Using company’s shares to deduct bonuses for employees – don’t play with fire

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Using company’s shares to deduct bonuses for employees – don’t play with fire

For many existing businesses, especially technology companies, “retaining good employees” is one of the most urgent need, even “vital” to the company. Accordingly, many founders of companies have applied the plan to issue bonus shares for their Employees while they do not clearly understand the conditions, performance method or legal risks that may arise for both company and employee when issuing shares to use as bonuses to the employees.

In fact, all the big companies that succeed in issuing ESOP (Employee Stock Ownership Plan) for the employees, that the press often mentions, have one thing in common – those are public joint-stock companies, this is also a prerequisite for applying the method of issuing bonus shares to employees. The act of issuing bonus shares for the employees is a public activity that encourages employees to work hard for the company’s development. Moreover, a public company must meet certain requirements to perform this program. Meanwhile, small and medium enterprises are usually not able to meet these requirements. The offering of bonus shares to employees while failing to meet the legal requirements may make the transaction to be invalidated under Article 117 of the current Civil Code.

In essence, shares of an ordinary joint-stock company can only be divided into two types:

(1)  Shares that Existing Shareholders currently own; and/or

(2)  New shares are issued to increase charter capital

For ordinary joint-stock companies, there is no direct regulation on issuing bonus shares to employees. Therefore, if the enterprise wants to award the shares to Employees, it must first determine the source of bonus shares for Employees created from which sources, then carry out the corresponding procedures.

For the shares owned by existing shareholders, the donation of shares to the Employees will be implemented by the way that all or some existing shareholders agree to donate a certain amount of shares to the Employer. These shares donated are performed through a civil agreement between Existing Shareholders and Workers. With this method, the obligation to donate shares is an obligation of the existing Shareholders but not the Company. Therefore, the Company will not offer any shares and will not increase its charter capital. In this case, the Shares of Existing Shareholders will be reduced equal to the number of shares donated to Employees.

From the legal aspects, the share donation of existing shareholders to employees is a reasonably safe option for the company because this is only civil transactions between individuals, the constraint of taxes, company’s approval, etc., is not much. However, the method is not always applicable to all companies because the retaining of employees is for the company’s benefit, while the shareholders donating shares must sacrifice their interests (reduced the percentage of equity capital in the company).

In case where the Company awards shares to the Employees from the Company’s capital source,  ordinary joint-stock companies can only perform in the form of releasing additionally private offering shares and employees buy such new issued shares following the law of enterprises. This will also lead to the result of increasing the Company’s charter capital. Moreover, the parties must comply with many regulations on taxes and labour-related.

Besides, this method has encountered a lot of issues such as:

  • Lack of cash flow to compensate for the increase in the charter capital of the company, which leads to the risk of virtual capital increase. The nature of ESOP can be understood as employees are entitled to buy a certain amount of shares additionally issued by the public company at a preferable price than the market price; or donated a certain amount of stock by the company. The difference between the actual proceeds earned from the Employees and the value of the share offered will be offset from valid revenues by Public companies.

Meanwhile, for ordinary companies, when donating shares to Employees, there is no money source to offset the above difference. In many cases that the Employees are recognized as shareholders and the Companies registers to increase the charter capital, but there is no actual capital contribution. This will lead to the virtual capital increase and the invalid of issuing shares to donate employees.

  • Regarding paying employees’ income tax: According to the Personal Income Tax Law, the employees receiving Shares from bonuses, no payment, or lower payments than price value can be determined as having personal income from salaries/ wages. But the Employees must only pay tax when they transfer the donated shares. However, the current share bonus for Employees only applies to a public joint-stock company, so this provision of personal income tax may not apply to the donation of shares of the ordinary joint-stock company.
  • Other issues on the conditions of the offering of individual shares and the implementation of registration procedures with business registration offices…

Within the scope of this article, the writer only presents the basic risks that the founders, existing shareholders of the company (joint-stock) need to acknowledge before awarding shares to employees. Depending on the form that the parties wish to fulfill, the concerns to be considered shall change accordingly. Therefore, the founders and existing shareholders should consult lawyers before any implementation of this incentive method.