Germany Update: Employee participation in start-ups is becoming more attractive for tax purposes

Since 1 July 2021, significant parts of the new Fund Location Act (FoStoG).  The law contains significant changes for the taxation of employee shareholdings. The direct participation of employees in start-ups will become more attractive from a tax point of view as a part of the new regulations. Whether the changes can make the desired contribution to increasing the competitiveness of Germany as a business location and in particular of the local start-up scene remains to be seen.

Previously, direct participation was subject to wage and income tax at the time of acquisition

Direct equity investments are usually not transferred to an employee at market value, but regularly at a discount or even at nominal value. If the actual value of the company participation at the time of acquisition by the employee exceeds the purchase price to be paid by the employee, this has so far led to income from employment for the employee concerned and was subject to wage tax as a pecuniary advantage. Since the employee usually initially wants to hold the stake and does not want to or cannot sell it (blocking period for employee shares), he was regularly subject to a high tax burden without any actual liquidity inflow (taxation of so-called “dry income”). Despite possibly good prospects for an increase in the share value and considerable investment income – both of which are significantly cheaper to tax and especially advantageous compared to the taxation of payouts from a virtual participation – direct investments in start-ups that had already formed a considerable company value have therefore so far ultimately been unattractive. The tax-free allowance of EUR 360 was hardly significant in this respect.

Innovations by FoStoG: Increase of the allowance and postponement of taxation

This is where the innovations by the FoStoG, which have been in force since 1 July 2021, come in: The tax allowance will be increased from the previous 360 euros to 1,440 euros (§ 3 No. 39 EStG). In addition, a new § 19a will again be inserted into the Income Tax Act (EStG) for income from employment in the case of asset participations. The new rules apply to employee equity participations in companies that fall under the EU definition of micro, small and medium-sized enterprises(SMEs)and which were set up no more than 12 years ago. New equity participations for employees of such companies, which are granted at a reduced price or free of charge, should not be subject to taxation by payroll tax in the year of transfer with the consent of the employee in the payroll tax deduction procedure; only social security contributions are incurred. According to the new § 19a sec. 4 EStG, taxation as a pecuniary advantage should only take place if (1) the investment in the assets is transferred, (2) 12 years have passed since the transfer of the investment, or (3) the employment relationship with the previous employer is terminated.

The law thus ultimately regulates a postponement of taxation,which makes direct capital participation in the company initially seem quite attractive. Deviating from the government draft, the tax allowance has also been further increased, instead of the originally planned EUR 720 now to EUR 1,440 – which, however, still seems rather meagre. The new § 19a EStG also covers indirect shareholdings, i.e. if an employee is involved in the start-up in question via an investment company, provided that the investment company is a partnership. Difficulties could arise with regard to the valuation of the investment at the time of acquisition, since especially for young start-ups, the future prospects as a parameter for the company valuation are associated with high uncertainties and the usual update based on the historical data is not suitable for valuation. However, Paragraph 19a(4) of the EStG nevertheless provides that, in the event of a loss of value since the acquisition of the share, the market value of the shareholding (less co-payments made) is to be decisive at the time of taxation. The new regulation is criticized for the fact that the deferral of taxation ends after the expiry of time or in the event of a change of employer, which can ultimately lead to the taxation of “dry income” at a later date or in fact to an unreasonable restriction of the employee’s right of termination. The advantages and disadvantages of the new regulation as well as its application requirements should therefore be examined and weighed up on a case-by-case basis. The new regulation does not apply to any form of virtual participation or other pecuniary benefits, e.B. deferred compensation. For virtual participations, however, taxation only takes place at the time when the employee receives a payout.

Result

Despite open questions and sometimes justified criticism, the changes made by the FoStoG are likely to contribute in principle to making direct participation in a start-up more attractive for employees. However, the still low allowance of EUR 1,440 restricts the scope of application. Apart from this, the employee should only agree to the deferral of taxation after closer examination and consideration of the advantages and disadvantages of subsequent taxation. The new regulations of the FoStoG apply for the first time to investments acquired after 30.06.2021.

By Dr. Victoria Berger, MELCHERS, Germany, a Transatlantic Law International Affiliated Firm. 

For further information or for any assistance please contact germanylabor@transatlanticlaw.com

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