Tax-efficient forms of remuneration, serving at the same time, as a means of motivating management have never been more popular. And the range of options available for doing this has expanded this summer to include what’s known as a Special Employee Co-Ownership Program (“KMRP” in Hungarian), a vehicle that can be used for in certain situations that cannot be handled in the context of an Employee Part-ownership Program, MRP. In addition, KMRPs are an excellent vehicle for implementing management buyouts.
Giving employees a share of ownership can benefit the owners of a business in numerous ways. For a start, it helps to align the long-term interests of the employees with the growth and profitability targets of the company. Secondly, it allows employees to receive a part of their pay in the form of “equity remuneration”, which is taxed at 15%, instead of the 49% taxation of a regular salary.
Paying employees in shares, however, can also have several drawbacks. For one, it can give employees an unwanted say in the strategic running of the company. Secondly, the transfer of shares at below market value generates an income that is itself taxable. However, favoured forms of employee remuneration of recent years such as, especially, employee stock option plans and the MRP, have completely eliminated these disadvantages. And the KMRP, which has already been in place for a couple of months now, can provide other benefits, too.
MRP or KMRP?
Both the MRP and the KMRP modelled on it involve the establishment of legal entities through which employees can indirectly obtain a stake in their employer. These entities either distribute to the participating employees a portion of the dividend paid by the employer or pay out part of the profit on the sale of shares in the employer. Employees participating in the program are not directly entitled to attend the general meeting of the company; ownership rights are exercised solely by the MRP (or the KMRP).
The KMRP has expanded the frame within which this form of remuneration can be established in several respects. Thus, in contrast to an MRP, which can only be set up at a company limited by shares (Zrt.), in the case of a KMRP the employer can assign an equity stake of a Kft. to the KMRP, which means that a KMRP can be established by a limited liability company (Kft.) as well. While only employees of the issuing company can be included in an MRP, with an KMRP it is possible to reward members of the board of directors as well as the supervisory board, which itself shows that the KMRP was designed specifically as a means of remunerating management. Last but not least, while a stake in an MRP cannot be sold, a stake in a KMRP can. This also provides an opportunity for income to be paid from a KMRP more flexibly and – in contrast to the MRP’s two-year holding period – with relatively little waiting time.
The perfect management buyout vehicle
KMRPs present an ideal vehicle for conducting management buyouts. Once the management has set up the KMRP entity, the latter is entitled to take out an “acquisition loan” under the conditions specified by law. At the same time, the target company can supplement the financing of the acquisition with extremely favourable conditions: if the target company transfers some of its equity to the entity, this capital injection is not taxable either for the KMRP or for its owners, and what’s more, the amount can be expensed at the company.
Another point in favour of using the KMRP as a vehicle for implementing management buyouts is that the stake acquired in a KMRP can be transferred to a trust. By doing so, the tax advantages of the KMRP can be stacked with those of a trust.
But hold your horses...
Before you rush to set up a KMRP, however, it’s essential to thoroughly review the legal background to all this – which is decidedly complicated. The regulations that apply to KMRPs contain several restrictions and pitfalls. Thus, for example, KMRPs can only be set up and run with a minimum of ten employees. In addition, the KMRP must hold the equity stake it obtained in the company for at least ten years in order to benefit from the favourable tax rules. While these restrictions create certain difficulties that may be overcome by careful planning, it certainly doesn’t hurt to be extra careful when drawing up the rules for your own KMRP entity.