Employee retention through employee participation with SARs

Participation is becoming increasingly popular as a means of motivating employees and committing them to the long-term goals of a company. An attractive option within employee ownership is the Stock Appreciation Right (SAR), which allows employees to benefit from the increase in value of the company without actually acquiring shares. These “virtual shares” offer both tax benefits for the employer and a financial advantage for the employee, without dilution of shares or loss of control for existing shareholders.

In this article, we explain how a SAR scheme works, what the advantages and disadvantages are, and which tax points are important for both employers and employees.

What is a Stock Appreciation Right (SAR)?

A SAR is a form of long-term compensation for employees, where they are entitled to a monetary amount based on the increase in value of the company’s shares. Unlike stock options or Restricted Stock Units (RSUs), a SAR does not give the employee ownership rights in the company, but it does give the employee a financial advantage when the value of the shares increases. As a result, control is retained by the current shareholders, and there is no dilution of shares. This amount can be paid out at certain milestones, such as a profit target, sale of the company, or reaching a certain business value. The conditions are laid down in an agreement between the employer and employee.

How does a SAR work?

When a SAR is granted, a starting value for the shares is determined. If the value of the shares has increased at the time of exercise (for example, after a number of years or in the event of a company sale), the employee will receive an amount corresponding to that increase in value. This amount is considered income and is taxed in box 1 (income tax) at the time of payment.

A SAR is flexible in design: the employer can set conditions for the exercise, such as the number of years of service or the achievement of performance requirements. Taxation is only activated upon payment, which means that the employee does not pay tax until he actually receives the benefit.

Tax consequences of SARs

The tax treatment of a SAR has important implications for both the employee and the employer:

• For the employee: the payment is taxed as salary in box 1, with a tax rate of up to 49.5% (2024). This can lead to a significant tax burden;
• For the employer: the payment to the employee is deductible from the taxable profit, resulting in lower corporate income tax. For high annual wages (above €699,000 in 2024), a deduction limitation applies. The advantage of this is that the employer can enter the bonus payment as an expense, except when the employee’s salary in the year before the payment is above the deduction threshold.

Benefits of SARs

The benefits of SARs are as follows:

1. The SAR creates a direct financial stake for the employee in the company’s success, which can lead to higher motivation and engagement;
2. The employee does not have to invest in shares or take out loans to participate in the scheme;
3. The employer can impose conditions on the SAR, such as a minimum number of years of service or the achievement of specific business goals;
4. Because no new shares will be issued, the company’s ownership structure will remain unchanged and the current shareholders will retain their full ownership share;
5. Employees are not given voting rights or influence over the company’s management;
6. The costs of the SAR benefit are in principle deductible for corporate income tax, which can provide a tax advantage for the employer;
7. The payment usually does not affect the fiscal unity of the company.

Disadvantages of SARs

The disadvantages of SARs are as follows:

1. The payment from the SAR is taxed progressively in box 1. In the Netherlands, this tax rate could rise to 49.5% (2024), and the phasing out of tax credits could increase this tax burden even further;
2. The employer must have liquid assets available for the payment of the SAR at the time the employee exercises his right;
3. The valuation of the underlying stocks can be challenging, especially in companies that are not publicly traded;
4. Drawing up regulations for the SAR is essential. This must accurately record the allocation value, exercise value and term in order to avoid administrative and tax problems.

Conclusion

A SAR is an attractive tool for companies that want to reward employees based on the company’s value development, without giving them property rights. This encourages employees to commit to the long-term success of the company, without losing control of the current shareholders. The flexibility of SARs, along with the tax benefits for the employer, make it a popular choice within long-term compensation. However, the tax burden and liquidity requirements can be disadvantages for both employee and employer.

When implementing a SAR scheme, it is essential that all conditions are carefully laid out to avoid unexpected tax charges and administrative obstacles.