Tax Implications of Cancelling an Employee Stock Option Plan (ESOP)

Employee stock option plans (ESOPs) are a popular way to boost performance and retain key talent. However, there are instances when such programmes are cancelled, which can create unexpected tax complications.

If the compensation paid to an employee for cancelling an ESOP is misclassified for tax purposes, it may lead to a tax shortfall. This can occur either due to an incorrect tax calculation or because the obligation to pay tax is attributed to the wrong party.

Tax Treatment of Stock Options

Receiving stock options under a motivational programme does not generate taxable income for the employee, provided the conditions outlined in Article 24(11b) of the Polish PIT Act are met. A similar tax-neutral result may apply even if these conditions are not fulfilled, as long as the options granted are non-transferable. This view has been confirmed by Polish tax authorities, including in a binding ruling issued on 12 March 2025 (ref. 0115-KDIT1.4011.35.2025.2.MN). According to this interpretation, if the options are non-transferable and not traded on the market, it is impossible to determine their market value. Without a determinable value, no tax liability arises. It is also worth noting that stock options do not convey any property or corporate rights, such as profit participation or voting rights. They merely entitle the holder to acquire shares in the future, meaning the actual benefit will materialise at a later stage.

Exercising Stock Options

The tax implications of exercising stock options depend primarily on whether the ESOP qualifies as a “motivational programme” under Article 24(11b) of the PIT Act. If the programme meets the requirements, the tax event is deferred until the employee sells the acquired shares. The exercise of the options itself is tax-neutral. When the shares are sold, the income is treated as capital gains and taxed at a flat rate of 19%.

Compensation for Cancelled Options

There may be cases where a company decides to cancel the ESOP, for example due to group restructuring or the sale of the company. In such situations, participants may receive financial compensation instead of being allowed to exercise their options.

This raises the question of how to correctly classify the compensation for tax purposes. Should it be treated as employment income, capital gains, or income from other sources?

Employment Income?

At first glance, it may seem that since the payment is made by the employer to the employee, it should be treated as employment income. Article 12(1) of the PIT Act defines this category broadly, using the phrase “in particular.” However, tax authorities take a different view.

They emphasize that income is considered employment-related only if it can be received exclusively by an employee. It also depends on whether the payment forms part of the employee’s remuneration under the employment contract. This view has been confirmed in rulings issued on 14 October 2024 (ref. 0115-KDIT1.4011.488.2024.1.AS) and 29 April 2019 (ref. 0113-KDIPT2-3.4011.113.2019.2.SJ).

Capital Gains?

Tax authorities also point out that compensation for cancelled options granted on the basis of ESOP does not qualify as capital gains. This category typically includes income from the sale of securities or financial instruments. While the existence of a financial instrument is not in doubt, the issue lies in whether a sale has actually taken place. The tax authorities have ruled that if options are “cancelled” or “annulled,” the payment does not result from a sale and thus cannot be classified as capital gains (rulings of 4 April 2025, ref. 0113-KDIPT2-3.4011.158.2025.1.AK and 14 October 2024, ref. 0115-KDIT1.4011.488.2024.1.AS). The reasoning is supported by the literal meaning of “cancel,” which, according to the PWN Polish Language Dictionary, means to “invalidate or revoke a directive or obligation.”

Income from Other Sources

If the factual circumstances do not support classifying the compensation as employment income or capital gains, it should be treated as income from other sources. In this case, the income is taxed according to the progressive scale (12% or 32%). The employer is not responsible for withholding tax. Instead, the employee must report and pay the tax independently. The employer is required to issue a PIT-11 form indicating the amount of compensation paid.

Consequences of Misclassification

Misclassifying the compensation paid for cancelled options can have serious consequences for both the employer and the employee. According to Article 62b(1) of the Polish Tax Ordinance, tax can only be validly paid by the person legally obliged to do so, usually the taxpayer. If the employer wrongly withholds tax, this may result in a tax underpayment and interest due from the employee, while the employer ends up with a tax overpayment.

Author: Konrad Gańczarczyk, Paralegal in Tax Practice. Originally published by (Wolters Kluwer) prawo.pl.