Since the introduction of an exemption from personal income tax related to granting share options to employees back in February 2020, employee share options have become one of the most attractive tools to motivate employees and attract or retain the best talents in Lithuania.
The legal framework surrounding employee share options in Lithuania encompasses several aspects. Below is a general legal overview of the key points concerning employee share options in Lithuania.
1. General Framework
Employee share options in the Republic of Lithuania are primarily governed by the Civil Code of the Republic of Lithuania and the Law on Companies of the Republic of Lithuania. Limited liability companies issuing share options must adhere to the relevant provisions of their corporate structure and ensure proper authorization through their corporate bodies (such as shareholder resolutions) to allocate shares or share options to employees. As per usual practice, the employee share options are implemented by preparing and approving the rules of the company’s employee advisor option pool (“ESOP Rules”) and concluding a share option agreement between the company and the employee.
ESOP Rules generally outline the terms and conditions under which share options are granted to employees and advisors. Key provisions include the grant of options, specifying eligibility, the total number of options available, and restrictions applicable for the option and shares, such as option or shares being non-transferable, non-voting etc. Also, standard ESOP Rules usually includes the bad and good leaver provisions, describes the liquidity events and defines the formal process of how the share option shall be exercised.
A typical share option agreement between the company and the employee formalizes the grant of share options pursuant to ESOP Rules. Such agreement specifies the number of options granted, the exercise price, and the vesting schedule, establishing the terms and conditions the employee shall fulfil to exercise the options. It also includes provisions regarding the non-transferability of the options, defines the procedure for exercising the option, and establishes future obligations for the employee applicable after the option is exercised (e.g. to adhere to the company’s shareholders’ agreement, to enter into voting rights transfer agreement, etc.).
2. Granting, Vesting and Exercising of Employee Share Options
Companies may grant share options to their employees under specific terms outlined in the ESOP Rules (if such are prepared and approved) and option agreements. In Lithuania, it is typical to have a pool of 5-10% of the total share capital of the Company allocated to employees for granting share options. There is no requirement to have the shares issued or transferred at the moment of granting of shares to employees.
The vesting schedule, which requires the employee to stay with the company for a certain period before the option can be exercised, is typically established in the share option agreement. Considering the requirement applicable for tax exemption (see below for this), the vesting period is usually at least 3 years.
Once the vesting period is completed, option holders may exercise their right to acquire shares in the company. This process involves the employee paying the exercise (strike) price (if any) to the company in exchange for shares. The company shall follow corporate procedures to issue the shares, such as increasing the company’s share capital, allocating shares from its own (treasury) shares, if available, or ensuring that the major shareholders transfer part of their shares.
3. Key requirements for personal income tax exemption
According to the Law on Personal Income Tax of the Republic of Lithuania, the fringe benefits from share options are exempt from personal income tax, if:
- the shares are acquired pursuant share option agreement concluded in written form. Under such agreement, the employee shall have a right, but not the obligation, to acquire shares from the employer or related party to the employer in the future at the agreed price (or gratuitously);
- the shares are acquired not earlier than 3 years from the grant date of the option. It shall be noted that tax exemption is applicable only for those options that were granted after February 1, 2020;
- the option grantor must be either the employer (i.e. a person with whom the employee (option holder) is in an employment relationship or a relationship similar in nature) or a person who is considered as the related person to the employer (e.g. person holds 25% or more of the employer’s shares);
- the object of the option agreement may only be shares of the employer or a person who is considered as the related person to the employer.
It shall be noted that it is possible to grant share options to individuals or entities who do not meet the conditions for tax benefits. For instance, options can be granted to advisors, contractors, or even legal entities. However, such share options will not qualify for the tax benefits described above and may be subject to different taxation rules. The company may choose this route for strategic reasons or to incentivize key partners, investors, or board members.
In summary, employee share options in Lithuania offer a strategic incentive for both employers and employees. However, this tool shall be well-structured from legal and tax perspective to fully achieve their benefits. Given the complexity of the regulatory and tax environment, seeking expert advice is highly recommended to maximize the effectiveness and compliance of any employee share option plan.
