When you want to retain key employees in your company, you can choose to let them participate in your company through management participation. There are several areas of concern here. One of these concerns is the possible qualification of the participations as a lucrative interest.
On April 14, 2023, the Supreme Court ruled on the lucrative interest scheme. As a result of this tax ruling, a legislative amendment has been proposed to retroactively amend the lucrative interest rule. In this article, we like to explain when the lucrative interest rule can come into play, what the consequences of a lucrative interest are and how the lucrative interest rule will change.
When does the lucrative interest rule come into play?
To avoid the imposition of payroll taxes, the managers must pay an arm's length deposit when issuing the management participations in the form of shares. That is, the managers must deposit the actual value of the shares. In order to still keep the participation interesting and affordable, in many cases it is designed in such a way that the business contribution is relatively limited, but is shared in a relatively large portion of the company's excess profits. This is called leverage. The potential returns that can be achieved from the management participations may then be disproportionate to the risks incurred by the managers in connection with the investment in the management participations.
This leverage is an important indicator of the presence of a lucrative interest. An equity interest qualifies as a lucrative interest if two conditions are met.
- Remuneration condition: there can only be a lucrative interest if the benefits from the shares are partly intended to be remuneration for work done by the manager.
- Leverage: if a disproportionate return can be achieved with a small own contribution, this is known as leverage. This is in any case the case when the management participations concern a subordinated type of shares that represent less than 10% of the total issued share capital (10% requirement).
There may also be a lucrative interest if capital rights are acquired that are economically similar or comparable to shares where such a leverage effect is involved. In the case of these economically similar capital rights, both the remuneration condition and the 10% requirement also apply. This is evident from the Supreme Court ruling of April 14, 2023.
Consequences of the lucrative interest scheme
Benefits from an equity interest are normally taxed in box 2 (if the equity interest is greater than 5%) or in box 3 (if the equity interest is less than 5%) of income tax. When the lucrative interest scheme applies, the benefits from the equity interest are taxed in box 1 of the income tax instead of in box 2 or 3.
The tax levy in box 1 can reach 49.5%. This is a high levy compared to the levy in box 2 (top rate of 31% as of 2024) and the current flat-rate levy in box 3 (in 2023 about 2% of the value of the shares). The law includes an option to avoid taxation in box 1. If the management shareholdings are held through a company in which the manager owns more than 5% of the shares and at least 95% of the benefits received from the management shareholding are distributed to private persons in the same calendar year, these benefits will be taxed in box 2 instead of in box 1.
Recently announced legislative change
In the Supreme Court ruling of April 14, 2023, the Supreme Court ruled that for the economic comparability of property rights with subordinated species shares, the 10% requirement should be followed. The question that arose here is whether loans provided by the investor to a company should be taken into account in the 10% requirement. This method of financing creates leverage, giving managers a share of the company's excess profits for a relatively small contribution.
The Supreme Court ruled in the recent ruling that in principle, loans need not be taken into account when assessing the 10% requirement. This would create a lot of room to design management participations with considerable leverage, without leading to the qualification as a lucrative interest. The State Secretary of Finance considers this undesirable and has therefore announced a legislative amendment with retroactive effect to June 26, 2023. The proposed legislative amendment provides that certain loans must also be taken into account when assessing whether the 10% requirement is met when assessing whether there is a lucrative interest. Exactly which loans these are will have to be specified in the bill that will be communicated on Budget Day. It is clear that management participations will qualify as a lucrative interest after this legislative amendment.
In conclusion
The lucrative interest rule is an important consideration when framing, for example, leveraged management shareholdings. A lucrative interest can have undesirable tax consequences. If you would like to receive more information about a lucrative interest, or would like personal advice when, for example, issuing management participations, please contact us via your relationship manager, by phone at 040 - 2 504 504 or via the contact form below.