Incentive program and the risk of tax authorities’ reassessment

The Head of the National Revenue Administration [KAS] has refused to issue letter of practice regarding incentive programs (ref. DKP16.8082.4.2024 and DKP16.8082.7.2024). This decision raises questions about the tax security of such solutions and potential risks for companies implementing incentive schemes.

Which incentive programs were challenged by the Head of KAS?

In both cases, the incentive program targeted company board members and involved the issuance of shares to be acquired by participants. The share issue was planned as part of one or multiple increases in the company’s share capital. The shares were offered at their nominal value – several times lower than their book value – and were to be repurchased by the company at a predetermined buyback price.

Although the Head of KAS did not challenge the concept of incentive programs itself, they concluded that the primary objective was to obtain tax benefits rather than to genuinely motivate management staff to improve company performance.

Key concerns raised by the Head of KAS

1. Lack of a clear distinction from employment income
   The programs’ structure closely resembled a variable remuneration component, on similar terms to those applied by companies in previous years.
2. Absence of investment risk
   The acquisition of shares at nominal value and their repurchase at a predetermined price (calculated based on the book value of shares determined using past financial data rather than their current market value) eliminated the risk of financial loss, and consequently, investment risk. Additionally, the Head of KAS deemed unconvincing the argument that the program aimed to attract key management personnel, as the entire first tranche of shares was allocated to the existing management team.
3. Negative impact on the company’s financial stability
   The program was to be financed from amounts accumulated in the reserve capital (funded from a portion of the companies’ supplementary capital and profits from previous years), which, in the Head of KAS’s view, could negatively impact the companies’ financial stability. The tax authority also considered it illogical to introduce an incentive program, which is in fact based on accumulated profits from previous years, and, on the other hand, the accepted practice of transferring amounts of net profit to the companies’ reserve capital every year, which would allegedly have a positive impact on their creditworthiness.

Tax benefits identified by the Head of KAS

1. Personal Income Tax (PIT)
   The program would allow participants’ income to be taxed at a preferential flat rate of 19% instead of being subject to the progressive tax rate up to 32% applicable to additional employment-related benefits or income from personal activities.
2. Corporate Income Tax (CIT)
   The program’s structure would enable payments to the ultimate beneficiary to be recognized as a tax-deductible expense for the companies — unlike dividend payments, which do not qualify as such.
3. Value Added Tax (VAT)
   The companies would have the right to deduct input VAT on invoices related to the implementation and operation of the incentive program.

Will all incentive programs be challenged?

The refusal to issue letters of practice by the Head of KAS does not automatically mean that every incentive program will be challenged by tax authorities. However, ensuring that the program is properly structured is crucial to demonstrating its genuine motivational purpose.

An appropriately structured program can effectively increase the involvement of key employees and management staff , while also enabling the use of the provisions of the PIT Act allowing tax deferral until the sale of shares.

If your company is planning to implement an incentive program and you want to ensure its tax security, our experts are here to help. Contact us today to discuss solutions tailored to your objectives.