Taxation is certainly something which is important for an issuer, and you do not want these things to come as a surprise for you while the reward program is already running. This applies both to you as an issuer and to the persons you would like to grant virtual shares to (contributors/virtual shareholders).
As you are likely well aware, all tax treatment depends on individual circumstances and such treatment may also change over time along with the changes in your own business, the reward program, laws and regulations, etc. This is why we cannot know and consider all your circumstances and can discuss the potential tax considerations only generally here. Please consult with your external or in-house tax advisers for going through your circumstances and receiving appropriate tax advice.
What should you understand first?
Firstly, taxes are normally applied by governments, and they apply in a specific tax jurisdiction / country. So, you should know your country of tax residence and we believe that as you already have business activities and have recruited employees, you are paying taxes in a specific country. In some cases, countries also tax the income or revenue of non-residents.
Secondly, the design of your program determines the applicability of different taxes. For example, the purpose of a virtual share, the behaviour or activity that is rewarded, the type and residence of persons that are rewarded are all relevant for understanding which taxes may apply.
Thirdly, keep in mind also the potential tax implications on recipients. If they receive a cash payment or another benefit under or against the virtual share, they may need to declare and pay income tax on such gain or you may need to withhold a tax.
The following is provided for informational purposes only, and it does not constitute tax advice. Estonian tax laws do not specifically elaborate on the concept of (reward) virtual shares and the substance of the actual relationship / transaction underlying the virtual share should be looked into to determine the applicable taxes. The below examples describe scenarios where both the issuer and recipients are residents of Estonia.
We are working towards preparing similar overviews for other countries as well, along with the geographical expansion of our services.
Estonian residents for tax purposes are taxable on their worldwide income in Estonia. A legal person is a resident if it is established pursuant to Estonian law. European public limited companies and European associations who are registered in Estonia are also residents. All other persons are considered as non-residents and may be subject to Estonian income tax only on income sourced in Estonia. Also, the permanent establishment concept applies, which means that non-residents may become taxable on income derived from their permanent economic activity carried out in Estonia.
Depending on the design of the program, all scenarios are possible - no tax applies to the issuer, or no tax applies to the recipient, or they are both taxed or neither of them is taxed. For example, the following taxes may be relevant to consider (the list is not exhaustive):
- income and other labour taxes to be withheld and paid by the issuer in case the recipient gets the virtual share as remuneration for services provided through employment, management, services or other similar type of contract
- income and other labour taxes to be withheld and paid by the issuer in case the virtual share is considered as fringe benefit to your employee, manager, contractor, etc.
- value added tax to be paid by the issuer if the virtual share is a promotional gift with a value beyond EUR 10
- income tax to be paid by the issuer if the virtual share is considered as a gift or donation
- income tax to be withheld by the issuer if the virtual share qualifies as a debt instrument and an interest payment is made to a resident private individual.
So, if virtual shares are issued as promotional gifts as part of commercial activities with no connection to employment or similar relationship, the issuer should pay attention to taxes related to gifts. If virtual shares are issued partly or fully in relation to employment or similar relationships, the issuer should also analyse the applicability of labour taxes. If virtual shares only certify certain accomplishments or a participation in an event (e.g., a badge) probably no taxes would apply to the issue of virtual shares (or tokens as previously referred to) specifically.
Persons subject to tax obligations are also obliged to declare their tax obligations with the local tax authority. In Estonia, it is the Estonian Tax and Customs Board, see further www.emta.ee.
Declaration forms and filing deadlines are different per different taxes and types of persons. The general principle for Estonian resident individuals is that income or revenue must be declared at the point when such income is received / realized, whereas such income must be monetarily appraisable. For example, in case of virtual shares, which have no specific value at the time they are issued, there is also nothing to declare (i.e., no income tax return to be filed). But if a virtual share has a market value at the time of issue, or when the pay-out event occurs, the value must be declared accordingly.
Below are examples of how it could work in certain scenarios assuming that a respective tax applies:
The notion of “salary” generally stands for monetary remuneration received for working under the following contracts or getting monetary remuneration for the following activities:
- employment contract
- employment in the public service
- remuneration or service fees paid on the basis of a contract for services, authorization agreement or any other contract under the law of obligations
- remuneration paid by a legal person to a member of a management or controlling body.
You can read about different employment contracts at the website of the the website of the Labour Inspectorate. If a pay-out under a virtual share qualifies as a salary, then labour taxes (income tax, social tax, unemployment insurance premium, contribution to mandatory funded pension) may apply.
Please note that if a person is an employee, he/she should be registered in the employment register. You can find more information about the employment register on the webasite of the Estonian Tax and Customs Board.
A fringe benefit
Fringe benefits are any goods, services, payments in kind, or monetarily appraisable benefits that are given to an employee in connection with an employment or service relationship; membership in the management or controlling body of a legal person; or a long-term contractual relationship, regardless of the time at which the fringe benefit is granted. Fringe benefits can include, among others, free or below-market transfers of an item, financial instrument, proprietary right, or service. Generally, the value of fringe benefits is calculated based on market value.
Fringe benefits are taxable only at the level of the employer (not employee) and are subject to corporate income tax as well as social tax, with the combined effective tax rate being 66.25% on the value of the fringe benefit. Therefore, if virtual shares are granted in connection with an employment or services relationship, there is a high likelihood that they will be taxed as fringe benefits as follows:
- if the virtual share has no value at the time of issue – no taxation with fringe benefit taxes occurs at the time of issue
- if the virtual share value is known at the time of issue – fringe benefit taxes will have to be declared by the issuer on the value of the virtual share through the company`s TSD form at the latest by the 10th day of the month following the month in which the virtual share was issued
- if the value of the virtual share arises or increases by the time of pay-out to the recipient being an employee – increase in value (capital gain) will be taxable with personal income tax at the level of the employee
- if the virtual share is structured as and is accepted as an employee share option by the tax authority – issue of the virtual share will be tax exempt (even if the virtual share has value already upon grant) and potential taxation with fringe benefit taxes will occur only at exercise / redemption at the level of the issuer. However, if the virtual share qualifies for the tax exemption rule set out in § 48 (53) of the Estonian Income Tax Act, i.e., (i) will give the employee a right to acquire a share in the employee or employee’s group company, and (ii) such share is acquired not earlier than 3 years after grant, then the exercise of the virtual share will be exempt from fringe benefit taxes. Further sale of the shares underlying the virtual share/option will be taxable as capital gain at the level of the employee.
According to the Estonian law, a gift is a transaction without consideration and is given to a recipient free of charge. A gift can be monetary and in kind. From Estonian resident company’s (issuer’s) perspective, the value of the gift is generally taxable with corporate income tax, whereas, receipt of a gift by the Estonian resident individual is tax exempt. The issuer needs to be able to prove and make sure that the payment is not viewed as and is requalified into a work-related benefit, i.e., a salary or a fringe benefit.
Regarding promotional gifts, the approach is that if it is a good or service provided for advertising purposes it is not subject to taxation if the whole cost is under 10 euros (VAT excluded). You can find more information about gifts and related taxation and declaration requirements on the webasite of the Estonian Tax and Customs Boardopen in new window.
A donation is a voluntary gift in cash or in kind which does not involve consideration for the donor. Donations are taxable with corporate income tax at the level of the company (issuer) similarly to gifts.
If event or circumstances occur triggering the pay-out and the virtual share is exchanged or redeemed for a monetary value, then the amount paid should be declared through the company’s (issuer’s) TSD form and income tax is payable. There are, however, companies who are on the list of non-profit associations, foundations and religious associations with income tax relief and payments to them are not taxed to a certain extent.
You can find more information about donations and taxation on the webasite of the Estonian Tax and Customs Board.
The following is provided for informational purposes only, and it does not constitute tax advice. UK tax legislation does not specifically elaborate on the concept of (reward) virtual shares, and all the facts and circumstances of specific scenario should be considered to determine the tax consequences. The below examples describe scenarios where both the issuer and recipients are residents of the UK.
UK incorporated companies are generally treated as UK tax resident. A company is UK tax resident if it is incorporated in the UK or is centrally managed and controlled in the UK (subject to exceptions). Resident companies are taxable in the United Kingdom on their worldwide profits. If your program includes virtual shares or payments to employees in the UK, it would also be important to determine your PAYE presence in the UK.
Depending on the design of the program, all tax results are possible - the issuer is taxed, the recipient is not taxed, or they are both subject to a tax or neither of them is taxed. For example, the following taxes may be relevant to consider (the list is not exhaustive):
- income tax and social security contributions (NIC) to be withheld and paid by the issuer under the Pay As You Earn (PAYE) system in case the person is receiving a virtual share as a remuneration as an employee
- income tax and social security contributions to be paid by a self-employed individual who are granted virtual shares for their services and who do not qualify as employees. They will need to report their trading profits through the Self Assessment tax return
- income tax payable by the recipient for receiving a virtual share or proceeds under the virtual share, as miscellaneous income
- capital gains tax on the proceeds from the disposal of the virtual share to be paid by the recipient, whereas the receipt of a virtual share could be seen as a miscellaneous income.
Persons subject to tax obligations are also obliged to report their tax obligations with the local tax authority. In the UK, it is the HM Revenue & Customs (https://www.gov.uk/government/organisations/hm-revenue-customs). Reporting forms and filing deadlines are different per different taxes and types of persons. In some cases, the reporting requirement apply even if the tax withholding or payment obligation is not due or if there is no taxable amount.
Employment income and social security
An employee is taxed on all remuneration and benefits from employment received during a tax year. An employee is someone who works under an employment contract. You should carefully work out the status of the person – an employee or a self-employed individual – as your payroll tax obligations and formalities will depend on this. You can find more information about the employee status and the employment contracts on https://www.gov.uk/employment-status/employee and https://www.gov.uk/employment-contracts-and-conditions.
An employee is taxable not only on basic salary but also on benefits in kind. In case of benefits in kind, it should be further assessed if the benefit will be subject to PAYE or not.
Employers must withhold income tax and social security considerations from the remuneration of employees under the PAYE system. Where the virtual shares are issued to an employee by their employer there is a presumption that the virtual share/rights under the virtual share will be regarded as employment income. Depending on the rights assigned under the virtual share a taxable point may be at the time of award of the virtual share or at the time of receiving the rights or benefits under the virtual share.
UK resident individuals are taxable on their worldwide income and gains. Thus, if virtual shares are issued to the individual as a gift under no formal relationship, e.g., an employment, and the person expects no reward for the activity you want to thank or reward them for, then such issue or receipt of virtual shares may qualify as not taxable. If a recipient receives a pay-out under the virtual share, this may qualify as a taxable income that they need to report and pay taxes on.
If the person would be able to sell virtual shares or they will sell the share received under the virtual share, a capital gains tax should be considered on the gain of such disposal of assets.