On August 2, 2024, Law numbered 7524 was published in the Official Gazette numbered 3260 and came into force, amending the Income Tax Law (“ITL”) numbered 193 to include a provision on the tax exemption for benefits provided to employees in the form of free stock options (“Employee Stock Option Plans” or “ESOP”).

This legislative change introduces significant mechanisms designed to enhance employee engagement and motivation for entrepreneurs and companies, particularly start-ups. These mechanisms are attracting attention as Employee Stock Option Plans (“ESOP”) enable employees to become shareholders and benefit from financial rights associated with the company’s shares. By aligning the interests of employees and shareholders, these plans contribute positively to companies’ overall success and long-term sustainability.

An ESOP is a mechanism that grants employees the right to acquire company shares at no cost or at a discounted price, generally after a specific period or upon meeting certain conditions. For employers, ESOPs serve as a motivational tool to increase employee loyalty, while also representing a strategic tool to enhance company value and performance. This is especially beneficial for companies, such as start-ups, that may not have the capacity to pay high salaries to qualified employees.

1. Stages of ESOP

1.a. Notice of Stock Option

The first step involves offering the stock option to employees. In this process, the employer provides a written notification to the employee specifying the conditions under which the option can be exercised. This notice outlines the exact timing and circumstances under which the option may be exercised. The vesting schedule, which dictates the conditions that must be met for the employee to acquire the right to exercise the option, shall be carefully defined. These conditions are typically based on factors such as the duration of employment, sales targets set by the company, revenue targets, or specific performance criteria.

An employee can only exercise the option when the vesting conditions are met, either on a specific date or upon the occurrence of a particular event. The vesting conditions are typically fulfilled progressively, reflecting the employee’s performance and contributions to the company. For example, meeting certain sales targets or working for a specific duration within the company may lead to partial or full vesting of the stock option.

To avoid potential disputes, it is essential that the vesting conditions are based on clear and measurable criteria. Company goals, performance targets, and other metrics should be defined in a concrete manner to eliminate ambiguity. In the event that the vesting conditions are not met, the employee will forfeit the right to exercise the option. Moreover, the vesting conditions must be clearly communicated, and both parties should provide written approval. This ensures that the rights and obligations of both parties are explicitly understood in case of any disputes.

It should also be noted that the option plan must comply with local tax laws, labor laws, and commercial laws, ensuring that the employees’ financial rights and tax obligations are addressed within a legal framework.

1.b. Vesting Period

In this phase, employees fulfill the conditions required to vest the stock options. The vesting process refers to the completion of the necessary steps by the employee to qualify for the right to exercise the option.

1.c. Exercising Period

Once the employee has satisfied all the vesting conditions, they automatically acquire the right to exercise the option. At this stage, the employee may choose not to exercise the option without providing any reasons.

1.d. Stock Option Agreement and Stock Option Plan

To ensure the smooth progress of all the stages of the ESOP, a Stock Option Agreement and an Employee Stock Option Plan should be prepared. These documents outline the terms and conditions of the stock option, including the number of shares, the method and timing of exercising the option, and other relevant matters. The Employee Stock Option Plan also regulates the overall management of the company’s employee stock options.

It should be emphasized that both the Stock Option Agreement and the Stock Option Plan play a key role in the process. For example, if the employee fails to meet the conditions outlined in the option terms of the Stock Option Agreement or if the employment contract is terminated, the company should have the opportunity to terminate the Stock Option Agreement via written notification as per the agreed terms.

Additionally, once the employee fulfills all vesting conditions, they will have the right to purchase shares at the predetermined price (“strike price”). If the value of the company shares has significantly increased since the signing of the Stock Option Agreement, the employee will still be entitled to purchase the shares at the original strike price. However, if the value of the shares has decreased, the employee may choose not to exercise the option.

2. ESOP Under Turkish Law

Before the enactment of the Law numbered 7524 on August 2, 2024, which was published in Official Gazette numbered 3260, there was no specific provision regarding stock option plans in Turkish law. Therefore, ESOPs are now regulated within the framework of the Turkish Commercial Code numbered 6102 (“TCC”), the Turkish Code of Obligations numbered 6098 (“TCO”), and the Capital Markets Law numbered 6362 (“CML”).

According to Article 403 of the TCO, it is possible to provide employees with a share of the profits, turnover, or earnings along with their salaries. Moreover, under Article 463 of the TCC, the general assembly is authorized to approve a conditional increase in capital by granting employees the right to acquire new shares through the exercise of options. Article 464 of the TCC further stipulates that the nominal value of the capital increase should not exceed 50% of the total capital, and the payments made must be at least equal to the nominal value. Additionally, Article 465 of the TCC specifies that these conditions should be included in the company’s articles of association.

It is well known that, under the TCC, newly issued shares must first be offered to existing shareholders on a pro-rata basis. However, shares issued specifically for employees are considered an exception under Article 461 of the TCC. Furthermore, the general assembly has the authority to authorize the board of directors to implement a stock option plan, as per Article 379 of the TCC. According to Article 380 of the TCC, the company may also provide financial support to employees who wish to purchase shares.

3. Tax Implications of ESOP

Under Article 32 of the Turkish Labor Law numbered 4857 (“TLL”), the employer is obligated to pay employees a salary in cash. However, in addition to the salary, the employer may offer stock options to employees that are not based on the employee’s base salary. Previously, stock options granted free of charge under ESOP were considered as salary under Article 61 of the ITL, and the market value of these shares was subject to income tax, with the withholding tax process.

However, with the new regulation introduced by the Law numbered 7524, shares provided to employees under ESOP at no cost or at a discounted price are exempt from income tax, thereby easing the tax burden.

Under this new regulation, shares given to employees of companies that qualify as tech-entrepreneurial firms, as determined by the Ministry of Industry and Technology, will be exempt from income tax to the extent that their fair market value does not exceed the employee’s gross annual salary.

However, if the employee sells the shares within:

• 3 (three) years, 100% of the exempted tax amount must be repaid,
• between 4 (four) and 6 (six) years, 75% of the exempted tax amount must be repaid,
• between 7 (seven) and 12 (twelve) years, 25% of the exempted tax amount must be repaid

by the company along with delayed interest, but without a tax penalty.

Moreover, under Repeated Article 80/1.1 of the ITL, the capital gains tax will not apply if the shares obtained through ESOP are held for more than 2 (two) years by the employee.

4. Advantages and Disadvantages of ESOP

For further questions or additional information on this topic, please feel free to contact us.

Sincerely,
DT Law
Attn. Birnur Dal Erasla