How do employee shares work?

Employee stock ownership, also known as an ESOP (Employee Stock Ownership Plan), is a tool by which companies allow their employees to gain an ownership stake in the company through stock ownership. This benefit is particularly popular in large companies such as Google, Amazon and Microsoft, but it is also growing in popularity in smaller companies across various countries, including the Czech Republic. The aim of employee shares is to increase employee motivation, employee loyalty and strengthen their commitment to the company

Employee shares are shares in a company that an employer grants to its employees as a form of remuneration. When a company decides to give its people employee shares, it benefits for several reasons. The first is to motivate the employees, because if the employee has a share in the profits, then he himself has a greater interest in seeing the company prosper. Another thing that employee stock contributes to is a reduction in turnover. Employee shares tend to be contingent on seniority, so they have more reason to stay, even if something is not right for them. In addition, employee shares as an attractive benefit can often attract talented employees.

On the other hand, employee shares also have their drawbacks. Employees have to take the risk of loss because if the value of the shares falls, they may lose some of their finances. Setting up and administering stock plans is administratively very challenging for companies and requires advice from legal and tax professionals. In mergers and acquisitions, employee shares are sometimes converted into shares of the new company, but they may not always be worth the same amount. For example, there have been several large lawsuits in the US where employees have lost the value of their shares because of strategic decisions made by management.

What forms do employee shares take

Employee shares can take different forms. Here are the most common types:

1. Real shares – the employee receives a real share in the company. The downside is that the value of the shares can fluctuate.
2. Stock Options – Usually subject to a “vesting period” – the length of time the employee must stay with the company before the options vest. This system is popular in startup environments.
3. Restricted Stock Units (RSUs) – These shares are often enjoyed at technology companies like Google or Amazon. The shares are allocated to the employee but can only be disposed of after certain conditions are met.
4. Shadow Shares (Phantom Shares): Employees do not have actual shares, but their compensation is tied to the value of the company’s stock, simulating stock ownership
5. Profit sharing – the employee does not receive shares but shares in the company’s earnings.

For example, Google offers its employees stock options with a “vesting period”. This means that the employee earns the options after working for the company for several years. If he leaves before then, he loses his entitlement to a portion of the shares.

What is the life cycle of employee shares

The first phase is the so-called grant, where the company grants the employee the right to purchase shares in the future or to receive a share of the stock’s appreciation. This is followed by a vesting period, which is a period when the conditions for acquiring shares are gradually fulfilled. The third phase is vesting, when the employee becomes the beneficial owner of the shares or acquires the right to exercise an option. In the next stage, the employee can exercise his right and buy the shares at a predetermined price. Finally, there is shareholding, the period when the employee has full rights as a shareholder, such as the right to dividends or to sell shares.

Legal regulation of employee shares in the Czech Republic

Czech legislation allows companies to issue employee shares under the Companies Act, which provides that joint stock companies may designate part of their shares as employee shares. The relationship between employee shares and employment is usually regulated in an employment contract or a separate agreement and the Income Tax Act, in turn, determines when shares are considered taxable income.

Taxation of employee shares in the Czech Republic

Until the end of 2023, an employee’s income from employee shares was taxed at the time of acquisition or exercise of the option. This income was treated as employment income and subject to personal income tax. The employer also had to pay social security and health insurance. In the Czech Republic, for example, there were several cases in 2023 where employees had to pay tax on income from stock options even though they had not yet sold them.

However, with effect from 1 January 2024, there was a significant amendment to the Income Tax Act, which also changed the way employee shares and options are taxed. The main change is the deferral of taxation of this income until

• The employee ceases to perform a dependent activity for the employer
• The employer enters into liquidation
• The employee or the employer ceases to be Czech tax resident
• The employee sells the shares or options
• The employee exercises the option
• An exchange of shares occurs in which the total nominal value of the employee’s shares changes
• 10 years elapse from the date on which the employee acquired the share or option

This change shifts the point of taxation to when the employee actually realises the economic benefit of the shares or options, which is considered a fairer approach

The amendment has thus had several practical effects:

• Employee incentive: The deferral of taxation has increased the attractiveness of share plans because employees do not have to pay tax at a time when they have not yet received a real financial benefit
• Administrative burden: Companies must keep track of various events that may trigger taxation, which can increase the administrative burden
• Tax planning: employees and employers must carefully plan when and how to implement stock plans to optimize tax consequences.

Employee stock plans are an interesting tool that can help companies motivate employees while allowing them to share in the company’s success. The new legislation in the Czech Republic was a step towards greater fairness and support for business.

Practical advice for companies and employees

For companies: get the terms and conditions of employee shares right so that they are both motivating and legally enforceable. Think about protecting employees in the event of a sale of the company – for example, you could introduce a right to buy back shares.

For employees: when negotiating terms and conditions of employment, consider whether employee shares are beneficial to you and what the terms and conditions are. Be sure to take into account any tax implications and consult a professional before buying shares to avoid unpleasant surprises.

Summary

An employee stock ownership plan (ESOP) is a benefit that allows employees to gain an interest in a company through stock. This tool serves to motivate, increase employee loyalty and engagement. The popularity of employee stock ownership is growing not only in corporations but also in smaller companies, including the Czech Republic. Shares can take various forms, such as real shares, stock options, restricted stock units (RSUs) or shadow shares. Employees can acquire shares after a certain period of time (vesting period) when the conditions are met.

Employee shares have benefits, such as motivating employees and reducing turnover, but also risks, including a decrease in share value and administrative complexity. In the Czech Republic, legislation was changed in 2024 to postpone the point of taxation until the moment of realisation of the economic benefit (e.g. sale of shares).

Companies should get the terms right and ensure employee protection, while employees should carefully consider the terms and tax implications before purchasing shares. This change brings greater fairness and incentives for all involved.