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Under German law the granting of a stock option to an employee is not a taxable event. The Federal Tax Court has consistently held that an option granted to an employee permitting the future purchase of stock at a predetermined price results in taxable income at the time the option is exercised to the extent the market value of the shares at the time of exercise exceeds the exercise price (strike price).

However, there are voices in the literature who contend that no taxable income can result from exercise of an option because any advantage derived therefrom is outside of the context of the employment relationship and, as a purely "private" event, not subject to tax under German law. To appreciate this argument one must recall that German income tax law does not define income as any increase in net worth from whatever source derived, but rather defines seven categories of taxable income. One of these categories is dependent service income (employment income). The crux of the argument is that the exercise of the stock option cannot be made to fit into this category and that none of the other categories is applicable either. In an article published in 1995, Rosemarie Portner and Axel Boedefeld thus state that stock options must be valued and subjected to tax when granted (based on the chance of gain which they confer). However, this view has so far not been accepted by the tax authorities.


Section 38 par. 1 EStG requires an employer to deduct wage tax from an employee's salary. This includes the taxable benefit from exercise of a stock option. The withholding obligation cannot be avoided by having the option granted by an affiliated company (e.g. by the parent company), instead of by the employer himself. The wage tax regulations provide that the employer is still required to withhold if the payment is made by a related party.


If the foreign parent company wishes to charge its local subsidiary in Germany for the costs associated with exercise of a stock option by an employee, these costs will be deductible for tax purposes if the following requirements are met:

  • the overall arrangement must benefit the German subsidiary (e.g. provide a performance incentive for its employees);

  • in case of a controlling shareholder the charge-back agreement must be entered into in advance.

The terms of the arrangement between the parent and its subsidiary must be at arm's length. However, a stock option plan clearly benefits a German subsidiary if it helps motivate local management. Costs relating to the exercise of a stock option would then be deductible at the level of the subsidiary, much as are its standard salary payments to its staff.


Since the exercise of a stock option leads to taxable income for the employee, the incentive effect of the option is at least in part a function of the marginal tax rate of the employee in question. Since such tax rates for key employees are likely to approach 60 % under current conditions, companies may find that they have to offer quite expensive stock option packages in order to make the opportunity attractive enough to their key German personnel for it to have its desired affect.

As an alternative, we have developed plans under which employees purchase stock in the German entity for which they actually work at the present fair market value with an option of selling the stock back to the company (or a related entity) based on a contractual formula which reasonably values the stock based on the performance of the company in question. Such plans have two major advantages over the traditional options to purchase stock in the foreign group parent:

  • Firstly, the employee has a stake in the company for which he actually works, and is thus able by his own performance to make a fairly direct contribution to the value of his own investment.

  • Secondly, gain on resale of the stock can be tax free to the employee if properly structured.

Direct stock purchase plans of the type described thus can create management incentives which are both superior in quality and more economical than stock option plans. In other words, the employer receives not only more incentive for its money, but the incentive received is better as well.

It must be admitted, however, that implementation of direct stock incentive schemes of the sort described generally is more complicated than a standard stock option scheme, in part because of the difficult valuation problems they often pose.


This article treats the subjects covered in condensed form. It is intended to provide a general guide to the subject matter and should not be relied on as a basis for business decisions. Specialist advice must be sought with respect to your individual circumstances. We in particular insist that the tax law and other sources on which the article is based be consulted in the original, whether or not such sources are named in the article. Please note as well that later versions of this article or other articles on related topics may have since appeared on this database or elsewhere and should also be searched for and consulted. While our articles are carefully reviewed, we can accept no responsibility in the event of any inaccuracy or omission. Please note the date of each article and that subsequent related developments are not necessarily reported on in later articles. Any claims nevertheless raised on the basis of this article are subject to German substantive law and, to the extent permissible thereunder, to the exclusive jurisdiction of the courts in Frankfurt am Main, Germany. This article is the intellectual property of KPMG Deutsche Treuhand-Gesellschaft AG (KPMG Germany). Distribution to third persons is prohibited without our express written consent in advance.