The draft bill of the Future Financing Act (ZuFinG) provides for improved framework conditions for Germany as a financial and business centre. In particular, the attractiveness for start-ups and future-oriented companies is to be increased through more favourable regulations on employee capital participation. However, the planned changes are generally of interest to companies of all sizes and sectors.

Background - Taxation of employee share ownership schemes

Incentivisation and more flexible remuneration through employee share ownership is also becoming increasingly important in Germany. Employee share ownership plans or ESOPs (Employee Stock Option Plans) are programmes in which employees are granted a stake in the company in the form of GmbH shares or shares at a reduced price. Participation via so-called profit participation rights or profit participation certificates is also possible. The non-cash benefit from the discounted transfer is subject to income tax and is generally taxable when the participation is granted, although the employee does not (initially) receive any income.

Section 19a EStG, which was only newly created in 2021, was intended to prevent this immediate taxation and thus make employee share ownership schemes more attractive. The regulation is mainly aimed at start-ups and young companies. § However, the current version of Section 19a EStG has a number of weaknesses, meaning that it is currently irrelevant in practice. This is now set to change with the ZuFinG, which is due to come into force on 1 January 2024.

Expansion of the scope of application to include "grown-ups", "late-stage" and growth companies

One of the main problems and criticisms is the scope of the regulation, which leaves out many future and growth companies. To date, only employees of companies that fall under the criteria for small and medium-sized enterprises (SMEs: maximum 250 employees, EUR 50 million turnover and EUR 43 million balance sheet total) in the current or previous calendar year can benefit from the tax relief under Section 19a EStG. In addition, a maximum of 12 years may have passed since the company was founded.

The SME criteria are now to be doubled and companies that are up to 20 years old are also to be included. In addition, the look-back period will be extended from one to six years: if the company in question has not exceeded the new thresholds in any of the last six years, Section 19a EStG will apply. Furthermore, shareholdings in companies affiliated with the employer company are also to be tax-privileged in future. This also opens up new opportunities for established companies with young subsidiaries.

Increase in the tax-free allowance

The annual tax-free allowance for the acquisition of employee shareholdings is to be increased from EUR 1,440 to EUR 5,000.

Showstopper "dry income" removed

The fundamental problem to be solved with employee share ownership schemes is that of so-called dry income, i.e. the taxation of a non-cash benefit. This is because the employee does not actually receive income until the shares are sold.

§ Although Section 19a of the German Income Tax Act (EStG) currently only provides for so-called longstop taxation after 12 years, there are also some problematic substitute realisation situations that also trigger taxation. In particular, a change of employer or termination of employment by the employee lead to immediate taxation.

Taxation is now to be deferred for 20 years. In addition, a change of employer or termination of employment by the employee or the expiry of the 20-year period will no longer trigger immediate taxation for the employee in future if the employer irrevocably assumes liability for income tax in the event of the actual sale of shares.

Flat-rate taxation of 25%

The draft also provides for the possibility of flat-rate taxation of the non-cash benefit in the amount of 25% (plus solidarity surcharge, if applicable). This would lead to a fundamentally uniform taxation of the granting and subsequent sale of the participation and is significantly more attractive than the wage tax rate of up to 45%.

Excursus: So-called hurdle shares as an alternative structure

If the draft is actually implemented, the granting of employee share ownership schemes will become much simpler and more attractive, both for companies and employees.

One relevant alternative in the current legal situation is the structuring of employee share ownership via so-called hurdle shares. These are shares that have a negative liquidation preference and therefore only allow participation in future earnings. The shares therefore have no value at the time they are granted, meaning that there is no taxable benefit in money's worth. However, such arrangements require a certain amount of structuring and should always be backed up by an income tax ruling.

Summary and outlook

The draft bill provides for a significant improvement in the tax framework for employee share ownership schemes and would be a first step towards promoting innovation and investment in Germany.