Effective 1st January, 2024, the German legislator has further improved the tax environment for employee share plans as part of the Future Financing Act ("Zukunftsfinanzierungsgesetz"). The updated law includes, inter alia, an extended tax deferral period for employee shares in start-up companies, and an increase of the tax allowance for a so called "all-employee equity plan" to € 2.000.
Background
Prior to the introduction of Sec. 19a German Income Tax Act (Einkommensteuergesetz - EStG) as of 2021, a significant barrier existed for employee equity plans in particular for start-up companies in Germany, known as the "dry-income problem", which arose from the traditional tax treatment of employee shares. Under these rules, a taxable benefit in kind was immediately triggered if an employee acquired shares free of charge or at a reduced price ("discounted shares"). This resulted in several detrimental consequences like employees being faced with an upfront tax burden for an asset they could not readily sell. This might have forced start-up employers to either provide an additional cash advance to the employee for covering the taxes, which further burdened often resourced constrained start-up companies or implement less tax-attractive incentive plans like stock option plans or virtual (i.e. cash-based) share plans.
Recognizing these challenges, the German government introduced a special tax regime for employee equity plans in start-up companies in 2021. This provision, applicable to (qualifying) relatively young SME companies, offered a key benefit by generally deferring taxation on benefits in kind resulting from discounted shares until a later sale. This significantly mitigated the immediate financial burden on employees, fostering greater participation and enhancing their satisfaction with their employers. However, a couple of practical barriers remained, as the law continued to provide for taxation after 12 years following acquisition (so-called "long-stop-taxation") or upon termination of the employment relationship, so that the dry-income-problem was not fully resolved. Furthermore, its initial iteration was limited to a specific group of still relatively small and young companies, which severely restricted its practical applicability of the tax regime.
Recognizing these limitations, the Future Financing Act which came into force on January 1, 2024, introduced wider eligibility criteria, which significantly increases the number of startups that can leverage employee equity plans and further addressed the problem of dry income.
What's new as of January 1, 2024?
- Further tax deferral
in exchange for full employer liability: Even after the
expiry of the long-stop taxation period or on termination of the
employment relationship, no immediate taxation will take place of
the original benefit in kind if the employer voluntarily and
irrevocably declares to be fully liable for any wage taxes due on
the sale of the shares. This means that taxation can now be
deferred in full until the shares are finally sold and there is
sufficient liquidity to fund the wage taxes payable, provided that
the employer agreed to its unrestricted liability.
- Extended long-stop taxationperiod: The long-stop taxation is now extended to 15 years (instead of the previous 12 years) with a further possibility to avoid taxation without a share sale at all (please see above).
- Benefit also applies on shares granted
by the shareholder of the employer: Previously, it was
unclear if the tax deferral was also available if the shares were
not directly granted by the employing company, but by the
shareholder of the employing company (e.g. a holding company). The
amended law now makes clear that also shares granted by the
employer's shareholder qualify for the tax benefits, offering
greater flexibility for start-up companies.
- Increased company size thresholds: Companies
with up to 1,000 employees and annual revenues of not more than
€ 100 million or a balance sheet total of not more than €
86 million would now still qualify as a start-up company in the
meaning of the law, which represents a doubling of the revenue
respective balance sheet total thresholds and even a
quadruplication of the maximum number of employees a company may
have. This widens the scope of eligible companies and significantly
increases the applicability of the tax regime in practice.
- Extended founding period: In addition to the above-mentioned increased thresholds, the age of a company to be considered a start-up company in the sense of Sec. 19a EStG has also been significantly increased from 12 to 20 years, so that now also more established companies can benefit from the tax regime.
Even though these changes are very welcome, specific additional requirements for the tax benefit as must still be met. It is therefore important to seek advice from a tax advisor when structuring employee equity plans in start-up companies that should benefit from the special tax regime.
Increase of tax allowancefor all-employee equity plans
Alongside with the adjustments of the German start-up scheme, the Future Financing Act as well increased the tax allowance for all-employee equity plans (Sec. 3 No. 39 EStG) from € 1,440 p.a. to € 2,000 p.a., i.e. benefits in kind from qualifying employee share plans are now tax exempted up to € 2,000 per employee and year. This regulation is generally applicable to all employers, i.e. not limited to start-ups. Furthermore, claiming the tax allowance on discounted shares does not affect the cost basis used for calculating future capital gains. This basis remains fixed at the market value of the shares at the time of purchase, i.e. the tax-exempted benefit is not taxed even if the shares are sold at a later date and only future value increases are taxed as capital gains.
Initially, the draft bill of the Future Financing Act envisaged increasing the tax allowance to € 5,000. Moreover, the draft aimed to include a minimum holding period in order to be allowed to consider the fair market value at acquisition as cost basis, however, both changes were ultimately rejected.
Conclusion
The German government's revisions to Sec. 19a EStG mark a very positive development for employee equity plans within the start-up landscape. These changes significantly enhance the appeal of share plans for both companies and their employees and helps to hire and retain top talents through more competitive share plan offerings. It also strengthens Germany as a business location and makes it more attractive and competitive, at least for start-up companies, in an international environment.
Finally, the € 560 increase of the tax allowance (Sec. 3 No 39 EStG) for all-employee equity plans is a welcome step, however, it falls short of the proposed increase of € 5,000. This missed opportunity leaves room for further improvement, as a more substantial increase could incentivize broader adoption of all-employee equity plans and further enhance the overall impact of the reforms in start-up companies and other corporations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
