A Belgian Court annulled the tax assessment levied by the Belgian tax authorities regarding carried interest income structured via the means of an option plan. The Belgian tax authorities claimed the setup was fraudulent and simulated and therefore the income gained at exercise of the options should be taxable as employment income.
On 27 February 2023 the Court of First Instance in Brussels confirmed the point of view of the plaintiffs that the income they earned out of the exercise of an option plan, accepted in writing within 60 days, was not taxable anymore at exercise.
In 2001 a co-investment structure was set up in which shares of so-called ‘co-investment vehicles’ (CIV) were established. Similar structures have been accepted from a tax point of view by the Belgian Tax Ruling Service.
The Belgian tax authorities claimed that there was no business risk for the plaintiffs and that plaintiffs could only have positive return. There was also no intention of the part of the plaintiffs to cooperate with the CIV in a sustainable manner. All of this led the Belgian tax authorities to conclude that the structure was fraudulent and simulated and the exercise gains should be taxed as professional income.
Simulation implies that there is an overt and a hidden reality. Participation agreements do not constitute a hidden act. The plaintiff further argued that there was as a business risk. Furthermore, there was a transfer of shares and the liquidation of the CIV was not earlier than expected. In addition, the CIVs certainly had substance and the co-investment system was based on business motives, it aimed at the bonding of the employee with the employer, and it corresponded to the economic reality.
The Court decided that the Belgian tax authorities did not demonstrate that the plaintiff had a fraudulent intent or an intention to harm. It is not proven that the plaintiff knowingly and willingly subscribed to stock options to avoid taxation of professional income via the co-investment system. The Court also found that the Belgian tax authorities failed to demonstrate that the granting of stock options via CIVs did not correspond to reality. Furthermore, the Belgian tax authorities did also not demonstrate that the construction with CIVs within the framework of the Options Act would be unrelated to the economic reality. Finally, the plaintiffs correctly reported a taxable professional income in their Belgian income tax return. As a result, the tax assessment was annulled, and no income tax was due at exercise of the options.
While the point of view of the Belgian tax authorities is not new, it is a clear indicator that the Belgian tax authorities are willing to explore different ways to tax income out of co-investment structures.
It is commonly accepted that under Belgian tax law the exercise gain cannot be taxable employment income (article 42 of the Law of 26 March 1999). As such the Belgian tax authorities (and the Ruling Service) have often tried to consider the exercise gain realised in the scope of a co-investment structured through options as taxable miscellaneous income. This however requires them to proof that the investment in options is risky. This actually depends on whether the acquisition of the options increases the average risk profile of the employee’s estate above what is reasonable for a prudent man. If not, the acquisition of the options should not be regarded as speculative and the proceeds arising from the options should then not be taxed as miscellaneous income. The mere fact that the return can be significant is thus irrelevant to assess whether the gain is taxable miscellaneous income or not.
In the above decision the Belgian tax authorities, however, argued that it concerned simulation, and the law of 26 March 1999 had to be ignored completely. The Belgian tax authorities were however unable to provide any proof of fraudulent intent or simulation. As a result, and in line with the Brepols doctrine, as the grant of the options was properly implemented and had been subject to its applicable tax treatment there was no room for the tax authorities to reclassify the spread value at exercise as employment income.
One of the arguments made by the Belgian tax authorities, namely that the option holder incurred a low risk, could further have arguably been put forward to defend that the acquisition of these options was not to be considered as speculative and thus that the option related proceeds could not be taxed as miscellaneous income, but this was not in scope of the court decision.