Taxation of Employee Stock Options

Special tax rules apply when an employee purchases shares by exercising stock options granted through their employment. The difference between the market value of the shares and the price paid is treated as employment income and taxed in the same way as other employment income.

When a stock option is exercised, the employer must pay social security contributions on the difference between the market value and the purchase price of the shares. No withholding tax is deducted from this amount. The employer must report the transaction to Iceland Revenue and Customs in the year following the exercise of the stock option.

The following information must be provided:

• Exercise date

• Nominal value of the shares

• Purchase price

• Employee's income (the difference between the market value and the purchase price)

If the Shares Are Not Sold Before the End of the Year

If you exercise a stock option but do not sell the shares within the same year:

• The shares are reported as an asset on the individual's tax return.

• The difference between the market value and the purchase price is not taxed immediately.

• Taxation takes place when the shares are sold.

This means that a deferred tax liability remains attached to the shares until ownership is transferred.

Determining Market Value for Tax Purposes

If the shares are listed on a stock exchange, the market price is used.

If the shares are not listed on a stock exchange and no transactions have taken place, the book value of equity according to the company's latest audited annual financial statements or interim financial statements is used.

Stock Option Plan

Provided certain conditions are met, income from shares purchased under a stock option plan is treated as capital income when the shares are sold. This exception applies only to purchases up to a specific amount determined by law, which is 1,500,000 ISK.

A company intending to grant stock options to its employees must submit its stock option plan in advance to Iceland Revenue and Customs for confirmation. Iceland Revenue and Customs has established rules in this regard, which provide, among other things, that:

• Each company must establish rules for the stock option plan that apply to all its employees and, where applicable, all employees of companies within the same group. The rules must state how the company intends to inform its employees of their rights under the plan and any applicable conditions.

• Stock options are only available to employees who have permanent employment with the company or another company within the same group. Contractors working for the company and members of its board of directors are not considered employees of the company for this purpose.

• At least 12 months must pass between entering into a stock option agreement and exercising the option. A stock option agreement is considered to have been entered into when both the company's commitment to grant the employee the stock option and the employee's confirmation of the agreement are in place.

• The purchase price may not be lower than the weighted average price of transactions in the company's shares during the ten full trading days preceding the date of the agreement, where such transactions have been recorded on a stock exchange. If no such listing exists, the price must be based on the prevailing market value in transactions or, alternatively, the book value of equity according to the latest audited annual financial statements or interim financial statements.

• The employee must retain the shares for two years after exercising the stock option. If this condition is not met, the income must be taxed under the general rule as employment income.

• A stock option agreement is non-transferable and must specify that it may not be pledged or otherwise transferred.

• Income under a stock option plan that meets the above conditions is taxed when the employee sells the shares.

Further Information

• Purchase of shares under a stock option: Article 9 of Act No. 90/2003 on Income Tax

• Purchase of shares under a stock option plan: Article 10 of Act No. 90/2003 on Income Tax