the company within the period specified in the employment agreement.

The employee's benefit from obtaining the option:

  • motivation to work for the long term;
  • the opportunity to get a share of the company, which can bring additional income in the future.

Note: Of course, if the startup does not grow, there will be no income for the employee in the future. But it is the "rise" of the company that directly depends on the quality of employees' work and their motivation.

Today the legislation of Ukraine is not perfect in the matter of options, but the emergence of the Diia City legal regime has enshrined in the legislation some elements of English law. One of these elements is the ESOP (Employee Stock Ownership Plan) - allowing employees to own company stock.

Now the ESOP is on its way to being implemented and is only available to Diia City residents.

How do Diia City residents get the options mechanism up and running?

First: Determine the list of positions that will be available for the issuance of options and the % of possible options.

Please note! This is quite a painstaking job. The time will come when the company will have to sell shares to employees and start paying them income according to the terms of the agreement. Therefore, you should engage investment analysts, lawyers, and other specialists in advance to help predict the option shares.

Second: Determine the conditions under which the employee has the right or forfeits it in terms of acquiring the stock.

Third: Determine the period when employees will have the right to purchase stock.

Fourth: Additional conditions on the joint work of the employee and the employer in terms of options.

All of the above steps shall be specified in the option agreement and offered to the company's employees (candidates or employees).

Note: You must remember that an option is not a gift of stock, but an opportunity to purchase it at a reduced price.

For example, you signed a share option agreement with a company on the possibility of buying its shares for 0 after 3 years of cooperation (on the terms of the cooperation option plan). After 3 years, the market value of the stock could be ,000 or more, allowing the employee to earn an additional ,500 from the sale of the stock.

That is, the employee must first pay the funds for the purchase of the shares, and then benefit from their sale.

You may also like: Software Rights for an IT Startup in Ukraine.

Taxation of transactions under the startup option agreement

At the time of signing the option agreement, the current legislation does not provide for taxation of transactions involving the receipt of a future right to acquire shares.

The actual sale of shares to employees is subject to taxation. According to current law, Diia City residents must pay:

  • 18% income tax on profits (the difference between the income and its cost) received from the sale of shares (provided they are on the general tax system);

or

  • 9% income tax on income received from the sale of shares (if they switched to a special tax regime).

The employee, in turn, pays 18% personal income tax and 1.5% military tax only if he/she decides to sell the shares after they are purchased.

Important! The option cannot be sold to a sole proprietorship subject to a single tax.

If you are not a Diia City resident but want to issue options, there is an alternative for you - a phantom option or a gift option.

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Phantom option and taxes in Ukraine

Phantom option is an agreement between an employee and a company that certifies the employee's right to receive a cash "bonus" in the form of:

  • fixed amount of remuneration;

or

  • remuneration in the equivalent of % of the estimated/market value of the company.

Please note! A phantom option does not entitle the holder to purchase shares in the company, but it does allow the holder to receive additional bonus payments.

Unlike a regular option, the owners of phantom options can be both employees and sole proprietors (single taxpayers).

All terms of cooperation on phantom options must be specified in detail in the agreement.

Transactions with phantom options are performed identically:

  • payment of bonuses (for company employees);
  • payment for services received from a sole proprietorship (when services are purchased from an entrepreneur).

For the company granting phantom options, the payout amount is an expense.

And for the recipient of phantom options, the amount of proceeds is income, taxable as:

  • a receiving employee - 18% of personal income tax and 1.5% of military tax from the amount of bonus received (phantom bonus);
  • a receiving sole proprietor - 5% or 3% of the single tax (depending on the taxation system of the sole proprietor) on the amount of the payment received under the phantom agreement.

Please note! The time of recognition of income and expenses under the phantom option agreement is the date of transfer of funds.

Gift option and taxes in Ukraine

Shares donated by a company (with the right of subsequent resale) are executed under a gift option agreement. As a rule, option agreements specify the value above which the owner cannot sell the shares.

Please remember that the tax law does not recognize anything for free and requires the taxation of gift amounts.Therefore, transactions from a gifted option (for their owner) are subject to double taxation of 18% personal income tax and 1.5% military tax:

  • first time - at the moment of receipt of the gift option;
  • second time - at the time of sale of shares under the option.

Options are quite a new tool for Ukrainian entrepreneurs, but the "novelty" does not stop Ukrainian specialists. So for the last 2 years the number of companies using this mechanism in their business has only been growing.

If you are considering using an option, feel free to contact us. We will help you to answer the main question - whether it will be profitable for your company, and how to implement such a plan within the framework of the Ukrainian legislation.

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Publication date: 04/10/2022

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