The French government has introduced a more favourable regime for the grant of free shares to widen employee share ownership in France. Pri...

The French government has introduced a more favourable regime for the grant of free shares to widen employee share ownership in France. Prior to this change, free shares were subject to social security contributions and recipients were subject to income tax on a progressive scale. Free shares were therefore relatively rarely awarded as options were usually more favourably treated under the French approved regime. Grants were nonetheless made to French recipients in a few cases, notably by Microsoft which replaced its stock option plan in 2003 with a free share plan and by Carrefour which granted free shares to some of its key executives in 2004.

The new rules for free shares constitute an attempt by the legislature to put into place a plan which takes account of the growing preference for free shares over options, and which has substantially the same tax treatment as the option regime.

Establishment of Plan - Shareholder Approval
The new rules have been codified in articles L.225-197-1 et seq. of the Commercial Code (Attribution d’actions gratuites) and are also contained in the 2005 Finance Act, which took effect on 1 January 2005. The procedures and requirements for granting free shares are similar in many ways to those required for French revenue approved stock options. The resolution adopting the plan (which must be authorised by shareholders if required by the parent company) must specifically deal with the following points:

- Shares must be awarded within 38 months from the date of the resolution,
- The maximum number of shares which can be awarded, which must not exceed 10 per cent of a company’s share capital,
- The minimum vesting period, i.e. the period at the end of which the recipients become owners of the shares, which must be at least two years after the award, and
- The sale restriction period, during which shares may not be sold by the recipient, which must begin at the expiry of the vesting period (see above) and which cannot be less than two years.
No French revenue authority approval is required, although any plan must be notified to the authority once the plan has been adopted. In practice, if the terms and conditions of a foreign plan do not already meet the mandatory French rules, a French law compliant sub-plan should be specifically set up.

Shares can be awarded either by the issue of new shares or by the transfer of existing shares.

Recipients
The plan can be used for employees and directors of a French company which is more than 10 per cent owned by the allocating company or which owns at least 10 per cent of the allocating company. Recipients are chosen by the board or an authorised committee. The plan does not have to be set up in favour of all employees, and companies can choose who is to receive awards, i.e. the plan can be operated on a discretionary basis, provided that the criteria for the granting of the shares are not in breach of anti-discrimination rules. Also, the amount which any individual may receive is uncapped, provided the allocation of free shares does not result (on its own or together with any other allocation of shares) in a recipient exceeding a shareholding of 10 per cent.

Terms of Awards
There can be a great deal of flexibility. Vesting conditions will normally be determined in accordance with the underlying objectives of the plan. Accordingly, if the objective is to reward future performance, these conditions will be defined in terms of goals to be met. These goals may be determined on an individual basis or by reference to a category of employees. If the aim is to ensure the continued service of recipients over a period of time, a minimum service period will be set before shares can be received. Both performance and time vesting are therefore possible.
In practice, all these conditions and the terms on which the plan will be operated will be set out in a written plan (“réglement”).

Tax Regime
Provided the above conditions are met, the tax and social security treatment will be as follows:
- No taxation or social security charges arise on the grant of the free shares or when they vest,
- At the date of the sale of the free shares, the then value of the shares is divided into:

- The “acquisition gain”, which is the fair market value of the shares when the shares vested. This gain is taxed at a rate of 30 per cent (41 per cent including social security contributions);
- Any capital gain since the shares vested (i.e. the sale proceeds less the acquisition gain) is subject to a 16 per cent tax rate (27 per cent including social security contributions).
Prior to the new legislation (and as will still apply if the relevant conditions are not met), free shares would be taxable as additional remuneration under standard employment income rules. A charge would therefore arise when the shares vest on the “acquisition gain” at the standard rates of income tax (top rate is 48 per cent) and social security charges for both the employer and employee (around 40 per cent and 20 per cent respectively for the type of employee who typically participates), leading to a combined rate of, so far as social levies are concerned, 60 per cent. This is in contrast to a combined tax rate of 41 per cent under the new plan, provided the relevant conditions are met (with no social levies).

Although this regime is very strongly modelled on the existing tax approved French stock option regime, many aspects still need to be clarified, and amendments continue to be sought in some areas.
· For example, under the approved stock option regime, an employee may sell the shares within 4 years from the date he was granted the options but still benefit from the favourable tax regime in case of:
- dismissal (although only for gains resulting from options granted more than three months before dismissal);
- retirement (although only at the initiative of the employer and only for gains resulting from options granted more than three months before retirement);
- serious invalidity; and
- death.

However, under the free share regime, no exception is currently provided for early sales except on death of the holder.

- No taxable capital gain normally arises if the aggregate value of all securities disposed of by the taxpayer and his tax household (“foyer fiscal”) in the relevant calendar year is less than €15,000. However, whether capital gains resulting from the sale of the free shares can fall within this exemption is still not clear.
- Furthermore, no provision currently deals with the case of a takeover, merger or de-merger of the allocating company. So far as a stock option plan is concerned, the law expressly specifies that such events are disregarded for tax purposes and so the exchange of shares within four years of grant of the option does not cause the favourable tax regime to be lost.
- Finally, the applicable tax regime for recipients who temporarily or permanently leave France has not yet been addressed.

Going Forward
Several key questions on the detail of the implementation of the legislation on free share plans therefore still need to be addressed. According to information currently available, these and other questions will hopefully be answered in a tax instruction to be published by the French tax authorities in November 2005. The instruction would apply to any free share awards already made, i.e. it would be retrospective.

We are already seeing interest from UK and US companies in adopting sub-plans to their existing free share plans, LTIPs or restricted stock plans so as to enable the employees and directors of their French subsidiaries to receive more tax efficient awards under them. Although commercial pressures may require companies to release shares to employees before the fourth anniversary of an award, if employees can be made to hold shares for that length of time, fairly substantial tax savings could be made under the new arrangements. Although France is not offering complete tax exemptions that are available in other countries for share plans, the relief on offer is still significant and can make share plans more attractive than cash-based remuneration.

The authors were assisted on this article by Caroline Sommer.