Employee share ownership: Tax incentives for start-ups through planned Future Financing Act
On April 3, 2023, the German Federal Ministry of Justice (“BJM”) and the German Federal Ministry of Finance (“BMF”) jointly presented the draft bill of the long-awaited law on the financing of future-securing investments (short: Future Financing Act – “ZuFinG”). Such law provides for important amendments and facilitations in the area of employee share ownership (asset participation) promising various improvements in particular for founders and start-ups.
Especially for founders and start-ups, participations in an enterprise’s capital and business success are an important instrument to attract and retain employees in the long term. By extending tax privileges and tailoring the German Income Tax Act’s (“EStG”) current regulations to founders’ and start-ups’ needs, Germany’s attractiveness as location for start-ups is to be strengthened.
The legislator plans in particular to significantly mitigate the so-called dry-income problem. Such term refers to the employees’ obligation to pay taxes on the transferred company shares although they have not (yet) received any liquidity.
What are the most important improvements for employee share ownership under the proposed Future Financing Act? (Summary)
- The tax deferral for non-cash benefits from the gratuitous or reduced-price allocation of employee share ownership is to be significantly extended (Art. 19a EStG-E).
- The tax deferral is to be extended to up to 20 years (Art. 19a (4) EStG-E). In certain cases, the law even provides for a tax deferral beyond the 20-year threshold (Art. 19a (4b EStG-E).
- The draft bill provides for the possibility of a 25 % flat-rate taxation in payroll tax (Art. 19a (4a) EStG-E).
- The tax-free allowance for employee share ownership as investment is to be increased from previously € 1,440 to € 5,000 (Art. 3 No. 39 EStG-E).
Extension of tax deferral for gratuitous or reduced-price allocation of employee ownership
Furthermore, the regulations on the tax deferral for the non-cash benefits obtained from the gratuitous or reduced-price allocation of certain employee share ownerships pursuant to Art. 19a EStG is to be significantly extended.
This is of particular interest for start-ups, since they, as micro companies and small and medium-sized enterprises (short: SME) typically meet the norm’s eligibility conditions. Furthermore, the thresholds applicable to SMEs are now to be doubled: now, companies with up to 500 employees and annual sales of EUR 100 million are to benefit from the privilege as well (Art. 19a (3) EStG-E).
In addition, the scope of application of Art. 19a EStG is to be extended to that effect that the tax deferral is also to apply to employee share ownerships the employees receive from their employer’s shareholders (Art. 19a (1) EStG-E). This would facilitate the handling in particular for start-ups, since founders can transfer to their employees their own already existing company shares.
By explicitly including a group regulation, the granting of participations to other group companies pursuant to Art. 18 AktG (German Stock Corporation Act) is to be covered by the privilege as well (Art. 19a (1) sentence 3 EStG-E). Such an interpretation of Art. 19a EStG in the sense of a group regulation had previously been rejected (subsection 34 of the BMF letter dated November 16, 2021, Federal Tax Gazette, I page 2308).
The extension of the privilege’s period of application for the issue of employee participations from previously twelve to now up to 20 years after formation of the company is also to be welcomed (Art. 19a (3) EStG-E).
Extension of the tax deferral to up to 20 years
The deferral of taxation effected by Art. 19a EStG is to be significantly extended and taxes will in future be due no later than after 20 years instead of twelve years as was the case before (Art. 19a (4) sentence 1 no. 2 EStG-E). As before, however, this will only apply if no other reason interrupting the tax deferral under Art. 19a (4) sentence 1 no. 1 or no. 3 EStG has been realized in advance.
In order to mitigate high tax burdens, the draft bill also provides that the tax deferral might even be extended beyond the 20-year threshold if the employer irrevocably declares, no later than in the payroll tax return following the relevant event, to be liable for payroll tax pursuant to Art. 42d EStG in case of a disposal of the share ownership and cannot opt out of such liability (Art. 19a (4b) EStG-E). Such declaration by the employer is also intended to suspend taxation pursuant to Art. 19a (4) sentence 1 no. 3 EStG in case of the employment’s termination.
Consequently, in these cases, the non-cash benefit would become subject to payroll tax only upon the participation’s disposal. This is appropriate since at such time the employee also receives the corresponding liquidity.
25 % flat-rate taxation in payroll tax
The draft bill also provides for a significant relief for taxpayers by granting the employer the option of deducting income tax at a flat rate of 25 % (Art. 19a (4a) EStG-E).
Increase of tax-exempt receipt of employee share ownership to € 5,000
The threshold for the receipt of tax-exempt employee share ownership as non-cash benefit is to be increased from previously € 1,440 to € 5,000, if these are granted in addition to remuneration (Art. 3 No. 39 EStG-E). In connection herewith, however, it should be observed that the tax-exempt proportion does not result in acquisition costs and as such a possibly higher capital gain if the participation is sold within a period of three years after its acquisition (Art. 20 (4b) EStG-E and Art. 17 (2a) EStG-E). The holding period is to ensure a sustained participation in the company and to avoid misuse but is quite moderate given its intended purpose.
The draft bill will now go to departmental coordination. We will follow its progress closely and keep you informed.