During the past 18 months, the French Supreme Administrative Court (Conseil d’Etat) has rendered several decisions requalifying capital gains realised by managers of companies, in the context of M&A transactions, as salary income.
While gross salaries would be subject to social security levies of approx. 45% for the employer’s part and 20% for the employee’s part, and the net salary would then be taxed up to 45% under the progressive personal income tax regime, capital gains would “benefit” from a flat taxation of 30% (including personal income tax and social contributions).
It goes without saying that practitioners have gradually developed management packages, including incentives for managers taking the form of capital gains, through a variety of legal instruments.
In three decisions on 13 July 2021, the Supreme Administrative Court stated, regarding the tax treatment of gains realised by managers, the (i) option to purchase shares exercised at a price of EUR 1 followed by the immediate resale of the shares at EUR 3; (ii) purchase of warrants at a preferential price, followed by their sale two years later to a third party; and (iii) acquisition of warrants and cross-promises to purchase and sell these warrants at terms guaranteeing the director the realisation of a gain.
The Supreme Administrative Court analysed both the gain realised on the acquisition and the gain realised on the sale as follows:
- The acquisition or subscription of stock options or warrants at a preferential price (compared with their actual value) may reveal the existence of an advantage up to the difference between the price thus paid and the value, which, when sourced essentially in the person concerned exercising their functions as a director or employee, is taxable with regard to the year of acquisition or subscription in the category of wages and salaries.
- As a principle, the net gains realised by a natural person from the sale of shares or stock warrants are taxable according to the regime of capital gains. However, if, whilst considering the conditions for realising such a gain, this gain must be regarded as acquired, not because of the transferor's status as an investor, but in return for their functions as an employee or manager, this gain is taxable as a salary in the year of the sale of the warrants or the shares.
In other decisions rendered in 2022, the Supreme Administrative Court confirmed its analytical grid and stated that:
- the subscription of a ManCo's shares was intended to involve the manager, due to their managerial functions within the group, in the sharing of the capital gain generated by the subsequent sale of the group (28 January 2022);
- the fact that the advantage in question had been granted not by the parent company of the group but by one of its subsidiaries, and one of its reference shareholders did not deprive it of the character of an incentive payment intended to reward the actual exercise of managerial functions (19 July 2022).
These decisions from the French Supreme Administrative Court generate significant risks for the existing management packages and considerable doubts when implementing new ones. A possible safe area can be found in “legally qualified” schemes (i.e. stock options, free allocation of shares (AGA) and warrants for shares of business creators (BSPCE)), but with their own limits, costs and constraints.
It goes without saying that this is not the end of the story.
Read the WTS Global Mergers & Acquisitions Newsletter here.
