Germany: Future Financing Act: Improved Conditions for the Tax Treatment of ESOPs

In mid-April, the draft bill on the Future Financing Act (Referentenentwurf für das Zukunftsfinanzierungsgesetz - RefE-ZuFinG) was presented (we had already reported on this). In the meantime, the government draft of the Future Financing Act (Regierungsentwurf zum Zukunftsfinanzierungsgesetz - RegE-ZuFinG) has been published (17.08.2023). The most important key points and changes at a glance.

Tightening of the realization criteria

For the most part, the realization criteria will remain as envisaged in the RefE-ZuFinG (see also our Insight from April 19, 2023).

No flat-rate wage tax

Compared to the RefE-ZuFinG, the option for the employer to tax the non-cash benefit at a flat rate of 25% has been eliminated. It therefore remains the case that the non-cash benefit granted by the share transfer is ultimately subject to taxation at the employee's personal income tax rate (typically 42%).

Tax-free allowance for benefits paid "in addition to the salary owed in any event”

It remains the case that the tax-free allowance for employee participation (Sec. 3 no. 39 Sentence 1 German Income Tax Act - EStG) is to be increased from currently EUR 1,440 to EUR 5,000. However, according to RegE-FinG, it is to be required that the benefits are granted in addition to the salary owed anyway within the meaning of Sec. 8 (4) EStG, insofar as they exceed the amount of EUR 2,000 per calendar year.

This is intended to prevent unwanted arrangements (wage optimization). It is also planned to establish a holding (vesting) period by introducing a new section Sec. 20 (4b) in the Income Tax Act in order to counteract undesirable circumvention of the tax-free allowance.

Blocking or holding periods for tax-privileged equity participations

Due to the lack of blocking or holding periods, it has so far been possible in principle for tax-privileged equity participations to be sold by employees immediately after they have been transferred without their tax exemption being withdrawn or otherwise denied. The proposed new regulation now provides that the tax-exempt non-cash benefits do not count as acquisition costs when calculating capital income, provided that the equity participation is sold or transferred free of charge within three years. As a consequence, the final withholding tax of 25% will be levied not only on potential gains from disposals, but also on the previously tax-free treated salary portion. According to (to be newly inserted) Sec. 17 (2a) Sentence 6 EStG, the provisions of Sec. 20 (4b) EStG (new version) are also relevant for situations in which the employee holds an equity participation of 1% or more in the company of his employer.

Valuation issues

The RegE-ZuFinG does not address the issue of valuation of the shares granted. However, a valuation is necessary in order to determine the value and thus the amount of the non-cash benefit granted as part of the transfer of shares that will be taxed at a later date. Determining the value of a start-up or scale-up is by its very nature challenging, and conventional valuation methods are often unsuitable in precisely this context. Currently, and apparently also in the future (according to the RefE and RegE-ZuFinG), the permanent establishment tax office shall in principle confirm the non-cash benefit granted by the employer after the transfer of the shares in the company and thus, as a result, also the value of the non-cash benefit by way of the wage tax ruling (Lohnsteueranrufungsauskunft). This procedure is likely to be considered insufficient in many constellations, especially since both the valuation difficulties remain and the wage tax ruling does not have any binding effect for the employee's tax office at the place of residence in the context of the tax assessment.

The amendments to the Income Tax Act are scheduled to take effect on January 1, 2024. The approvals of the German Federal Parliament (Bundestag) and the German Federal Council (Bundesrat) are still pending.