BSA and management package: risks of reclassification, tax and social security implications, PEA, and alternatives. Key points for structuring your Manpack.
Stock warrants havelong been the preferred tool of companies undergoing LBOs for structuring management packages for executive teams in order to align their interests with those of their investors.
Following tax audits conducted by the tax authorities, several recent court rulings have challenged the legality of these structures on the grounds of abuse of rights under tax law.
How have practices evolved, and what alternatives are now available?
Warrants (BSA) were long the go-to instrument for LBO management packages, thanks to their flexibility.
Today, there is a real issue around the risk that gains may be reclassified as employment income (salary), depending on the package’s terms.
As a result, market practice has shifted toward more tightly framed instruments: shares, preferred shares, free share awards (AGA), and BSPCE, with increased focus on documentation and traceability.
“Management packages,” or “manpacks,” are commonly used to align executives’ objectives with those of investors. The idea isto tie executives’ compensation to the value created for investors, thereby ensuring that executives and key managers have a tangible stake in the company’s success. Because executives generally have more limited financial resources than investment funds, their equity stake in the buyout holding company would be modest without these mechanisms.
To increase their potential for capital gains at exit, certain tools provide immediate or deferred access to equity on preferential valuation terms compared to those applied to the funds: these are management packages. To achieve this, stakeholders have a range of tools at their disposal: stock subscription warrants (BSA), common or preferred shares, warrants, options, stock options, and more.
Among this range of tools, stock subscription warrants (BSA) have long been favored by funds in the context of management packages, as they allow for adjusting executives’ equity stakes based on the achievement of objectives and thereby increasing their share of capital gains upon the sale. From a tax perspective, it was also more advantageous to opt for stock subscription warrants, which are subject to a flat tax of 30%, rather than bonuses, where capital gains were generally taxed at rates ranging from 45% to 49% for employees.
💡 Please note that granting share warrants (BSA) can generate two types of capital gains:
The tax treatment of BSA (stock subscription warrants) has undergone several major changes following decisions by the tax authorities, making them increasingly less attractive over time.
Prior to 2013, the tax authorities had attempted on several occasions to reassess the tax liability of executives of companies undergoing LBOs who had placed the components of their management packages in a PEA to benefit from the tax exemption offered by that account. However, these attempts met with little success due to the lack of case law on the matter. With the amendment to the 2013 Finance Act (Article 13, II of Law No. 2013-1279 of December 29, 2013, on the Amended Finance Act for 2013), the situation has changed drastically. Stock option warrants (BSA) subscribed to on or after January 1, 2014, are now excluded from stock savings plans (PEA).
Subsequently, the tax authorities highlighted the abuse of rights in the use of stock subscription warrants (BSA) for management compensation packages, leading to a major change in practices. In the Gaillochet ruling (Council of State, September 26, 2014, Gaillochet, No. 365573), the Council of State clearly established that gains obtained through preferential terms, without significant risk-taking or an investment deemed substantial, must be considered a financial benefit and taxed as such. In a document published in April 2015, titled “Map of Abusive Practices and Arrangements,” the Directorate General of Public Finance reinforced this point by noting that management packages “are not systematically fraudulent, ” but may lead to “unduly benefiting from the advantages associated with the tax regime for capital gains on the sale of securities.” Since the Gaillochet ruling and the publication of the “tax radar map,” the issue oftaxing gains from management packages has remained a major focus, both for the courts and the Committee on Abuse of Rights.
Several decisions by administrative courts concerning management packages structured as stock options (BSA) and preferred shares (Paris Administrative Court, July 12, 2016, No. 1431589, Mr. and Mrs. C) have been issued in line with these developments. The main point of these decisions was to inform the tax authorities that reclassifying a manager’s profit as salary requires proof of the existence of a salary benefit. This benefit may take the form of either subscribing to management package instruments at a cost below their market value or the absence of financial risk for the holder. In line with the Gaillochet ruling, judges must now first determine whether or not there is a direct benefit to the manager at the time the management package is established before examining the link between the grant of stock options and the manager’s involvement in the company’s management. This approach has the advantage of simplicity: if the management package reveals the existence of a benefit for the manager, it is then necessary to examine whether this consideration results from the manager’s professional activities within the company. If no benefit is apparent, the reclassification is without merit.
💡 In conclusion, the tax authorities distinguish between two situations:
To establish the second situation, the tax authorities must prove:
Beyond purely tax considerations, there is also the issue of how stock option warrants are treated for social security purposes. This issue was notably addressed in the“Barrière” case of 2019, in which the Court of Cassation ruled that the benefit subject to social security contributions must be assessed based on the “value of the warrants on the date the beneficiaries obtained full disposal of them” (Court of Cassation, Civil Division 2, April 4, 2019, No. 17-24470 FSPBRI). However, this decision raised practical difficulties and led the Court of Cassation to reverse its precedent in 2023, holding that the benefit must be valued “on the date of transfer or realization of the vouchers based on the gain obtained or the savings realized by the beneficiary ” (Court of Cassation, Civil Division, 2nd Chamber, September 28, 2023, No. 21-20685 FSB). Thus, the capital gain must now be calculated as of the date the stock options are actually exercised and corresponds to the difference between:
Consequently, the Court of Cassation holds that the triggering event for tax liability is the sale or exercise of the stock options, and no longer simply the commencement of the period during which such transactions become possible.
From a tax perspective, three decisions handed down by the Council of State on July 13, 2021, mark a significant shift in case law. They establish that the assessment of whether the total gain from a “management package” should be reclassified as salary must now be analyzed separately for each gain realized by the managers. The Council of State clarified that the preferential nature of the purchase price of the instrument has no bearing on the nature of the gains realized subsequently upon the exercise of options or warrants, nor upon the sale of the acquired securities or warrants. It is important to note that the existence of preferential terms had already been mentioned in the “Barrière” case law without further clarification. It was not until the September 28, 2023, decision of the Second Civil Chamber that this point was fully addressed. According to the court, the preferential nature of the terms results (Cass. Civ., 2nd Ch., September 28, 2023, No. 21-20685 FSB) from:
The Court affirms, however, that the financial terms of the subscription constitute “merely an indication” of the preferential nature of this allocation of stock options.
The decisions handed down on July 13, 2021, also shed new light on the tax year for this benefit. It would now be taxable in the year the options or stock purchase warrants are acquired or subscribed to, in accordance with Articles 79 and 82 of the General Tax Code, and not on the date of sale of the financial instrument. This position is very strict because the employee or executive must pay an immediate tax liability without having received any income from the sale of the BSA or the shares resulting from the exercise of the BSA or stock options.
Finally, in February 2024, the Council of State reversed its position on the exclusion of stock subscription warrants from PEA accounts, as specified in the second paragraph of No. 585 of the Official Tax Bulletin (BOI): “Not only are these rights and warrants prohibited from being included in a PEA, butso are the shares that they enable the holder to acquire or subscribe to. Indeed, these rights or warrants may not be registered, exercised, or transferred within the plan” (BOI No. 585, cited above). In its decision of December 8, 2023 (Joint 8th and 3rd Chambers, No. 482922), the Council of State ruled that the BOFIP’s comments add to the law and overturned the judge’s ruling. It clarified that the ineligibility of stock options (BSA) and stock subscription warrants (BSPCE) for the PEA does not preclude investing in the PEA the shares resulting from the exercise of BSPCE or BSA by paying the subscription price using the cash component of one’s PEA.
In conclusion, despite attempts at clarification through case law, the tax and social security treatment of stock options (BSA) remains complex and uncertain, depending heavily on the specific terms of grant. This legal uncertainty, combined with the initial investment required of the beneficiary, makes other employee stock ownership plans—which are better regulated legally—more attractive.
Recent case law also highlights the real risk that gains from packages structured as BSA or stock options could be reclassified as salary. In this context, AGADPs (Free Preferred Shares) appear to be attractive alternatives to BSA in the context of “manpacks.” The use of AGADPs has increased significantly, rising from 9% in 2019 to 31% in 2022. However, traditional ratcheted preferred shares remain the most widely used instrument (data from CFNews). It is important to note, however, that the use of AGADPs remains limited by constraints such as the 10% cap on share capital and the minimum grant and vesting period totaling two years. These constraints can pose significant obstacles for certain stakeholders.
Furthermore, recent developments in case law regarding stock option warrants (BSA) raise new technical issues. For example, the Council of State stipulates that to avoid double taxation of the gain upon acquisition, the gain upon disposal must be calculated by taking into account “the benefit that might have been taxed” upon acquisition. However, the practical implementation of this calculation method has raised questions when the tax authorities allowed the statute of limitations to expire regarding the taxation of an undeclared salary gain upon entry.
In this uncertain context, it is essential that companies, managers, and shareholders be well-informed and advised on the tax and legal implications of their choices. This will not only minimize risks but also maximize the potential benefits of their equity participation in the company.
Sources:
The share subscription warrants for business creators (BSPCE) remain the preferred solution for startups. We explain why!
The tax regime of free share awards has been the subject of numerous legislative reforms in recent years. Insight into the contours of their taxation:
Instrument of interest in social capital, the BSA are a solution favored by young companies in search of development: