GLOBAL INCENTIVES INSIGHT SERIES: Czech Republic – Another amendment to the everchanging rules of ESOP taxation

Times are turbulent for the taxation of employee stock ownership plans (ESOP) in the Czech Republic. The rules relating to the acquisition of ESOP shares (including following the exercise of a non-transferable option) that only came into force from 1 January 2024 are already set to be amended back to their pre-2024 state, but with one major caveat – you can now opt-in to the regime of taxation under the 2024 ESOP tax regulation. Confusing and convoluted? Most definitely, but the newly granted liberty might be just what private companies have been waiting for.  Let’s take a closer look at what such changes mean for the stakeholders, how the opt-in process works and which regime you might prefer…

Closer look at the regulation under the current regime (2024 amendment)

The 2024 amendment to the taxation of shares acquired pursuant to an ESOP (and any related exercise of non-transferable options, which we refer to as “options” in the rest of this article for simplicity) entered into force in quite a discordant state. At first, the legislators forgot about the social security and health insurance levies, requiring further amendments in the relevant regulations for these levies. And so, the complete catalogue of taxes and levies for the current regime came into force only on 1 July 2024.

While opinions on the current regime may vary, there is one point on which most stakeholders can agree:  it is complicated, especially for employers. The current regime has employers tracking seven different moments at which the income from the ESOPs may become taxable under the social security, health insurance and income tax regulations. This complex approach was adopted in order to improve the position under the pre-2024 regulation, which could levy tax on employees before a liquidity event, meaning that the acquisition of the shares could lead to dry tax charges for employees. 

Although it may indeed be more favourable to participants in ESOPs to set the point of taxation as the point when the shares become liquid, the current regime undoubtedly placed a much greater administrative burden on the employer given their withholding obligations, the length of time employees may hold such shares before disposing of them and situations where employees cease employment with the group. In fact, we understand that some companies are choosing to pay the tax at the point when the employees acquire the shares/ exercise the options even though the current tax deferral regulation is still in force.

The current regime may also be problematic for non-tax residents of the Czech Republic. This is because one of the moments when the income arising from ESOPs becomes taxable is the moment the employee ceases to be a tax resident of the Czech Republic, and so it is unclear whether the deferral of taxation can apply to such individuals in the first place. The regulations designed to prevent double taxation for such non-tax residents might also change during the deferral period, resulting in potential double taxation (once in their country of tax residency and once in the Czech Republic at the end of the deferral period).

So, while the 2024 amendment solved some of the problems plaguing the ESOP tax regime, it also introduced new ones. The desired effect (that is, to make ESOPs more attractive for both the employers and the employees) had not been achieved.

Back to the past – new (2025) amendment

To solve the problems introduced under the 2024 amendment, the legislators have come up with a solution – return the tax regulation of ESOPs to its pre-2024 form. But this time, to prevent the recurrence of the problems under the old regulation, as well as not to alienate the stakeholders already enjoying the benefits of the new taxation regime, they decided to give the employers a choice on how to tax the options exercised/shares acquired by the employee.

From the date when the 2025 amendment comes into force, the default regime will be the original pre-2024 regime, meaning that any gain will be taxed immediately upon the employee acquiring the shares/exercising the options even if no liquidity event has occurred. However, if the employer so wishes, the point of taxation can be deferred under the regime introduced by the 2024 amendment. For this to happen, they must report their intent to defer the taxation to the Czech tax authorities no later than the twentieth day of the month following the month in which the shares were acquired/options were exercised (e.g. if the shares are acquired/options are exercised by the employee on 10 January, the opt-in must be reported by the 20 February). This must be done for each acquisition/exercise event separately, even for different share acquisitions/option exercises by the same employee. This means that the employer is not locked into one regime and each share acquisition/option exercise by an employee can be subject to different regimes. While that may be beneficial in some cases, the requirement to report each acquisition/exercise event to take advantage of the tax deferral again poses a heavy administrative burden on the employer and so we expect more employers to rely on the default regime.

This change will also affect the shares already acquired/options already exercised under ESOPs in 2024. Should the employer wish to maintain the deferral of the moment of taxation for these shares/exercised options, they must submit a notification to the Czech tax authorities no later than at the end of the second month following the entry into force of the 2025 amendment (see further below for when this date is expected to be). If the employer does not do so, the taxation regime will swap from the deferral to the default and the shares acquired/options exercised before the force of the 2025 amendment will become taxable on the day of their acquisition/exercise. As the tax obligation will be retroactively changed, the employer then must submit a corrective filing on tax advances, deduct the advance from the employee and transfer such deducted advance to the tax authorities. (The silver linings are that (1) the employer should not be charged any interest on such additional deductions and (2) although confusing, insurance and other levies should not be affected in the same way.

Which path to choose?

Now that Czech employers have a choice, how do they decide which regime is best suited to their ESOP? 

For listed companies, the choice is neither here nor there (since their shares are liquid anyway), though payroll systems should be checked to ensure no alterations are needed under the new regime.

For private companies, it is impossible to say whether one regime is strictly better than the other. Each has certain advantages but, as mentioned above, both come with certain issues. The right choice for a company will depend on its specific circumstances and the final decision should be made based on many different factors, such as the structure of the workforce, the intended aim of the company in operating an ESOP, the timeline for any potential future liquidity events and the likely preference of the employees as a whole (though we would not recommend giving employees the choice unless the company wants to open the floodgates to endless administration).

Generally, however, it seems that taxing any gain under the new default regime (that is, on acquiring the shares/exercising the options) might be considered slightly more beneficial to employers, since it comes with a much lower administrative burden. However, the short-term financial impact (especially cash-flow) of the new default regime is undesirable for employers, since employer social security and insurance levies will then be payable earlier.

ESOPs are established as tool to recruit, retain and incentivise employees, and so employers need to be mindful of turning a tool for reward into a potential financial burden with dry tax charges for employees. Should the employer choose to opt-in to the deferral regime though, they should get ready for an increased administrative burden, as well as possible issues with non-tax resident employees, where the approach is still quite uncertain and (at least before any case law is established) subject to the views of the Czech tax authorities. 

Nevertheless, the freedom to choose a tax regime is a step in the right direction and could be especially useful for international group companies wishing to align the local tax regime with that of other group companies in different jurisdictions.

Looking forward

While it is certainly a positive step that the new regulation gives the employers a choice of selecting the tax regime they want to be subject to, the solution is not quite as elegant as many would wish for. It seems that the legislators are also aware of this, and supposedly the preparation of another amendment of the ESOP tax regulation is underway. Let the merry-go-round continue!

In the meantime, Czech companies could consider structuring their shares/options so that share acquisition/option exercise only takes place when there is a liquidity event (a so-called “exit-only” share/option). However, until the Czech legislature simplify ESOP taxation and find a way to marry taxation on share liquidity with administrative ease for private companies, a more likely outcome in our view is that Czech companies will continue to avoid “real” equity incentives in favour of more flexible phantom incentives (which are essentially a cash bonus that tracks the increase in value of a company and so are taxed under the same rules as any other employee compensation, rather than under the ESOP tax regime).

Closing remarks

The 2025 amendment has been approved by the Czech Chamber of Deputies. While we do not anticipate any delays during the remaining steps in the legislative process, the date when the 2025 amendment will come into force is not yet known. Our expectation is that the 2025 amendment will come into force sometime in the second quarter of 2025. Czech companies should mark this date in their diaries if they wish to maintain the deferral of the moment of taxation for shares/ options exercised under an ESOP in 2024 (that is, before the 2025 amendment comes into force): they must submit a notification to the Czech tax authorities no later than at the end of the second month following the entry into force of the 2025 amendment.

Note: The information in this article regarding share acquisitions under an ESOP also applies to the taxation of transferable options (essentially options that can be traded in the market and which will be taxed at the point of grant under the new default tax regime, significantly different to the tax regime for non-transferrable options that is outlined above). Transferrable options are not commonly seen as a form of ESOP incentive in the Czech Republic.

Your trusted adviser

If you are considering establishing an ESOP for your Czech employees, or have questions about your existing ESOP in the context of the new tax regime and expected ongoing tax changes, please contact Ľubomír Brečka or Sarah Ferguson at [email protected] and [email protected] respectively. We would be happy to offer our expert assistance.

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