GERMANY Law and Practice Contributed by: Carsten Berrar, Florian Späth and Heiko Blaut, Sullivan & Cromwell LLP
ered to accrue to the option holder as and when they exercise the option and acquire underlying shares at a discounted rate; only at this point is the monetary benefit realised and subject to taxation. As a result, employees are required to pay taxes on a non-cash sum, unless the time of exercise coincided with a liquidity event, potentially resulting in significant additional tax payments of up to 45% (plus a 5.5% solidarity surcharge thereon, resulting in an aggregate tax rate of 47.475% plus church tax, if applicable) in income tax on the benefit (dry income). Any capital gains from the increase of the value of the granted shareholding after the acquisition are subject to Capital Gains Tax. VSOP VSOPs do not entail dry income events as they are taxed upon the actual cash payment to the employee. However, VSOPs trigger a full taxa - tion at a rate of up to 47.475% in income tax/ solidary surcharge (plus church tax, if applica - ble), not offering any option to allocate at least part of the future increase in company value to Capital Gains Taxation. Hurdle Shares In order to overcome the disadvantages of the above instruments, hurdle shares have become increasingly popular in the German market. The envisaged tax treatment of hurdle shares is that the employee can acquire the shares for free/at a significant discount due to the “negative liqui- dation preference” attached to the shares. Not - withstanding the inherent “option value” of hur- dle shares, the negative liquidation preference is designed to result in a low/no value of the shares granted to the employee and, thereby, ideally avoid a dry income taxation. Any future increase of the company’s valuation is meant to permit Capital Gains Tax treatment. In this con - text, taxpayers often try to obtain a binding rul -
ing for the desired tax treatment of hurdle shares which, however, has become increasingly diffi - cult in the recent past. As a result, there remains a legal uncertainty with regard to the valuation of the negative liquidation preference. Tax Revisions to ESOP Schemes (Physical Shares Subject to Reverse Vesting Provisions) German tax law basically offers two benefits for the grant of physical company shares – ie, tax benefits only applicable to ESOPs, stock options and (likely) hurdle shares but not to VSOPs. German tax law may, subject to the satisfaction of certain conditions, permit a deduction of up to EUR2,000 from the income resulting from the acquisition. In practice, this deduction is, due to this low amount, not important for the structur - ing of incentives. More importantly, income tax resulting from the acquisition of discounted shares may be deferred until the occurrence of certain events (Section 19a of the German Income Tax Act ( Einkommensteuergesetz , or EStG)). This may result in an avoidance of the dry income prob - lem while enabling the employee to acquire the company shares at an early point in time so as to receive a preferential Capital Gains Tax treat - ment on the future increase of company value. This rule should generally also apply to Profit Participation Rights. However, this must be examined on a case-by-case basis, depending on the specific structure of this instrument. The enhancements and a broadening of com - pany eligibility criteria of Section 19a EStG under the Future Financing Act and the Fund Loca - tion Act ( Fondstandortgesetz ) led to a significant increase in incentive programmes under the regime of Section 19a EStG. Notably, the change
227 CHAMBERS.COM
Powered by FlippingBook