The Future Financing Act, which reforms the taxation of management and employee participation models was passed on November 24, 2023. The relevant regulations came into force on January 1, 2024. A primary concern of the law is to enable particularly small and medium-sized enterprises to offer more tax-attractive employee participation models.
Increased Allowance (§ 3 No. 39 EStG) applicable under strict conditions
The tax-free allowance for corresponding employee capital participations (specifically: benefits from the provision of equity participations in the sense of the Fifth Equity Participation Act) is raised from 1,440 to 2,000 euros. In the draft bill, an increase to 5,000 euros was proposed, which, however, failed due to resistance from the Federal Council.
The precondition for this tax exemption remains that the participation program is offered to all employees who have been in continuous employment with the company for at least one year at the time of the offer. However, the design can be differentiated for valid reasons depending on the employee.
Conversions of remuneration (cash salary into tax-advantaged equity participations) remain possible.
Still no holding period for received equity participations
According to the original draft law, a holding period was intended to ensure that tax-free received employee capital participations are not sold tax-free within three years after transfer. In these scenarios, a subsequent taxation as capital income was to take place.
This did not become law, as it would have triggered extensive monitoring obligations for custodian banks.
Thus, for example, a part of the granted shares can still be sold immediately after receipt according to the “sell-to-cover” model to pay taxes and possibly social security contributions.
Expansion of § 19a EStG: Granting by shareholders of the employer expressly favored
Since June 1, 2021, § 19a EStG already regulates that monetary benefits from received equity participations to avoid taxation of “Dry Income” (income without cash flow) are taxed only at a later stage, such as at the time of sale.
The provision (as far as it applies) avoids, for example, that in the month of the allocation of free or discounted employee shares/capital participations, no cash salary is paid out at all or even wage tax claims arise against a manager or employee.
The scope of § 19a EStG is being expanded. Initially, participations granted by (founding) shareholders are also favored, not only those granted by the employer itself.
§ 19a EStG: Still (for now) no group clause
A group clause, according to which a group company would also have been considered a company of the employer and accordingly equity participations in affiliated companies would have been favored, was removed during the legislative process.
§ 19a EStG: Also restricted shares favored
The law now clarifies that the receipt of restricted (legally restricted in transfer) shares also constitutes a taxable benefit.
§ 19a EStG: Significantly expanded circle of favored companies/employers
According to § 19a paragraph 3 EStG, the favored deferred taxation is only possible if the employer’s company does not exceed certain thresholds at the time of the transfer of the equity participation. These thresholds are significantly expanded, so that companies with an annual turnover of up to 100 million euros (instead of 50 million euros) or an annual balance sheet total of up to 86 million euros (previously 43 million euros) are covered. In terms of employee numbers, companies with up to 1,000 employees will be eligible for the tax advantage in the future, if the company has not exceeded the thresholds either in the year of transfer or in any of the six preceding calendar years.
A company is now considered young if it has been in existence for a maximum of 20 years (instead of twelve) at the time of the participation program.
§ 19a EStG: Mandatory subsequent taxation in the absence of a sale only after 15 years
There are also simplifications for the subsequent taxation provisions according to § 19a paragraph 4 EStG, which make up for the non-taxed granting of equity participations.
First, the point in time (Long-Stop-Date) at which taxation must be made up for in the absence of a sale is postponed from twelve to 15 years. Even then, taxation is not mandatory, see point 10.
Repurchase Value Instead of Market Value as the Basis for Taxation
In the event of the beneficiary leaving the company (Leaver Event) and a repurchase of the shares by the employer, only the repurchase value should be relevant for taxation, not the market value, according to § 19a paragraph 4 sentence 4 EStG. This is a reasonable clarification.
Employer’s Assumption of Payroll Tax as a Tax-Exempt Measure
Furthermore, the tax events of “15 years elapsing” and “termination of the employment relationship” do not trigger immediate taxation if the employer irrevocably declares, no later than with the following payroll tax registration, to be liable for the payroll tax, according to § 19a paragraph 4a EStG. Taxation then occurs only upon the actual sale of the equity participation.
No Flat-Rate Taxation
The optional flat-rate taxation at a tax rate of 25% (plus solidarity surcharge) envisaged in the original draft legislation has been omitted, meaning that deferred taxation occurs at the progressive income tax rate and not as part of capital gains tax.
No Benefits for Social Security Contributions
The shift in the taxation date according to § 19a EStG does not affect social security contributions, which thus continue to be due at the time of the discounted transfer of equity participations as a benefit in kind if the relevant assessment bases are exceeded.
Conclusion and Outlook
The tax improvements for employee capital participation models are welcome and were urgently needed in the international context, even if not all proposed changes were implemented. Valuation of young, non-publicly traded companies remains challenging to estimate the monetary benefit granted through equity participation in the company. However, since 2021, the law has allowed this issue to be clarified with the tax office free of charge under certain conditions, via a payroll tax query.
It is disappointing that a group clause was omitted in the legislative reform. This would have been a very practical further relief for young corporate groups divided into various companies (e.g., cross-border structures).
For practice, the question of how hybrid equity and debt participations benefit from §19a EStG is intriguing. In the case of profit participation rights and other arrangements, this depends on the individual case.
