What is the Kruse Smith model?
The Kruse Smith model is a somewhat complicated share incentive scheme that allows employees to buy shares in a company at a discounted cash consideration, but in return other requirements are imposed which we cover in more detail below.
This means that more people have the opportunity to become a full shareholder with voting and dividend rights in companies that have built up a certain market value. Under normal circumstances, a high market capitalization may make it difficult for employees to buy shares. This means that the scheme constitutes a real share incentive solution.
Background 📚
In 2001, the Supreme Court ruled on a tax incentive scheme in Kruse Smith, hence the "Kruse Smith" model. This has set a precedent for an incentive scheme that several companies have used since, with several of them securing advance tax rulings from the tax authorities.
On 01.01.2022, the Directorate of Taxes issued a new statement in which they shelved this established practice. This was met with great opposition, which resulted in the tax authority issuing a revised statement of principle on 28.03.2022, which again opens up for the use of this model.
The full text of the policy statement can be found here: https://www.skatteetaten.no/rettskilder/type/uttalelser/prinsipputtalelser/skattemessig-vurdering-av-aksjeincentivmodell/
How does the Kruse Smith model work 🧐?
In order for the incentive scheme to function properly, it is important that the agreement and its conditions are structured appropriately. This essentially involves:
- The employee is allowed to buy shares at a cash consideration much lower than the market price. The lower limit is set at 7%. Some companies choose to set this higher (10-20%).
- A residual remuneration, which is the difference between the fair market price and the cash remuneration, is set as a loan from the company to the employee with specified repayment provisions:
- In case of a sale of the shares of the company, the residual consideration will be paid to the company if the sale price is higher than the residual consideration.
- The employee retains the portion of the sale price that exceeds the residual remuneration.
- It can also be agreed that the residual consideration will be repaid by a dividend payment from the company or by another chosen payment structure, for example a fixed amount every year.
- If the sale price is equal to or less than the residual consideration, the residual consideration paid by the employee will be limited to the sale price. The employee will therefore never pay more for the shares than the cash consideration + the residual consideration. This also applies in case of a liquidation of the company.
- The residual remuneration/loan has to have an interest rate. This can be set at the standard interest rate level associated with reasonable loans in employment relationships
Tax considerations 💸
- The purchase/subscription of shares at a cash consideration much lower than the market price (in practice 7 percent) is not considered as an employment benefit if the employee undertakes to pay the balance of the consideration upon realization of the shares
- The Directorate of Taxes allows the employee to receive downside protection if the company develops negatively or goes bankrupt, but with salary taxation if the residual remuneration is forgiven
- Gains on the sale of the shares are taxed as capital income for the employee
- If the employee owns the shares through a holding company, the exemption method applies to dividends and capital gains
- The benefit of the loan is taxed as a benefit in any case, even if the ownership of the shares is through a holding company
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