Vesting: The In-Depth Guide 2023

Vesting means the period of time during which the beneficiary of an incentive plan gradually accrues the right to his or her share.

In this article, you will learn:

• Definition and functioning of vesting schedules
• The 3 types of vesting
• How the types of vesting affect employees when they leave the company
• Example of vesting schedules
• The primary factors when evaluating vesting

What does vesting mean?

Vesting is the process of obtaining full ownership of an asset. When an employees earn or are assigned an asset, they do not have full control of it until either the specified period has elapsed, a specified milestone based vesting has been achieved, or a hybrid, which is a combination of both period-based and milestone-based vesting.

Once the vesting condition or conditions for fully and vesting meaning it have been achieved, the option beneficiary owns the entire asset and can exercise rights over it (e.g. buy and/or sell it).

How does vesting work?

Vesting works by setting criteria to become the owner of an asset. If the criteria are not met, the shares have not yet been fully vested and consequently are not owned. There are three main types of stock vesting here: milestone based stock vesting amount-based (aka as target-based), time-based, stock vesting amount-based (the most common) and a combination of both. Let us take a look at the following examples:

Target-based Vesting:

The recipient can obtain equity ownership in their asset when the company or start up has completed a specific milestone of a project (e.g. IPO), or when performance targets are reached.

Time-based Vesting:

Stock options are generally time-based. If an option has a time-based vesting schedule of 3 years, the recipient will have to wait that period to receive his options under the relevant time-based vesting schedule, which could be cliff vesting or a graded vesting schedule. We will dive into the differences between cliff vesting and graded time based vesting schedule later in the article.

Hybrid Vesting:

Vesting for Restricted Stock Units (RSUs) or Performance Stock Units (PSUs) is usually hybrid in private companies or small businesses as is based on a combination of time milestones, internal to the company conditions and some external conditions, typically tied to the relative performance of the company vis-à-vis its peer group of companies.

Vesting schedules the acquisition of a right. It applies in various situations. In Italy, e.g., vesting is a mode of v. concerning the acquisition of a right in rem after a congruous period of maturation (➔ period) in which one has exercised it as if, although not being the owner, one were the owner of the right itself and in the absence of opposition to such conduct on the part of the legitimate owner.

Types of vesting: cliff vesting, graded vesting and immediate vesting

The type of vesting is highly dependent upon the outcome that the enterprise is seeking. For example, with a a one year vesting cliff, two-year vesting cliff and a four-year vesting schedule, employees must spend a certain amount of time in the organization before they are entitled to receive the asset.

When the employee completes the types of vesting schedules, they are gradually allowed a higher percentage. This incentivizes employees and encourages loyalty. Immediate four year vesting schedule is not as common as the other two as it does not require the employer or the recipient to wait a certain period of time to obtain ownership of the shares vested.

There are three types of vesting: time-based, target-based and milestone-based, time based vesting and finally hybrid vesting, time-based and target-based.

Cliff Vesting

This is a process by which you enable employees to earn or receive full or partial ownership of in shares. Suppose you offer your employee stock options with a cliff vesting of 3 years. This means that they will only be able to exercise their rights to the shares (e.g. buy them, sell them) once 3 years have elapsed. After 3 years, they will be able to exercise at the initially agreed price (e.g. exercise price) and sell the allocated shares.

Graded Vesting

This is a process by which employees obtain graduated ownership at specified intervals. Suppose your offer your employees, as an incentive and alignment mechanism, 300 stock options with a graded vesting schedule of 5 years. After the first one-year mark of service, they will receive 60 fully vested shares (20% of the total number of unvested shares), which they will fully own and can sell as well as exercise rights over. Thereafter 60 shares each year for the next four years until all of the stock options have vested or the employee departs the organization, in which case the unvested portion of employee stock options and units is forfeited.

Immediate Vesting

Under the immediate vesting approach, employees obtain 100% ownership of their shares on the grant date. This only partial ownership means that they can exercise their rights to the remaining shares or sell them immediately.

In the economic-financial sector, the definitive accrual of the right to a pension (➔ compulsory pension), both old age and seniority, is relevant and is regulated in detail by the legal term of the states. The retirement plans have different modalities regarding the necessary requirements and, in particular, the length of the accrual period.

Another important area in finance concerns the full vesting schedule of rights to the exercise of stock options (to subscribe to shares of the enterprise at a favourable price; stock options or company stock) by members of the Board of Directors, Consultants, or Third Parties as an extension of the enterprise itself. This is fairly common when seeking to onboard strategic partners or any other party that can drive top-line growth or provide strategic competitive positioning.

Typically, the full vesting schedule of this right is either gradual (progressive) over a certain period of time (i.e., so many stock options are fully vested per year for each year in which one has operated) or hybrid, inclusive of both time and milestone metrics.



Alternative forms

Alternative forms are those that provide for a latency period, at the end of which all rights accrued during that period accrue at the same time (cliff vs. graded). Cliff may be followed by a period of progressive accumulation. While definitively acquired pension rights may not be forfeited or revoked (except, of course, by operation of law), rights concerning stock options must be exercised under penalty of forfeiture within a certain period after the termination of the employment or collaboration relationship or, in any case, within a certain time after their definitive consolidation.

In determining the criteria for linking the fringe benefit of an employee who receives stock options in the international context, the amount unlike stock options' vesting schedule is of particular importance. This is also in connection with the conventional rules on the subject, which are based on Article 15 - Income from Employment of the OECD Articles of the Model Convention with Respect to Taxes on Income and on Capital.

Stock options are a form of incentive for strategic corporate resources, usually top management. Companies offer stock incentives to senior employees as a special form of incentive and a compensation package to create an alignment on the achievement of long-term results.

Through the adoption of stock options, an employee or collaborator is given the right to purchase, at the end of a given period, shares of the same company stock or another company in the group at a fixed price, usually represented by the value the securities had on the date the options were granted.

In a vesting schedule plan, we can distinguish some fundamental moments:

• Grant Date: The date on which the options are granted (grant date);
• Vested Options: The vesting schedules of the options during which they cannot be exercised
• Exercise Period: The period of four years during a specified period during which the employee or collaborator may exercise the options (exercise period of four years);
• Exercise Date: The date on which the options are exercised (exercise date);
• Expiration Period: The date on which the employee leaves remaining options lapse for four years (expiration date);
• Sale Date: The dates on which the shares granted following the exercise of options are sold (sale date).

Vesting schedule: The Vesting schedule of Stock Options

As mentioned above, in a stock option plan, we can identify three main phases:

• Granting: This is the phase in which the company grants its employees the right to purchase a certain number of shares in the company for a certain predetermined future time frame and at the company for a certain predetermined price;
• Vesting: This is the period from the offer date of the stock option to the beginning of the period for exercising the right; and
• Exercising: This is the final stage in which the option right is exercised, and the shares are purchased.

Thus, the vesting period is the period of time before the shares of an employee's stock option plan are unconditionally owned by an employee. Vesting is a legal term meaning to give or earn a right to a present or future payment, asset or benefit. As a reminder, through common stock, the employee has to earn the right to buy a certain number of shares at a fixed price. This happens monthly or quarterly basis at the end of a set period of time commonly referred to as 'vesting'.

Vesting is, therefore, the process by which an employee with shares fully vested in a stock option plan is entitled to benefit from their equity ownership. The employee stock and vesting period is only for employees who have the opportunity to purchase employer-provided shares. In the employee stock option plan, the shares vest and options granted under the plan confer a right but not an obligation on the employee.

Relevant Time for Taxation

For taxation purposes, where the options right is not already transferable to a third party, the relevant moment for taxation purposes in the hands of the employee is the same example as the moment the option right is exercised (i.e. the 'exercising'). Until the employee leaves that moment, there is no taxable moment for direct tax purposes.

The rule only governs the case where the employee retains the option right until the date of its exercise. The assignment of a transferable option right must be taxed as employment income from the time of the assignment.

If a non-transferable right subsequently loses this requirement, its value must be taxed only in the tax period in which it became transferable.



It is further held that the limit of EUR 2,065.83 of non-taxability refers exclusively to the tax year in which the assignment of the shares takes place. This is the case regardless of whether such exercise is conveyed by different options granted at different times.

However, Article 51(2) of the TUIR provides for the exclusion from employment income of shares allocated to the employer contributions of each employee. A value limit is provided for, i.e. not exceeding €2,065.83 for each tax period.

The value of the shares allocated, net of the amount paid by the employee, is subject to taxation as employment income for the part exceeding the limit. This limit is to be referred to the entire tax period and not to individual allocations.

What Happens In Case Of Vesting Period Abroad?

The general provisions indicated so far are complicated when we are faced with cases of international mobility of the employee who is benefiting from stock option plans.

Let us take, for example, the case cited by Circular No. 17/E/2017 of the Agenzia delle Entrate in Italy. The case in point is that of a manager employed by a foreign company or a multinational group of private companies. This employee was then hired by the Italian subsidiary of the same employer or group.

The employee was assigned Restricted Stock Units (RSUs) during his relationship with the foreign company. RSUs entitle the holder to receive, at the end of a fixed period, a number of shares, without payment of any consideration.

In this context, the manager wonders about the tax treatment to which the RSUs should be subject at the end of their common vesting schedule, meaning at a one-year milestone based cliff their monthly or quarterly basis and their common vesting schedule. The Agenzia Delle Entrate in the practice document under comment states that the principle to be referred to is that of the vesting period.

Being, in fact, fringe benefits linked to the manager's employment contract, it is necessary to divide the vesting period between the period spent abroad and the period, instead, spent in Italy. Only the latter vesting period must be taxed in Italy.

Returning to our case, the manager has become a resident in Italy and, therefore, the employer is required to declare in Italy the fringe benefits related to the employee leaving the employer contributions the RSUs accrued since one year cliff his return to Italy. In this case, it must also be reported that the worker, at the time of one year cliff his return to Italy, opted for the Forfeiture Regime, in the year in which he transferred his tax residence to Italy.