Subscription warrants have long been the preferred tool for LBO companies to structure management packages for executive teams to align their interests with those of their investors.
Following adjustments conducted by the tax authorities, several recent court rulings have challenged the legality of these structures on the grounds of tax abuse.
How have practices evolved and what alternatives should be considered now?
"Management packages," or "manpacks," are commonly used to align the goals of executives with those of investors. The idea is to index the executives' gains to the value created for investors, thereby ensuring that key executives/managers have a tangible interest in the company's success. Due to the generally more limited financial capacity of executives compared to investment funds, their participation in the holding company's capital would be modest without these mechanisms.
To increase their potential for capital gains upon exit, certain tools allow immediate or deferred access to capital under valuation conditions more favorable than those applied to the funds: these are management packages. To do this, stakeholders have a range of tools: subscription warrants (BSA), ordinary or preferred shares, promises, options, stock options...
Among this range of tools, BSAs have long been favored by funds within the framework of manpacks, as they allow for the adjustment of executives' participation based on the achievement of objectives and thereby increase their share of capital gains upon sale. From a tax perspective, it was also more advantageous to opt for BSAs, subject to a flat tax of 30%, rather than bonuses whose capital gains were generally taxed at rates ranging from 45% to 49% for employees.
The taxation of BSA (Bons de Souscription d'Actions) has undergone several major changes following decisions by the Tax Administration, gradually diminishing its attractiveness.
Before 2013, the Tax Administration had attempted several times to adjust the tax positions of executives in companies under LBO who had placed their management package tools in a PEA to benefit from the tax exemption offered by the latter. However, these attempts were largely unsuccessful due to the lack of case law on the matter. With the amendment of the 2013 Finance Law (article 13, II of Law No. 2013-1279 of December 29, 2013 amending finance for 2013), the context changed drastically. BSAs subscribed from January 1, 2014, are now excluded from equity savings plans (PEA).
Subsequently, the tax administration highlighted the abuse of rights in the use of BSAs for management packages, leading to a significant change in practices. In the Gaillochet ruling (CE September 26, 2014 Gaillochet, No. 365573), the Council of State clearly established that gains obtained under preferential conditions, without significant risk-taking or considered investment, must be regarded as a financial advantage and taxed accordingly. In a document published in April 2015, titled “Map of Abusive Practices and Schemes,” the General Directorate of Public Finances reinforced this point by noting that management packages “are not systematically fraudulent”, but can lead to “unduly benefiting from the tax advantages associated with the regime of capital gains on securities sales”. Since the Gaillochet ruling and the publication of the tax radar map, the issue of taxing gains from management packages remains very prevalent, both in the courts and in the Committee on Abuse of Rights.
Several administrative court decisions regarding Management Packages structured as BSAs and preference shares (TA Paris, July 12, 2016, No. 1431589, Mr. and Mrs. C) have been rendered in line with these developments. Most of these decisions have pointed out to the tax administration that reclassification of a manager's realized benefit as salary requires proving the existence of a salary advantage. This advantage can manifest either through subscribing to management package instruments at a cost lower than their market value or through the absence of financial risk for their holder. Following the Gaillochet ruling, judges must now first identify whether there is a direct benefit for the manager upon the establishment of the management package before examining the link between the allocation of BSAs 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 his professional activity within the company. If no advantage is apparent, the reclassification is unfounded.
Beyond the purely tax aspect, there is the question of the social treatment of BSAs. This issue was notably addressed in the “Barrière” case law of 2019 where the Court of Cassation established that the advantage subject to social contributions should be evaluated based on the "value of the warrants at the date the beneficiaries obtained free disposal of them" (cass. civ., 2e ch., April 4, 2019, No. 17-24470 FSPBRI). However, this decision raised practical difficulties and led the Court of Cassation to make a jurisprudential reversal in 2023 by considering that the advantage should be evaluated “at the date of sale or realization of the warrants based on the gain obtained or the savings made by the beneficiary” (cass. civ., 2e ch., September 28, 2023, No. 21-20685 FSB). Thus, the capital gain must now be calculated at the actual exercise date of the BSAs and corresponds to the difference between:
Also, the triggering event for contributions is therefore the sale or exercise of the BSAs, according to the Court of Cassation, and no longer merely the opening of the period during which these operations are made possible.
From a tax perspective, three decisions rendered by the Council of State on July 13, 2021, mark a significant evolution in case law. They establish that the assessment of reclassification as salary of the total gain from the "management package" must now be analyzed distinctly for each gain realized by the managers. The Council of State clarified that the preferential nature of the acquisition price of the instrument has no impact on the nature of the gains subsequently realized during the exercise of options or warrants, or during the sale of the acquired securities or warrants. It is important to note that the existence of preferential conditions had already been mentioned in the “Barrière” case law without further indications. It took until the September 28, 2023, decision of the second civil chamber for this point to be completed. According to it, the preferential nature of the conditions results (cass. civ., 2e ch., September 28, 2023, No. 21-20685 FSB):
However, the Court asserts that the financial conditions of the subscription constitute "a simple indication" of the preferential nature of this BSA allocation.
The decisions taken on July 13, 2021, also provided a new angle on the year of taxation of this advantage. It would now be taxable in the year of acquisition or subscription of the options or BSAs, in accordance with articles 79 and 82 of the General Tax Code, and not at the date of the sale of the financial instrument. This position is very strict as the employee or executive must bear an immediate tax cost without having received income from the sale of the BSAs or the shares resulting from the exercise of the BSAs or purchase options.
Finally, in February 2024, the Council of State reversed the exclusion of BSAs in PEAs specified in the second paragraph of No. 585 of the BOI: "the registration in a PEA is prohibited not only for these rights and warrants, but also for the shares they allow to be acquired or subscribed. Indeed, these rights or warrants can neither be registered, nor exercised, nor sold in the plan" (BOI cited No. 585). In its decision of December 8, 2023 (8th and 3rd Combined Chambers No. 482922), the Council of State ruled that the BOFIP comments add to the law and annulled the judge's position. It specifies that the ineligibility of BSA and BSPCE to the PEA does not prevent placing on the PEA the shares resulting from the exercise of BSPCE or BSA by paying the subscription price through the cash compartment of his PEA.
In conclusion, despite attempts at clarification by case law, the tax and social treatment of BSAs remains complex and uncertain, heavily dependent on the specific conditions of allocation. This legal uncertainty, coupled with the initial investment required from the beneficiary, makes other employee share ownership plans, which are better legally framed, more attractive.
Recent case law also highlights the real risk of requalification as salary of the gains derived from packages structured in the form of BSAs or options. In this context, AGADPs (Free Preferred Shares) appear as interesting alternatives to BSAs in the context of manpacks. Their use has significantly increased, rising from 9% in 2019 to 31% in 2022. However, classic ratchet preference shares remain the most 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 of share capital and the total minimum allocation and vesting period of two years. These constraints can be significant obstacles for some stakeholders.
Moreover, recent developments in case law regarding BSAs bring new technical issues. For example, the Council of State stipulates that to avoid double taxation of profit at the entry, the profit at exit must be calculated taking into account "the advantage that might have been taxed" at the entry. However, the practical implementation of this calculation method raises questions when the administration has allowed the deadline for reassessment related to the taxation of an undeclared salary gain at the entry to expire.
In this uncertain context, it is essential that companies, managers, and shareholders are well informed and advised about the fiscal and legal implications of their choices. This will not only minimize risks but also maximize the potential benefits of their participation in the company's capital.
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