Dutch Supreme Court further broadens participation exemption for stock options

Have you ever had to deal with (employee) stock options and related Dutch taxes? Then please keep reading!

Last Friday, 25 October 2024, the Dutch Supreme Court broadened the application of the participation exemption for stock options (link). Here is a quick overview, hopefully without too much tax jargon.

Understanding the participation exemption

Generally, Dutch companies are not taxed on income (like dividends and capital gains) from shareholdings of 5% or more in a subsidiary ("Qualifying Shareholdings") under the participation exemption regime. In the 2002 Falcons case, the Supreme Court extended this exemption to cover gains from stock options that would lead to a 5% shareholding if exercised ("Qualifying Options"). The rationale was that option holders with rights to reach this threshold are effectively in the same position as owners of Qualifying Shareholdings.

Here's where things got tricky. Under the law, if a Dutch company holds a Qualifying Shareholding for at least a year, it can still apply the participation exemption for three more years after its shareholding drops below 5% (e.g., due to dilution or sales). However, option holders with Qualifying Options did not seem to benefit from this rule if their options dropped below 5%.

The case

In 2014, a Dutch company, X BV, held an 8.5% stake in a Japanese company (i.e., a Qualifying Shareholding) and options for an additional 5% (i.e., Qualifying Options). X BV held both for more than one year. By 2017, dilution had lowered both below 5%. X BV exercised its options, sold all shares in tranches, and claimed the participation exemption. Parties agreed that the gain from the sale of (former) Qualifying Shares was exempt, as it fell within the rule's three-year term. However, the tax inspector – and later the State Secretary – argued that the gain from the exercise of (former) Qualifying Options was not exempt.

Legal proceedings and Supreme Court ruling

Initially, the court rejected X BV's claim, stating that only direct shareholdings – not options – qualified for the rule. X BV appealed. The Dutch Attorney General, an advisory body to the Supreme Court, sided with X BV, stating that various interpretations of the law do not oppose that view. The Supreme Court now ruled in favor of X BV, stating that Qualifying Options should also benefit from the three-year extension under the rule.

Who should care?

Option holders with vested options now receive the same tax treatment as if they owned the underlying shares, even in case of dilution. Previously, exercising before dilution (ideally a year prior) was advised to secure an exempt gain, though this could lead to liquidity issues. With this ruling, that urgency is reduced.

Start-ups, scale-ups, and companies considering employee option schemes may find this ruling valuable for designing incentive plans.

It also benefits companies, including personal holding companies, owning Qualifying Options by providing guidance on the optimal timing and strategy around exercising them. For companies undergoing funding rounds, this ruling is especially relevant. Dutch companies with existing Qualifying Options immediately benefit, as the ruling confirms that diluted options are still eligible from the participation exemption, reducing the prior urgency to exercise before dilution.

Our take on the ruling

We welcome this clarification. It made little sense that qualifying options could not benefit from the rule, given their similarity to direct shareholdings. That said, vesting terms can still materially impact eligibility, so each case merits careful consideration. Clear documentation is crucial to show that, at some point, the option could be exercised into a Qualifying Shareholding, as well as the precise timing of dilution, which starts the three-year dilution clock.

Let's discuss how this might impact your situation.