Germany | Wage tax deferral for German start-ups in an international setting
Published on 31st Jan 2023
The Ministry of Finance is looking at whether the law should apply to granting shares in an employer's affiliated entity
There are a number of challenges posed by the new wage tax deferral for German start-ups in an international setting, but the regime prevents a premature taxation on the granting of start-up equity awards and shares and, therefore, the taxation of "dry income".
The ambiguous wording of the provision – section 19a of Germany's Income Tax Act – could also apply to equity awards granted by a foreign affiliated entity of the employer. In the meantime, this interpretation has been rejected by Germany's Ministry of Finance (MOF). Its decree of 16 November 2021 denies a wage tax deferral if the employee share scheme does not provide for a direct participation in the German employing entity itself.
However, the wording of the decree still leaves room to apply the wage tax deferral to certain scenarios in which the employee receives direct shares in a foreign-tax resident employer (such as a stock company). What these scenarios have in common is that the foreign employer has a presence in Germany (for example, through a permanent establishment or agent) and is, due to this presence, required to withhold German wage tax.
Although the wording and structure of the law should support such a view, it would not be surprising if the MOF would simply deny such application and update the decree accordingly.
Calls have been made against narrowing the application to direct participation in the employer. The MOF is currently discussing internally the possibility of an amendment of the law on whether the wage tax deferral should explicitly apply to the granting of shares in an employer’s affiliated entity.
The MOF pursues a narrow approach to the scope of application that is not coherent with the wording and structure of the law. Ongoing internal discussions of the MOF on potential changes of the law are still at an early stage.
As a result, international start-ups have currently only very limited room to structure employee share schemes suitable for a German wage tax deferral. Further, there are alternative structuring approaches that might, in effect, result also in a wage tax deferral without falling back to the special German wage tax deferral regime, such as using stock options, restricted stock units (RSUs) or "hurdle" shares. Although most of these approaches are designed under foreign law, they may in certain circumstances have a wage tax deferral effect under German tax law.
These alternative structuring approaches do not result in a timing mismatch between taxable event (grant of share) and point in time of potential realisation (sale of share). Mismatches often have the undesirable effect that taxes become due for a benefit that cannot be economically realised in the future. This could be seen in the case of certain well-known company RSU programmes, where these units were granted at a high value determined in the course of an initial public offering and wage tax was triggered. However, due to restrictions, the RSUs could only be sold months later and, at that time, the value of the RSUs had already declined significantly. Taxes were therefore paid for “dry income” that would never become liquid.
In cross-border cases, in which German tax-resident employees are working for foreign-tax resident employers, an application of the wage tax deferral should be considered, if the foreign employer is subject to withholding German wage tax; for example, in case of a permanent establishment. Legal certainty might be achieved through a binding ruling by the tax authorities.
Common schemes should in particular be examined regarding the taxable event: to which extent participation and sale will trigger tax. This should minimise the risk that the benefits from the employee scheme are economically diminished due to a taxation of unrealised values, which is often caused by transfer restrictions of the shares.
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