Draft of Future Financing Act Published – Tax-Free Share Schemes to Come?

The taxation of share schemes (“Mitarbeiterbeteiligungsprogramme”) as an instrument for recruitment and development of employees is, in part, regarded as problematic in Germany. Depending on the structure of the share scheme, especially taxable dry income needs to be avoided. In 2021, a deferral of income tax (sec. 19a Income Tax Act) was introduced for employees of small and medium-sized companies. According to that privilege, under certain conditions, employees are not liable to immediately pay income tax when they acquire shares at a discounted rate. Although this regulation has solved some of the issues arising from dry income, in practice there are still dry income situations, e.g., in the case of leaving employees, who might still face dry income situations. On April 12, 2023, the Federal Ministry of Finance (“MOF”) published a first draft of the Future Financing Act (“Draft Act”), which also includes changes—among others—for the Income Tax Act. The Draft Act intends to update the existing rules for the postponement of income tax in the case of share schemes and would also introduce several other tax relief measures.

Purpose of the Future Financing Act

The Draft Act shall introduce a number of changes to the law of financial markets, corporate law, and tax law. The purpose of these changes is the strengthening of the German capital market, as well as the improvement of Germany as an investment location.

With the amendments of the Income Tax Act (especially sec. 19a and sec. 3 No. 39 Income Tax Act), the recruitment and development of employees is a goal. Further on, the changes are intended to solve still existing problems of taxation of dry income, especially in the case of termination of the employment. The Draft Act also brings tax relief measures for employees of larger companies.

Amendments to the Income Tax Act

With the Draft Act, the scope of Sec. 19a Income Tax Act will be extended substantially. According to the Draft Act, employees of companies with an annual turnover of no more than 100 million euro or an annual balance sheet total of no more than 86 million euro in the past six calendar years can benefit from the postponement of income taxation. Compared to the currently existing rules, the thresholds of a company’s turnover or balance sheet will be doubled. Further on, the new rules would extend the scope for the privilege to companies that are up to 20 years old, compared to 12 years now. In addition, a company qualified for the postponement of income taxation is also a group company within the meaning of sec. 18 Stock Companies Act (“Aktiengesetz”). The MOF also clarifies that the shares can be granted either by the employer itself or by the founding shareholders. Further on, it is intended to extend the maximum time frame for income tax deferral accordingly, from 12 years to 20 years.

Another important change is the introduction of a flat tax rate of 25%. Anyone benefitting from the taxation postponement under the new rules could also benefit from the new flat tax rate without further requirements. The new rules shall also apply to employees receiving shares before 2024. Irrespective of the aforementioned requirements with respect to the postponement of taxation, the current allowance of 1440 euro will be increased to 5000 euro.

Tax-free employee share schemes

A major change would also be the opportunity for a tax-free receipt of shares within share schemes in the case that the employer irrevocably declares to the competent tax office his liability with respect to the employee`s wage tax. Once declared, the employer would irrevocably remain liable for the wage tax of the employee. However, in such situations, the employer can also benefit from the flat tax rate of 25%. With such a rule, the MOF would solve a major remaining issue of dry income taxation, as the employee when leaving might still not have received sufficient liquid funds to pay income tax.

Outlook

With the published Draft Act and the intended amendments to the Income Tax Act, the German legislator will bring some substantial tax relief measures for employee share schemes. Not only the extension of the postponement time frame, but also the introduction of a flat tax rate of 25% and a possible tax-free receipt of shares can help to make share schemes more attractive from a German tax perspective.

As the Future Finance Act is still a draft, it might be subject to changes in the ongoing legislative process. We will carefully monitor the future developments and keep you posted.

In the case of any queries, we are happy to advise.