Fresh Impetus for Employee Stock Ownership Plans (ESOPs)? The Proposal for a Viable Investments Act Package

The Ministry for Finance and the Ministry of Justice presented their proposal for a viable investments act (Zukunftsfinanzierungsgesetz - ZuFinG) yesterday (12.04.2023). It contains reliefs with regard to employee stock ownership schemes. Therefore, several amendments to section 19a of the German Income Tax Act (EStG) are being proposed. This disposition was only introduced in 2021. It provides for a special tax deferral in order to attenuate the so-called dry income problem for employees. The tax burden only arises once (i) the participation is transferred, (ii) the employment is being terminated or (iii) 12 years have lapsed. This is supposed to encourage employee participation with real shares (ESOPs). We now want to summarise the main amendments proposed for section 19a EStG.

Granting of the Participation by Shareholders

First of all, the proposal clarifies that employee stock ownership may be granted by shareholders of the employer. This means that founders and their respective holding companies as well as investors are included. This clarification is presumably very much appreciated, as it was not that obvious as it might have seemed.

Inclusion of Group Companies

Moreover, group companies in the sense of section 18 of the German Stock Corporation Act (AktG) shall be included. In the future, participations in group companies shall become eligible by extending the scope of § 19a EStG to them. This amendment would open new possibilities for the structuring of employee stock ownership.

Lowering of the Eligibility Criteria

Furthermore, the factual eligibility criteria for companies shall be lowered. These criteria were perceived as being too extensive until now. In accordance with the proposal, companies shall be eligible under section 19a EStG if they were incorporated within the last 20 years. Currently, the incorporation must have taken place within the last 12 years. Additionally, the thresholds regarding the number of employees and the turnover shall be lifted to the double SME-thresholds. In consequence, companies with (i) up to 500 employees and (ii) an annual turnover of up to 100 Mio. € or an annual balance sheet of up to 86 Mio. € shall become eligible. Up to now, these thresholds amount to (i) 250 employees and (ii) an annual turnover not exceeding 50 Mio. € or an annual balance sheet not exceeding 43 Mio. €. On top of this, it shall be sufficient that a company has not exceeded the new thresholds during one of the last six years. Especially slightly bigger companies will benefit from this amendment, as they are more likely to fit the new eligibility criteria.

Extension of the Tax Deferral Period

The proposal provides for an extension of the period of the tax deferral from 12 to 20 years. This means that the taxation falls only due after the lapse of 20 years; in so far, the participation has not been transferred or the employment has not been terminated before. The extension of the tax deferral period shall have retroactive effect and apply to employee participation schemes granted before 2024. Companies which have already made use of section 19a EStG in its current version and their employees will therefore benefit from the extension.

Special Treatment of Leaver-Schemes

In addition, so-called leaver-schemes are explicitly taken into account. These reserve the right to the company, to demand the retransfer of its shares, in case the employment is being terminated. In this event, the taxation shall no longer be based on the fair value of the participation but on the consideration actually paid by the employer. Usually, this consideration for the withdrawal of shares is significantly lower than the fair value of the participation. Therefore, this would be a hands-on provision.

Opt-in for Flat-Rate Taxation

Another new key point shall be the introduction of a possibly flat-rate taxation. It is designed as an opt-in solution and the employer shall have the choice to make use of this possibility. The wage tax shall be levied at a fixed tax rate of 25%. As a consequence, the risk of a significant increase of the personal wage tax is being eliminated. The employer is the tax debtor. However, it shall be possible to pass on the tax burden resulting from the flat-rate taxation to the employees by a special contractual provision.

Optional Assumption of Liability

Finally, the employer shall have the option to assume the liability for the payment of the wage tax. In case the employer assumes the liability, only the transfer of the participation will trigger taxation; the termination of the employment and the lapse of the 20 years period will no longer trigger taxation. The assumption of liability and the flat-rate taxation can even by cumulated by the employer.

Checklist

Please find a checklist on the proposed amendments below:

1. Granting of the participation by a shareholder of the employer
2. Inclusion of group companies
3. Attenuation of the eligibility criteria (20 years + double SME-thresholds)
4. Extension of the tax deferral period to 20 years
5. Special treatment of leaver-schemes
6. Opt-in for flat-rate taxation at a rate of 25%
7. Optional assumption of liability