In detail
Background
Until the introduction of the new provision in Sec. 19a German Income Tax Act (Einkommensteuergesetz (EStG)) two years ago, the grant of equity participations to employees at no cost or at a reduced price generally resulted in taxable wages, although the employees did not receive any liquid funds (the so-called dry income). In this situation, the resulting income tax had to be paid out of other funds. Since the general tax allowance for such non-cash benefits was only EUR 360 per calendar year prior to the new legislation, the grant of equity participation to employees was not very attractive from a tax perspective. In practice, therefore, phantom stock solutions and other virtual forms of participation were frequently used.
The tax framework was improved to some extent in 2021 with the increase of the tax allowance to EUR 1,440 and the introduction of a deferral of taxation under Sec. 19a EStG as part of the German Fund Jurisdiction Act (Fondsstandortgesetz). The new regulation enabled employers to grant employees shares in startup companies at no cost or at a reduced price, whereby taxation of the non-cash benefit can be postponed beyond the time of acquisition and until the subsequent transfer of the shares by the employee or upon the termination of the employment relationship — but at the latest after 12 years. Due to the very restrictive requirements for the deferred taxation, companies were often not able to make use of the privileged taxation because they were either not (or no longer) considered to be small or medium-sized enterprises or because the company was founded more than 12 years ago. In addition, according to the view of the tax authorities, equity participations in other group companies were not included in the scope of application.
Under the Draft Bill, the general tax allowance will not only increase to EUR 5,000 per year, but the scope of application of the deferred taxation in Sec. 19a EStG will also be significantly extended and an optional lump sum taxation at a rate of 25% will be introduced for the employers. The following overview compares the currently applicable law with the planned changes under the Draft Bill.
Overview of the main planned amendments
1. Tax allowance in Sec. 3 No. 39 EStG
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Current rules |
Draft Bill of the Financing for the Future Act |
| Increase of the tax allowance of Sec. 3 No. 39 EStG |
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| Requirement for tax allowance |
- Employee participation is open to all employees who have been continuously employed by the company for one year or longer.
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- Employee participation is open to all employees who have been continuously employed by the company for one year or longer.
- Participation must be granted in addition to the wages owed anyway (no wage conversion).
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| Indirect holding period for equity participations granted tax-free for the purposes of calculating the subsequent capital gains |
- No; the benefit in kind provided tax-free under the tax allowance is considered as acquisition costs when calculating the amount of capital gains, regardless of when the equity participation will be transferred.
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- Yes; the benefit in kind provided tax-free under the tax allowance will only be included in the acquisition costs when determining the amount of capital gains if the equity participation is not sold or transferred for no consideration within a period of three years (Sec. 17 Para. 2a and Sec. 20 Para. 4b EStG new version).
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2. Deferred taxation under Sec. 19a EstG for equity participations in start-up companies
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Current rules |
Draft Bill of the Financing for the Future Act |
| Doubling the thresholds for eligible companies |
- Eligible companies are the following:
- Companies that employ less than 250 employees and
- that either have annual sales of no more than EUR 50 million or an annual balance sheet total of no more than EUR 43 million
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- Eligible companies are the following:
- Companies that employ less than 500 employees and
- that either have annual sales of no more than EUR 100 million or an annual balance sheet total of no more than EUR 86 million
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| Extension of the time period for considering threshold values |
(Temporary tax exemption, provided that the threshold values were not exceeded at the time of transfer of the participation or in the previous calendar year) |
(Temporary tax exemption, provided that the threshold values were not exceeded at the time of transfer of the participation or in one of the six preceding calendar years) |
| Extension of the eligible period for foundation of the company |
(Foundation of the company within last 12 years) |
(Foundation of the company within last 20 years) |
| Extension of the scope of application to equity participations in group companies |
- Only equity participations in the employer’s company
(According to the tax authorities, participation in other companies of the same group within the meaning of Sec. 18 of the German Stock Corporation Act (Aktiengesetz (AktG)) is not covered.) |
- Also equity participations in other companies of the same group within the meaning of Sec. 18 AktG.
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| Extension of the period of the deferred taxation |
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(The longer period shall also apply to the participations acquired before 2024.) |
| Optional lump sum taxation at a rate of 25% |
(Taxation occurs on the basis of individual wage tax deduction characteristics.) |
- Yes, optional lump sum taxation at a rate of 25%
(Employer as debtor of the lump sum wage tax; passing on to the employee possible by means of a contractual agreement.) |
| Trigger event for deferred taxation |
- Taxation in the following circumstances:
- If participation is transferred in whole or in part
- Upon expiry of 12 years or termination of employment relationship
(So-called dry income problem, since taxation occurs without receipt of liquid funds) |
- Taxation in the following circumstances:
- If participation is transferred in whole or in part
- Upon the expiry of 20 years or termination of the employment relationship, unless the employer voluntarily and irrevocably accepts secondary liability for the wage tax to be withheld and remitted
(The employer cannot file a notification releasing them from the secondary wage tax liability anymore; elimination of the so-called dry income problem)
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| Limitation of the taxable amount in the event of buyback |
- Only general limitation to the fair market value of the participation (less any payments made by the employee) if lower than the tax-free amount
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- In the event of buyback upon termination of the employment relationship, limitation to the purchase price paid by the employer (less any payments made by the employee), if lower than the tax-free amount
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Perspective
The planned Financing for the Future Act is intended to strengthen Germany’s position as an international business location and make employee share participation schemes more attractive from a tax perspective. In particular, the extension of the scope of application of Section 19a EStG, including the introduction of the group clause (Konzernklausel), and the increase of the generally applicable tax allowance are very positive. It remains to be seen how the further legislative course will unfold and to what extent the planned measures will actually be implemented and applied in practice by the tax authorities.
We would be happy to answer any further questions you may have or assist you in introducing or adapting your employee participation program.
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