Income Tax Treatment of Employee Participation

We present the income tax framework of employee participation, which has become more attractive, especially for start-ups, with the introduction of the German Fund Location Act (“Fondsstandortgesetz”) on July 1, 2021.

Tax exemption of employee participation

Since July 1, 2021, an income tax exemption of EUR 1,440 per year has been granted for the non-cash benefits of employee participation provided free of charge or at a reduced price (Section 3 No. 39 of the German Income Tax Act). In addition, there is an exemption from social insurance contributions in the same amount.

The prerequisite is a direct asset participation of the employee in the employer’s company, e.g. in the form of shares, convertible bonds, profit participation certificates or shares in cooperatives/limited liability companies (“GmbHs”). Indirect asset participations such as investment shares as well as virtual participations (= simple promises by the employer under the law of obligations) or stock options that have not yet been exercised are excluded. Similarly, cash payments by the employer to the employee for the acquisition of such asset participations are not subject to income tax exemption. The employer may also engage a third party as a vicarious agent for the transfer of the asset participation - such as a credit institution in the case of the transfer of security papers.

In addition, the employer must make a corresponding offer regarding employee participation to all employees who have been in an employment relationship with the company for at least one year.

The income tax exemption also applies if the employee participation is granted to the employee as part of deferred compensation; it therefore does not have to be granted in addition to the salary that is owed anyway. However, social insurance law generally requires an additional benefit, so that in the case of deferred compensation the exemption from social insurance does not apply.

Special provision for income from employment in the case of employee participation

The non-cash benefits from employee/asset participations provided free of charge or at a reduced price, such as shares, convertible bonds, profit participation certificates or shares in cooperatives/ limited liability companies (“GmbHs”), which, however, in contrast to the above-mentioned tax exemption, must be expressly granted in addition to the salary owed anyway, are no longer subject to income/wage taxation in the calendar year in which they are transferred (Section 19a of the German Income Tax Act) as of July 1, 2021 - and to an unlimited extent.

Instead, it is possible to tax the corresponding non-cash benefits at a later date. Taxation takes place when the employee participation is transferred for a consideration or free of charge or the employment relationship with the previous employer is terminated, but no later than twelve years after it was originally granted.

The prerequisite for this is that the employer’s company has not exceeded the thresholds for microenterprises or small and medium-sized enterprises (SMEs); this is based either on the transfer date of the employee participation or the previous year. Accordingly, only companies that employ fewer than 250 persons and that either generate annual sales of no more than EUR 50 million or have an annual balance sheet total of no more than EUR 43 million are eligible. Furthermore, the company must not have been founded more than twelve years ago. In addition, the employee’s consent must be obtained for the application of this regulation.

However, the preferential treatment for income tax purposes does not apply to social insurance; in this respect, contributions are made at the time the employee participation is transferred.

The regulations on income/wage taxation of employee participations, which will already come into force in 2021, provide for all kinds of relief in this area. In particular, the deferral of taxation under the special provision for income from employment in the case of employee participation will significantly reduce the problem of so-called “dry income”, i.e. income/wage taxation without having the corresponding liquidity.

This offers a wide range of opportunities, especially for start-ups. With our experience, we are glad to support young companies and founders in expanding their global network and establishing themselves on the market. We would be delighted to advise you individually on the tax-optimized structure for your company. Please contact us!