Different classes of shares in a SIA and the related tax considerations

Employee shares as a personnel motivation tool with effective tax advantages.

Since 2021, Latvian private limited companies (SIA) have been able to issue different classes of shares. This option opens up wide possibilities for the company itself, as well as for its shareholders and employees, yet in practice it is still used relatively rarely.

This article looks at the ways different classes of shares can be used, with particular attention to employee shares as a tool for motivating personnel and to the related tax considerations. A practical example compares the tax impact of paying a bonus versus paying dividends.

What did the 2021 amendments to the Commercial Law change?

Section 186.1 of the Commercial Law, which entered into force on 12 January 2021, allows a SIA to provide in its articles of association for several classes of shares carrying different sets of rights. What may differ includes, for example, the right to dividends, the liquidation quota, voting rights at the shareholders’ meeting, and other shareholder rights. Within a single class, all shares carry the same set of rights. If a company has several classes of shares, each is given a separate designation - for example A, B or C - or a descriptive name, such as ordinary, preference or employee shares.

Shares of the same class carry equal rights and an equal nominal value. The nominal value can start from one cent, and it may differ between classes.

Employee (personnel) shares

One practical application of this regime is the use of employee, or personnel, shares in employee motivation programmes. A well-designed programme can be a highly effective long-term incentive: it ties the employee’s economic benefit to the growth in the company’s value and to its performance, while at the same time giving the company a significant tax saving compared with paying a classic bonus.

The core idea of the programme is to create a separate class of shares that gives employees the right to dividends while not granting voting rights or other control rights in the company. The articles of association and the related documents also set out the rules of the programme, including the procedure for returning the shares when the employment relationship ends.

For the existing owners, this model makes it possible to retain control over the company, because employee shares need not carry voting rights. The buy-back rules usually distinguish between cases where an employee leaves voluntarily and on good terms and situations where the employment ends because of misconduct - the consideration paid for the shares may depend on this.

In practice, an existing bonus scheme can be a good starting point for a company to consider introducing an employee-share model. If bonuses are already linked to the results of the company or of particular business units, employee shares can allow this arrangement to be reshaped organically into a long-term participation model. The difference in taxation is considerable: a bonus is subject to the full set of payroll taxes as standard - the employer’s mandatory state social insurance contributions of 23.59%, the employee’s contributions of 10.5%, and personal income tax (25.5%, but 33% on income above EUR 105,300 a year, and if total annual income exceeds EUR 200,000, an additional 3% on the excess). Dividends, by contrast, are subject only to 20% corporate income tax. I return to the tax side separately below.

Flexibility in calculating and paying dividends

Another significant advantage is the flexibility in distributing dividends. Section 161 of the Commercial Law provides that dividends are paid to a shareholder in proportion to the total nominal value of the shares held by that shareholder, unless the articles of association provide otherwise. This means that different classes - and, in certain cases, even different holders within the same class - can be given a different basis for calculating and paying dividends.

Likewise, distributing profit to one class does not in itself create an obligation to distribute profit to the others. The shareholders’ meeting can decide to pay dividends only to the holders of shares of particular classes. It is also important that the decision to pay dividends is taken only by those shareholders whose shares carry voting rights. If employee shares have not been granted voting rights, their holders do not vote on the distribution, and control over the allocation of profit remains with the existing owners.

In the context of employee shares, these considerations matter when building a system with several classes of employee shares - for example, for employees at different levels.

Tax considerations

Using different classes of shares within an employee long-term incentive programme is one of the solutions that can give a fairly wide range of companies significant benefits - mainly in terms of employee motivation, but in the right circumstances also in terms of tax cost.

When considering the introduction of employee shares, the decisive factors are the actual circumstances and the economic substance of the specific situation. Such a solution must genuinely perform an employee-motivation function. It is not intended for replacing salary with dividends, and features that point to such use can create tax risks.

The tax difference is well illustrated by a comparison with a cash bonus. Profit distributed as dividends is subject to 20% corporate income tax, with the tax base first divided by a coefficient of 0.8. In practice this means a 25% tax on the amount paid out, i.e. on the net amount. After the corporate income tax has been paid, dividends paid to a natural person who is a Latvian tax resident are no longer subject to personal income tax, except in certain cases discussed later in the text. A cash bonus, on the other hand, is subject to the same taxes, in the same way, as a salary.

Precisely because the tax difference is significant, the employee-share model must be used thoughtfully. If the programme reflects genuine employee participation in the company’s results, the legal form reinforces the economic substance. But if there is no such substance and the State Revenue Service (VID) has grounds to consider that the dividends are in essence a substitute for salary, the tax risk increases significantly. For example, if the dividends are linked to hours worked, are guaranteed regardless of the company’s results, or are used in place of market-level remuneration, VID may assess the true substance of the payments and reclassify them as remuneration for work.

Practical example: SIA “DEMO Optikas risinājumi”

To show how an employee-share programme might work in practice, the following uses a hypothetical example of SIA “DEMO Optikas risinājumi” - a fictitious company with several management-level groups and an existing bonus scheme.

It should be stressed at the outset that the example described below is deliberately made fairly extensive: it has several classes of shares, each for a separate management level, and its own dividend-calculation and payment mechanism for each level. In practice, motivation programmes can be both much simpler and more complex - depending on the company’s structure, its objectives, and the intentions of the owners and management. There is therefore no universal template for such a solution; the programme must be tailored to the specific situation.

The company and its current system

SIA “DEMO Optikas risinājumi” is an entirely fictitious Latvian company, founded in 2001 by two Latvian citizens and tax residents, Andris and Līga, who each own 50% of the company. The company’s total share capital is EUR 10,000. The company’s core business is the design and manufacture of high-precision optical components for medical devices. The company exports around 85% of its output to Germany, Scandinavia and other Western European countries. It employs 118 people, and management is organised on three levels:

• Senior management (3 people): CEO Kristaps, CFO Anete and Technology Director Mārtiņš.
• Middle management (4 people): Sales Manager Ilze, Production Manager Jānis, Head of R&D Elīna and Operations Manager Roberts.
• Team leaders (5 people): Dāvis (assembly), Laura (quality), Kārlis (logistics), Sanita (customer support) and Toms (procurement).

The company closed 2025 with turnover of EUR 10.0 million, 100,000 units sold, gross profit of EUR 4.0 million and EBIT of EUR 1.9 million.

At present the company runs a classic bonus scheme. Each management level has its own targets, and if they are met, the relevant employees are awarded a bonus at the end of the year. The targets, indicators and calculation base differ at each level: for senior management they are linked to the company’s profit, for middle management to sales results, and for team leaders to revenue growth.

The new incentive programme

The senior management of SIA “DEMO Optikas risinājumi”, together with the existing shareholders, has decided to introduce an employee long-term incentive programme based on granting employee shares to key employees. The programme provides for the creation of several classes of employee shares according to the employees’ management level: Class A shares for senior management, Class B shares for middle management, and Class C shares for team leaders.

The number of shares to be granted to each employee will be set individually, taking into account criteria defined in advance, including the employee’s competence, experience, length of service, scope of responsibilities and contribution to the company’s development.

Two basic elements are set for each class of employee shares: the target to be met, the achievement of which is a precondition for calculating dividends, and the dividend-calculation mechanism for that class.

If the target set for a particular class is not met, no dividends are calculated or paid to the holders of that class of employee shares, regardless of what result the applicable formula would produce.

The share structure after the programme

On introducing the programme, the company creates three new classes of employee shares and grants them to employees. Employee shares give a right only to dividends, subject to the conditions of each class, but give no voting rights or any other shareholder rights. Control over the company therefore remains with the two original shareholders: together they hold 100% of the votes.

In this example, the nominal value of one employee share is assumed to be EUR 1.00. Because employee shares carry no voting rights, after the new shares are issued both holders of ordinary shares still retain 100% of the voting rights.

The result: 2025 versus 2026

In 2026 the company’s financial results, compared with 2025, were as follows. Revenue grew by 10% (from EUR 10.0 million to EUR 11.0 million), EBIT reached EUR 2.4 million, and gross profit increased by EUR 0.6 million. However, the number of units sold increased by only 9%.

As a result, the targets for 2026 were met for only some of the employee-share classes. The senior management (Class A) target - EBIT of at least EUR 2.0 million - was met, as EBIT reached EUR 2.4 million. The team leaders’ (Class C) target - revenue growth of at least 8% - was also met, as revenue grew by 10%. The middle management (Class B) target, however, required an increase of at least 12% in units sold. Since the actual increase was 9%, the Class B target was not met, and no dividends are calculated for that class for 2026.

In total, under the terms of the programme, the dividends to be distributed for 2026 amount to EUR 150,000: EUR 120,000 for the Class A shares and EUR 30,000 for the Class C shares.

The decision to pay dividends

Once the results for the reporting year are known, the decision on distributing profit is taken by the shareholders’ meeting. Only shareholders with voting rights take part in the vote - in this example, the two holders of ordinary shares.

In this case they decide to pay dividends only to the holders of Class A and Class C employee shares, because the targets for those classes have been met. No dividends are calculated for Class B, because its target has not been met. Likewise, no dividends are paid on the ordinary shares, because the holders of the ordinary shares decide not to distribute profit to themselves for the year in question.

The holders of employee shares do not take part in this vote. Moreover, if the articles of association so provide, a decision to pay dividends to one class of shares does not in itself create an obligation to pay them to other classes as well.

What an employee’s remuneration costs the company in total: dividends versus a bonus

Class A and Class C employees together receive EUR 150,000 in dividends from the employee shares - this is the amount they receive in their bank accounts. To show the tax difference, this same net amount can be compared with a situation in which the company paid it out as a bonus. The next table shows how the tax burden and the company’s total cost differ in the two cases.

Accordingly, to pay employees the same after-tax amount, EUR 37,501 must be paid in taxes in the dividend case, but EUR 128,033 in the bonus case. The company’s total costs are EUR 187,501 and EUR 278,033 respectively. This means that, for the same net amount, the bonus model costs the company EUR 90,532 - or roughly 48% - more.

The calculation uses a single 25.5% personal income tax rate, with no tax-free minimum or tax reliefs applied, and the solidarity tax is not taken into account. The real tax burden on a bonus would most likely be even higher (PIT progression, an additional 3% PIT on income above EUR 200,000 a year, and the solidarity tax).

Calculation for each employee

Below, the result of the previous table is shown for each employee. This makes it possible to see how the tax difference arises not only at the aggregate level but also for each holder of employee shares. In the bonus case, the taxes are split into three parts: the employer’s social contributions, the employee’s social contributions and personal income tax.

The calculation uses a single 25.5% personal income tax rate, with no tax-free minimum or tax reliefs applied, and the solidarity tax is not taken into account. In practice the tax burden on a bonus would most likely be higher (personal income tax progression, an additional 3% tax on income above EUR 200,000 a year, and the solidarity tax), so the real difference between a bonus and a dividend would be even greater than shown here.

What is important to bear in mind in 2026?

With effect from 2026, changes to the Corporate Income Tax Law have entered into force. From 1 January 2026, a company whose shareholders are only natural persons may choose an alternative regime for taxing dividends: 15% corporate income tax and 6% personal income tax, instead of the previous 20% corporate income tax (with no personal income tax). The total tax burden on the distributable profit remains very similar in both cases - only its split differs.

This regime is mainly intended for situations where the dividends are also taxed in the shareholder’s other country of residence. In the case of employee shares, where the employees are usually Latvian residents, the overall result does not change materially; nevertheless, when planning payments, it is worth including this option in the calculations.

What is important to consider before introducing an employee long-term incentive programme?

Before introducing such a solution, several questions need to be thought through. There must be a clear and economically justified motivation system: the employee shares must reward the employee’s contribution to the company’s results. Likewise, there must be a defined policy under which the system operates - the procedure for calculating and paying dividends and for returning shares, together with other key conditions, must be precise and must then be applied consistently, so that no tax risk arises, i.e. no grounds for VID to consider that dividends are paid on a whim and used to replace a salary on which full payroll taxes should be paid.

The most important thing to bear in mind: the aim of such a share-based employee long-term incentive programme is growth in the company’s value and employee motivation. The tax benefit is a consequence, not the goal. This is very important when designing such systems. For more complex systems, our recommendation is to agree the terms of the incentive programme with VID proactively before implementation, in order to avoid the risk that VID might not understand the system, or might in future change its interpretation of how tax applies in the specific cases.