Belgium promotes employee participation

Unlike the Anglo-Saxon countries and a number of EU countries (eg France), employee profit participation has developed very slowly in Belgium. The main reason seems to be the lack of a specific and coherent legal framework, and the absence of tax and social security incentives to promote such participation. This seems to go back to the traditional aversion of the Belgian trade unions to promoting employee participation, because it would endanger acquired rights regarding fixed remuneration and benefits in kind.

The absence of an overall legal framework does not mean that Belgian employees have been totally excluded from the benefits of employee participation in the profits or equity of the employer. However, the problem has been that, apart from a few very specific incentives, most of the participation schemes (in particular profit participation schemes) turned out to be rather unattractive from a tax and/or social security perspective.

The most popular profit scheme was, and still is, that of cash bonuses. However, cash bonuses are treated as ordinary salary from an income tax and social security perspective and are therefore not very attractive, given the rather high progressive personal income tax rates.

As far as equity participation schemes are concerned, three incentives have been introduced over the years. These include a tax deduction for funds applied in acquiring shares of the employer, a tax-exempt discount of 20% in respect of a subscription to new shares issued by the employer and tax-exempt stock options. Due to the lack of success of the tax-exempt options legislation, a completely new tax regime for share options was introduced by the Law of March 26 1999 (the Option Law), applicable to options granted on or after January 1 1999.

Apart from these specific incentives, most other participation schemes have suffered from legal uncertainty regarding the application of social security contributions (employer and employee contributions) and personal income tax at progressive rates between 25% and 55%, to be increased by local and crisis surcharges.

Milestone decisions in case law include:

• the Agfa-Gevaert case that held that dividends under a profit share scheme were salary subject to social security contributions;

• the HBK Spaarbank case that established that the nominal value of the shares in an intermediate cooperative company (pooling the employees' shares in HBK Spaarbank) obtained without consideration by the employees of HBK Spaarbank and financed by a continuity premium paid by HBK Spaarbank to the cooperative company, constitutes salary subject again to social security contributions; and

• the Colruyt case that found that the waiver by existing shareholders of bonus shares (issued in consideration for the incorporation of taxed reserves into the share capital) in favour of the employees of Colruyt constituted remuneration subject to social security contributions.

New legislative initiatives were therefore needed.

New law on employee participation

A new law on employee participation in the capital and profits of companies (the Participation Law) was enacted on May 22 2001 and was published in the Belgian State Gazette on June 9 2001. The date of entry into force is still to be determined by royal decree.

Background and philosophy

The Belgian government's aim in introducing the Participation Law is to bring Belgium in line with its neighbouring countries in respect of employee participation. Employee participation is considered a tool for increasing the active involvement of personnel in the economic and financial situation of a company and its management. It is also seen not only as an incentive to motivate employees, but also as an instrument for supporting the dynamics of acquiring and divulging information and know-how within a company, which is essential in today's information technology economy.

The Participation Law is based on the European Recommendation of July 27 1992 regarding the "Promotion of Participation by Employed Persons in Profits and Enterprise Results" and the PEPPER I and PEPPER II reports linked thereto. PEPPER II, dated January 8 1997, clearly stated that the development of financial participation in Belgium was hindered by the absence of a coherent and specific legal framework and by the lack of tax incentives. The basic criteria of the Recommendation and the PEPPER reports have served as inspiration for the drafting of the Participation Law, in that:

• the employee participation plan must be introduced on a voluntary basis at the company level;

• the plan must be the result of collective negotiation between employer and employees;

• the plan must be presented to all employees of the company as a collective incentive for the entire work force;

• the plan must provide for a predetermined formula reflecting the links with the company; and

• profit participation is not a substitute for salary, but an additional income.

A governmental working group, chaired by university professor Dr Paul De Grauwe (the De Grauwe Working Group), was created to develop the fundamentals of the statutory framework for employee profit participation. The Participation Law largely adopted the conclusions of the final report of the De Grauwe Working Group published in March 2000. The Working Group added two principles to the above five criteria:

• profit participation is not treated as salary under current law and is therefore excluded from the tax and social security regime of salary; and

• employees of a company or relevant group will be entitled to receive either participation in the capital or cash participation or both in the ratio determined in the participation plan.

The intention of the legislator was to introduce a favourable tool for promoting employee profit participation alongside existing tools and techniques. Employers are therefore free to choose whether they adopt the possibilities offered under the Participation Law, but the new tax and social security incentives (see below) only apply in the context of that law.

Profit participation

The Participation Law provides for two types of employee participation in the taxed profits of the company or the group (see below), ie a capital participation and profit participation in cash. These participation forms can be introduced as alternatives or can be combined in accordance with the rules of the Participation Law and the provisions of the participation plan. Under a capital participation, the employees receive a share in the profits of the financial year in the form of voting shares or share certificates issued or to be issued by a relevant company or affiliate. A "relevant company" is defined as the company, its subsidiaries or Belgian establishments (ie branches of foreign companies) that have implemented a participation plan.

In the case of profit participation, employees receive their share of the taxed profits in cash. In the case of participation in the capital, the shares or parts are subject to a mandatory lock-up to be determined in the specific collective bargaining agreement or deed of accession, which may not be shorter than two years or longer than five years. The shares or parts in bearer form are the object of an open deposit with a credit institution or a stockbroker company, at the choice of the employer. The shares are credited to a blocked account. Registered shares or parts are the object of a special entry in the share register of the issuing company and, where applicable, on the share certificates representing the registered securities.

The Participation Law provides for two special categories of participation: the investment savings plan and the use of a cooperative participation company.

Since participation in the capital (through the attribution of voting stock) is less suitable for small companies (ie companies of a more private and, in most cases, familial nature), the Participation Law provides for an alternative type of participation: the investment savings plan, based on a system similar to that in France. Under an investment savings plan, the employees undertake to make their participation in the profits available to the company in the form of a non-subordinated loan, which is recorded by the company under a separate item of liabilities. The principal of the loan needs to be repaid after a period of between two and five years as determined by a collective bargaining agreement or deed of accession. The loan bears an annual interest (payable within 30 days following the annual due date) to be determined in the participation plan, which may not be lower than the interest rate for linear bonds (OLOs) issued by the Kingdom of Belgium with the same tenure.

Under exceptional circumstances (such as termination of employment contract, resignation by the employee for serious cause, retirement or death of the employee, public offer of the shares, or change of control of the employer or a transfer of a going concern with change of employer under the Belgian acquired rights legislation), the non-subordinated loan is terminated early. However, no early termination occurs in the event that the company loses its status as a small company. The definition of a small company is any company with a legal personality that does not exceed, for the most recent closed financial year, one of the following criteria:

• annual average employment of 50;

• annual turnover, exclusive of value-added tax (VAT), of euro6,250,000 ($5.36 million); or

• balance sheet total of euro3,125,000.

ie the total annual average employment exceeds 100, a company does not qualify as a small company.

The proceeds of the loan have to be applied for investments in fixed assets within a period shorter than the period during which the loan is outstanding.

The second special type of participation relates to the use of an intermediate holding company to hold the share or parts in the relevant company. Employees who participate in the capital can choose to make a contribution in kind of their shares or parts, and any dividend rights attached thereto, into the capital of a cooperative participation company (CPC) with or without limited liability in return for the issue of new shares. At least three employees must contribute their shares or parts to the CPC. The new shares are again subject to a lock-up period of between two and five years, to be determined in the participation plan, subject to the same exceptions as in the case of a direct capital participation. At the end of the lock-up period or in case of its early termination, the shares in the CPC can only be transferred to the other participating employees or be nullified.

The CPC is obliged to redistribute all dividends distributed by the employing company under its shares or parts, after deduction of any management expenses. The CPC benefits from a favourable tax regime to make its interposition neutral from a tax perspective (see below).

Eligible employees

Unlike the Options Law, the Participation Law only applies to the participation of employees, ie anybody who performs work in return for remuneration under the authority of another person on the basis of an employment contract or otherwise. This means that members of the board (who are self-employed) and consultants, who can receive tax-favoured stock options, are excluded from the concessions in the Participation Law, unless they also work in an employee capacity for the company.

All employees of the company introducing a participation plan must have the possibility of enrolling in the plan. However, it is possible to provide for a minimum seniority requirement that may, in any event, not exceed one year. Successive employment contracts are lumped together for calculating the minimum seniority.

Relevant companies

Only Belgian companies that have their tax residence in Belgium and non-resident companies with a Belgian establishment (ie the Belgian equivalent of a permanent establishment under bilateral tax treaties) employing personnel in Belgium (a "company") can introduce a so-called "participation plan", ie a plan governing the participation of the relevant employees in the capital and/or profits of a company or of the group to which the company belongs, the specific rules of which are in line with the Participation Law, and are included in a collective bargaining agreement or in a deed of accession containing all specific provisions of the plan. A group is defined as a group of companies affiliated on the basis of legal or factual control or which form a consortium.

A participation plan can be introduced at the level of a specific company or at group level covering the employees of all group member companies. A group participation plan can be implemented via one or more specific collective bargaining agreements or (in the absence of a union representation) via a deed of accession. The fact that a participation plan is introduced at group level does not necessarily mean that the profits to participate in are realized at group level, instead it refers primarily to the range of employees who are eligible to participate.

Finally, only employers who are bound by a collective bargaining agreement regarding the level of the employees' remuneration for the same period of reference (as the participation plan) can introduce a participation plan for their employees.

Creation of a participation plan

The initiative for introducing a participation plan rests with the employer. The participation plan needs to be introduced via a specific collective bargaining agreement. This agreement needs to include only the obligatory terms and conditions covered by the Participation Law. However, companies without union representation can choose between a specific collective bargaining agreement or the procedure of a deed of accession. The deed of accession procedure is the object of a complicated employee consultation procedure regulated in the Participation Law, which will not be discussed in detail here.

All other terms and conditions (not covered by the Participation Law) are introduced at the initiative of the employer by the legal instrument of its choice, after obtaining the advice of the works council or, in the absence of a works council, the committee for the prevention and protection at work (the former health and safety committee) or, in the absence of such a committee, the union representation. In the absence of a union representation, the employees themselves are informed and invited to provide their comments in a special register within 15 days of the notification. Again, a rather complicated implementation procedure is provided in the Participation Law, which will not be described here.

The participation plan with the mandatory terms and conditions and the other provisions has to be notified in writing to all relevant employees. The participation plan must contain a whole range of elements enumerated in the Participation Law, including, among other things:

• where applicable, the supplementary rules regarding the calculation of seniority;

• whether participation in the plan is mandatory for the employees;

• the type of participation, which has to take the form of either cash or shares/parts, or a combination of both;

• the lock-up period for the voting shares/parts, in the case of a capital participation (see below);

• where applicable, the objective criteria for determining the individual distribution to the participating employees (this is an exception to the rule that the advantages under a participation plan must be the same for all employees. Only objective criteria can be applied for differentiating the benefits, such as function, age, seniority, working time etc);

• the method and thresholds for calculating the attributed share participations; and

• the term and method of termination of the participation plan.

A royal decree will specify which amendments may be made to the mandatory provisions of a participation plan.

When a participation plan is introduced, the employer will notify the works council or, in its absence, the committee for the prevention and protection at work or, in its absence, the union representation, on the relationship between the participation plan and its employment prospects and policy. The specific collective bargaining agreement or deed of accession must confirm that the introduction of the participation plan cannot result in a reduction of the level of employment calculated in full-time equivalents.

Furthermore, the participation plan may not replace salary, premiums, benefits in kind or any other advantage or supplement of the foregoing elements, irrespective of whether social security applies to these elements, to the extent that these are included in individual or collective agreements. This restriction does not apply to plans introduced prior to the date of entry into force of the Participation Law.

Statutory limitation

The total amount of the participations in the capital and profits attributed to the employees pursuant to the Participation Law and the participation plan may not exceed, at the end of the relevant accounting period, one of the following limits:

• 10% of the total gross salary cost; or

• 20% of the profit of the accounting period after tax, as defined in the royal decree implementing the Companies Code.

To the extent that the participation plan has been introduced at the level of the group, the profit after tax and the gross salary cost are calculated on a consolidated basis, which is determined in accordance with the terms of a royal decree to be enacted. Such limitations do not apply in respect of stock options under the Options Law.

Social security aspects

As indicated in the report of the De Grauwe Working Group, any profit participation that meets the above seven criteria should be excluded from the tax and social security treatment of ordinary salary income. This principle was adopted in the final text of the Participation Law.

By excluding the distributions of profits in cash or shares under a qualifying employee participation plan from the application of the Law of April 12 1965, the Belgian legislator achieved one of its key objectives, ie excluding profit participations from Belgian social security contributions. The exemption is complete as far as the employer's contributions are concerned (average rate of 35%). By contrast, the employee contributions (current rate of 13.07%) are only effectively set aside in respect of capital participations (in the form of shares or parts) and investment savings plans.

However, profit participations in cash are subject to a so-called "solidarity contribution" (the scope of application of this contribution is wider than that of the employee social security contribution, since it also covers participations distributed by companies that are not employing the relevant employees) at the same rate as the employee social security contributions (13.07%). This contribution has to be withheld at source by the employer (or the company bearing the economic cost of the profit distribution) and transmitted to the social security authority in the same way and within the same timeframe as the ordinary social security contributions. The reason behind this contribution on the cash participation is the intention of the government to provide incentives to employees to show an interest in, or even to participate in, the management of the relevant company or group for which they work.

The solidarity contribution is also due (ie as a component of the special tax rate of 23.29%, see below under income tax aspects), in respect of capital participations, which do not respect the above-mentioned lock-up period (ie between two and five years) for the shares or parts, and under investment savings plans introduced by small companies, in the event that the loan is not repaid within the normal terms of the loan (ie between two and five years).

Income tax aspects

Taxation of the employees

The Participation Law explicitly excludes the three types of employee profit participation (ie cash, shares or parts, and investment savings loans) for income tax purposes from professional income (ie salary income). The legislator also took the view that these benefits cannot be treated as portfolio investment income (dividends). Based on the principle that the benefits resulting from the profit participation constitute a new (sui generis) type of benefit, a new specific tax was created in the form of a lump-sum withholding tax, discharging the entire tax liability of the employees, who will not have to enter these benefits in their annual tax return.

The Participation Law introduces a new tax assimilated to income taxes applicable to the profit participation of employees in cash or in capital, which tax is levied by the employing company and borne by the participating employees. The new tax follows the principles governing the withholding tax on dividends, interest and royalties in terms of collection, payment method and enforcement. The tax includes the ordinary withholding tax on participation benefits, as well as an additional withholding tax applicable in the case of non-compliance with the lock-up of shares or parts (in cases of capital participation) or the term of the loan under an investment savings plan.

The taxable event is the actual participation in the taxed profits in the form of cash or shares.

The tax base is determined as follows:

• profit participation in cash ? the amount paid in cash, after deduction of the special solidarity contribution (of 13.07%); or

• profit participation in the capital ? the amount allocated to the participation in the capital, attributed in accordance with the annual participation plan of the company; this amount cannot be lower than:

  • for listed shares, the amount corresponding to, at the option of the company attributing the shares, the average share price during 30 days preceding the day of attribution of the shares to the employees, or the last closing price preceding the day of attribution of the shares; or

  • for non-listed shares, the fair value of the shares at the moment of their attribution, determined by the company attributing the shares in accordance with the advice of a company auditor or external accountant, appointed by the company. This value cannot be lower than the accounting value of the shares, expressed in the most recent annual accounts of the issuing company, closed and approved by the shareholders prior to the attribution date of the shares. A binding tax ruling can be requested in respect of the valuation of the attributed shares; and

• investment savings plan ? the amount attributed in cash, in accordance with the annual participation plan of the company.

In the event that the tax is borne by the debtor under the participation plan (ie the relevant company) at the discharge of the employee, then the tax is added to the tax base (gross-up).

The tax base of the additional withholding tax corresponds to that of the ordinary withholding tax, but is limited to the proportion of shares or loans (under an investment savings plan) that no longer meets the lock-up condition (see above).

The tax rate of the ordinary withholding tax varies in accordance with the type of participation:

• for capital participations ? 15%;

• for participations in cash, which are the object of non-subordinated loans under an investment savings plan ? 15%; and

• for other participations in cash ? 25%.

The tax rate for the additional withholding tax amounts to 23.29%.

The ordinary withholding tax is due at the date of attribution or declaration payment of the profit participations. The entry of the shares into an account opened for the benefit of the employee is treated as an attribution, even if the employee cannot freely dispose of the account based on an explicit or implicit agreement of the employee or on the share lock-up provisions under the Participation Law itself. The additional withholding tax is due at the time that the minimum lock-up period of the shares or parts, or the minimum term of the loans under an investment savings plan, is no longer respected.

The ordinary and the additional withholding tax are both levied by way of a deduction at source applied by the company employing the participating employees, except for the additional withholding tax in the case of a breach of the lock-up period under a capital participation, where either the bank or stock broker company or, if a CPC is interposed, the CPC needs to levy the tax. The bank or stock broker company will either sell a sufficient number of shares in the name and for the account of the employee and finance the tax with the proceeds of such sale or, alternatively, the employee will put the bank or stock broker company into funds prior to a release of the shares or parts in deposit.

The shares acquired by the employees under a capital participation will form part of their private estate as soon as the lock-up period expires. This means that any capital gains realized after that period will, as a matter of principle, remain untaxed, in the absence of any speculative intentions due to compliance with the lock-up provisions.

A final comment relates to the interest on the non-subordinated loans granted by the employees under an investment savings plan for small companies. These interest payments will attract the normal 15% withholding tax on interest, to be deducted at source by the borrowing company. This withholding discharges the entire tax liability of the employees, who will not have to enter this income in their annual tax return and will not be further taxed on the interest income.

Taxation of the employing company

The advantages granted under a profit participation plan are not deductible for tax purposes (as is the case for salary payments), since they form an attribution of profits in the same way as a dividend distribution. Technically, these benefits are included in the company's tax base as disallowed expenses.

In the event that the employer decides to bear the cost of the ordinary and/or additional withholding tax (thereby discharging the employee from his or her personal tax liability), this tax will also not be deductible for the company.

The Participation Law also provides that certain deductions, such as certain gifts, losses carried forward, the 95% dividend received deduction (ie the Belgian equivalent of the Dutch participation exemption), and the investment deduction for new investments cannot be applied in respect of that portion of profits corresponding to the disallowed expenses resulting from a profit participation plan. The reasoning behind this is that the legislator wants to make sure that the corporation tax payable on the profit participations (of which 50% is allocated to the social security system) is effectively levied, and not absorbed or exempted through the above-mentioned deductions.

In the case of an investment savings plan, any interest charges payable by the company on the non-subordinated employee loans will constitute deductible business expenses.

Any increase in the share capital resulting from the issue of new shares under a participation plan benefits from an exemption from the 0.5% capital registration duty.

Tax aspects of interposing a cooperative participation company

A CPC benefits from a special income tax base to allow a tax-neutral flow of dividends from the employing company to the participating employees holding shares in the CPC. The tax base is limited to the disallowed business expenses (other than reductions in value and capital losses on shares, which are normally not tax deductible) and the disbursements that are not justified by individual and global payment slips in respect of salaries, commission income, etc. No other deductions can be applied to this minimum tax base, in terms of losses carried forward, the 95% dividend received deduction, etc.

The contribution of their shares by the employees to the capital of the CPC is also exempted from the 0.5% capital registration duty.

Any dividends received from the employing company by the CPC will, in principle, be subject to a dividend withholding tax (not a tax assimilated to income tax) at the rate of 25% or, under certain conditions, 15%, but this withholding can be credited by the CPC against its corporation tax liability and any excess will be reimbursable to the CPC. In the case that the CPC holds 25% or more of the shares of the employing company during an uninterrupted period of one year, an exemption from dividend withholding tax will normally be available. Such dividends will not be taxable at the level of the CPC due to its limited corporation tax base. The CPC must redistribute these dividends to the participating employee-shareholders after the deduction of any management costs.

The CPC will, in turn, have to deduct a dividend withholding tax (not a tax assimilated to income tax) at source at the normal rate of 25%, or 15% in the event that the employing company could apply a 15% dividend withholding tax on the distribution to the CPC, in the absence of an exemption. This dividend withholding tax will again be the final tax, discharging the income tax liability of the participating employees, who will not have to enter these dividends into their annual tax return. This means that the use of a CPC is not entirely neutral for the participating employees, since a direct participation would always be subject to a withholding (assimilated to income taxes) of 15%, while an indirect participation via a CPC may be subject to a dividend withholding tax of 15% or 25%.

Comparative example

Below is a calculation of the net amount after social security and income tax in the hands of the employee of (i) an additional gross cash salary or bonus compared to (ii) a participation into the profits before corporation tax of euro10,000 in the form of cash, shares or an investment savings plan.

Labour law aspects

Without entering into any details, it should be noted that the Participation Law helpfully provides that the benefits resulting from a participation plan do not constitute employee remuneration for employment law purposes, which means, for example, that they are not taken into account for the calculation of severance payments in the case of dismissal of the participating employees.

Furthermore, these benefits do not enter into the calculation base for holiday pay, and do not benefit from the protection of normal employee remuneration in terms of deductions at source, payment in kind etc.

Securities law aspects

Finally, the introduction of a participation plan will not trigger the application of the public offering rules in Belgium. This means that even in the case where the plan would be targeted to more than 50 employees in Belgium (and would therefore constitute a public offering), there will be no need to notify in advance the Commission for Banking and Finance (CBF), nor will a prospectus have to be approved in advance by the CBF and be published.

Conclusions

By way of general conclusion, it can be stated that the new Participation Law has the main advantage of creating a new predictable and advantageous tax and social security system for profit participation by employees. Furthermore, it offers considerable flexibility in terms of the forms in which the employees can participate in the profits (cash and/or capital, direct or indirect capital participation, investment savings plan for small companies etc) and the level at which a plan can be introduced, ie individual companies or a group of companies.

Disadvantages of the new legislation include the rather complicated procedure for introducing and implementing a participation plan, and the fact that the Participation Law has been driven by tax and social security motives, which means that other aspects, in particular corporate aspects, are less developed and open for discussion.

Nevertheless, after the successful introduction of the Options Law in March 1999, the Participation Law forms a second milestone in Belgian law as far as the financial participation of employees is concerned.