Dr Bert Kimpel


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Dr Bert Kimpel


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10 December 2020

ESOP, VSOP and management incentive schemes

  • In-depth analysis

Fund Location Act (draft bill) - Status 1 December 2020

Taxation of employee shares to be changed - what does this mean exactly?


  • A new draft bill is about to solve the dry income issue. It is important that it is only a draft. The following comments should therefore be seen under the proviso that the draft can still be amended and refer to the draft of 1 December 2020. 
  • The planned new regulation solves the issue of so-called dry income. The typical scenario is that the employee receives shares which is a benefit in kind for income tax purposes triggering income/wage taxes – but the employee does not get money to pay the taxes. If, for example, the employee is to receive shares in a GmbH (German limited liability corporation) whose value is 100,000 Euros, then wage tax is triggered, regardless of whether the corresponding liquidity is available or not. It is obvious that this tax consequence dissuades many from choosing such a form of employee participation.

The draft of the so-called Fund Location Act provides for a new regulation in the Income Tax Act which expressly states that no monetary advantage is accrued at the date of share transfer (deferred taxation) (Section 19a EStG-E):

„Section 19a

Special rule for income from employment in the case of participation in capital

(1) If an employee is transferred by his employer, free of charge or at a reduced price, in addition to the remuneration already owed, a share of assets within the meaning of Section 2 Para. 1 No. 1 (a), (b) and (f) to (l) and Para. 2 to 5 of the Fifth Capital Accumulation Act in the employer's enterprise, the advantage shall not be subject to taxation under Section 19 or to wage tax deduction in the calendar year of the transfer under the conditions set out in paragraphs 2 and 3. When determining the advantage, the tax-free amount pursuant to Section 3 No. 39 is to be deducted if the relevant conditions are met. Section 39b Para. 2 sentence 5 number 3 shall apply. The acquisition costs are to be assessed at the fair market value of the asset participation.

2. The temporary non-taxation referred to in paragraph 1 may be applied in the payroll tax deduction procedure only with the consent of the employee. The temporary non-taxation may not be made up for in the course of the assessment for income tax.

3. Paragraph 1 shall apply only if, at the time of the transfer of the shareholding, the employer's undertaking does not exceed the thresholds laid down in Article 2 Para. 1 of the Annex to Commission Recommendation of 6 May 2003 concerning the definition of micro, small and medium-sized enterprises (OJ L 124, 20.5.2003, p. 36), as amended, or did not exceed those thresholds in the previous calendar year and was not set up more than ten years previously. 

(4) Wages not taxed in accordance with subsection 1 shall be subject to taxation in accordance with Section 19 and to the deduction of income tax as other income if

  1. the participation in assets is transferred in whole or in part, whether for payment or free of charge, in particular also in the cases of Section 17 Para. 4 and Section 20 Para. 2 sentence 2 or in the case of contributions to business assets,
  2. ten years have elapsed since the transfer of the shareholding, or
  3. the employment relationship with the previous employer is terminated.
In the cases referred to in the first sentence, Section 34 Para. 1 and section 39b Para. 3, sentences 9 and 10 shall apply mutatis mutandis to the wages to be taxed if at least three years have elapsed since the transfer of the share of assets. If, in the cases referred to in the first sentence, the fair market value of the share of the assets less any additional payments made by the employee in the case of the transfer at a reduced rate is lower than the wage not taxed under paragraph 1, only the fair market value of the share of the assets less any additional payments made by the employee shall be subject to taxation. In the cases of sentence 3, in addition to the additional payments made, only the wages actually taxed shall be deemed to be acquisition costs within the meaning of Sections 17 and 20. Sentences 3 and 4 shall not apply insofar as the reduction in value is not due to operational reasons or is based on a measure under company law, in particular a distribution or return of deposits. 
(5) The fair market value of the share of assets not taxed under paragraph 1 and the other details of the taxation procedure carried out under the preceding paragraphs shall be recorded by the employer in the payroll account.”
The draft regulates the timing of its application (Section 52 Para. 27 EStG-E):

“(27) Section 19a is applicable for the first time to assets transferred after 30 June 2021. ”


The mechanics of the new regulation can be summarized as follows: If the employee receives objectively valuable shares free of charge, which are not sold until later, then the pecuniary advantage is taxed as salary only at the time of sale and thus "retroactively".

It is exciting as far as the increase in value is concerned, which was achieved after the acquisition by the employee and which will then be realized in the event of sale. Here, a distinction must be made between the original value (wages, see above) and the hidden reserves formed thereafter.


Employee A is to receive shares in the S GmbH where he is employed free of charge at the end of 2021. The shares (1.5%) then have a value of 100,000 Euros. Later, in 2023, all shares in S GmbH will be sold. A's shares will have a purchase price of 300,000 Euros.


  • In 2021, A does not receive any monetary advantage. 
  • In 2023, A has to pay tax on the first 100,000 Euros as a salary. 
  • The remaining 200,000 Euros are taxable as capital gains in accordance with Section 17 EStG. 
  • As a result, A has to pay full tax on the first 100,000 Euros (e.g. 42%) and only 60% will be taxable at the individual tax rate on the remaining 200,000 Euros (partial income procedure, tax rate e.g. 25.2%).
  • If at least three years had elapsed since the transfer of the shares, the so-called fifth rule pursuant to Section 34 Para. 1 EStG would apply to the salary portion. The fifths rule has the effect of curbing tariffs. Put simply, current income is increased by only one fifth of the additional income (here: the value of the participation), and the tax due on this increase is then multiplied by five. In combination with a progressively increasing tax scale, the effect is clear.

Modification of the example

A would like to realize the further 200,000 Euros later in a tax-efficient manner and is considering whether he should not transfer the shares to a private holding company at the beginning, because this would then be able to realize capital gains almost tax-free later (participation exemption).


  • At the time of the contribution, A has to pay tax on the first 100,000 Euros as salary (full tax rate). 
  • In terms of value creation, the tax rate at the level of his holding company would be only about 1.5% (i.e. the future increase in value, e.g.200,000 Euros). 
  • A (provisionally) tax-free transfer directly to the holding company is likely to contradict the draft law. 
  • In other words, A has to decide whether he will not pay tax for the time being (first portion in the amount of 100,000 Euros) or whether he will later realize the future increase in value with only 1.5% tax.
Brief commentary on the draft law

No dry income, paragraph 1, first sentence

  • At the heart of the planned new rules is that the non-cash benefit will not be taxed for the time being. 
  • It covers both free share (or other eligible asset) transfers and transfers at a reduced price. 
  • The transfer must relate to eligible assets (shares in GmbH etc.) in accordance with the investment catalogue of the Fifth Capital Formation Act.
  • These asset participations must exist in the employer's company. 
  • Virtual shares or ESOP or mere bonus payments are not covered by the new tax rules.
  • Asset-sharing schemes must be granted in addition to the salary already owed.

Tax allowance, paragraph 1, sentence 2

According to sentence 2, the tax-free amount pursuant to Section 3 No. 39 EStG must be deducted once when determining the advantage within the meaning of sentence 1 if the corresponding conditions (cf. Section 3 No. 39 sentence 2 EStG) are met. Under the new regulation, the tax-free amount is 720 Euros.

Obligation to pay social security contributions, paragraph 1, sentence 3

  • Non-taxed income from the transfer of a share of assets is nevertheless subject to social security contributions. To this end, the Fdraft bill amends Article 1 Para. 1, first sentence, point 1, second half of the SvEV (Article 7 Para. 1 FoG). 
  • The social security contributions are included in the lump-sum pension plan in accordance with Section 19a Para. 1 sentence 3 EStG-E. 
  • In the cases of Section 19a Para. 4, sentence 1 EStG-E (e.g. sale or expiry of ten years or termination of employment with the employer), taxation as wages is made up for. Social security contributions are then no longer incurred.

Acquisition costs, paragraph 1, sentence 4 

  • Pursuant to sentence 4, the acquisition costs are to be stated at the fair market value of the investment.
  • This means that up to the fair market value at the time of transfer, the share/asset value qualifies as salary (full taxation, but deferred) – and it means that the future increase in value will be taxed as capital income (reduced tax rate).
  • This addresses a very crucial aspect. The future increases in value are no longer recorded as wages, see example above.
  • If the employer wants to have legal certainty regarding the wage tax treatment at the time of the transfer of the asset shares, he can obtain a call information (Section 42e EStG). This also applies to deferred taxation under Section 19a paragraph 4 EStG.

Employee consent requirement, paragraph 2

According to paragraph 2, the employee's consent is required (sentence 1) and will not be taxed (dry income) in the course of the income tax assessment (sentence 2).

Eligible SMEs, paragraph 3

  • The conditions are that the company must have invested in small and medium-sized enterprises (SMEs) founded no more than ten years ago
  • SMEs: fewer than 250 employees, annual turnover not exceeding 50 million Euros or annual balance sheet total not exceeding 43 million Euros. 
  • The thresholds must not have been exceeded at the time of the transfer or in the previous calendar year in order to allow for temporary non-taxation of the benefit derived from the transfer of a share of assets. 

Deferred taxation as wages, paragraph 4, sentence 1

The draft law aims to solve the problem of so-called dry income - but does not intend to waive any taxation of it. According to the draft bill, the following cases will trigger downstream taxation:

  • According to No. 1 Var. 1 the sale of the asset;
  • in accordance with No. 1 Var. 2 a transfer free of charge; in particular, cases of Section 17 Para. 4 EStG (e.g. liquidation of the corporation) or Section 20 Para. 4 sentence 2 EStG (hidden contribution, if participation is less than 1%) or contributions to business assets (e.g. to a partnership generating business income) are regulated;
  • in accordance with No. 2 with the expiry of ten years since the transfer;
  • pursuant to No. 3 upon termination of the employment relationship with the employer. A transfer of business according to Section 613a BGB (Civil Code) is not a termination triggering subsequent taxation. 

Fifth rule, paragraph 4, sentence 2

According to this, the tariff reduction pursuant to Section 34 Para. 1EStG applies if at least three years have passed since the transfer of the asset share. The tariff reduction is already applicable in the wage tax deduction procedure. 

The practical effect of this facilitation is likely to be comparatively small, especially in the case of assets with significant value.

Downside protection, paragraph 4, sentence 3

If the value of the capital participation (including additional acquisition costs) is lower later when taxed than at the beginning of the transfer, only the later (lower) value will be used as the basis for taxation.

Acquisition costs of the asset, paragraph 4, sentence 4

The "tax value" of the assets (e.g. shares in GmbH) also constitutes the acquisition costs for income tax purposes. This is necessary in order to avoid double recognition of subsequent increases in value.

Correction of valuations, paragraph 4 sentence 5

Impairment losses are not recognized (i.e. for taxation as wages and correspondingly for acquisition costs) if the impairment is not caused by operational reasons or if the impairment is based on a measure under company law, in particular a distribution or return of investment.

Recording in the payroll account, paragraph 5

The provisionally untaxed fair market value of the participation and other information must be recorded by the employer in the payroll account. The employee will be informed accordingly about the pay slip. In this way he can understand the tax treatment himself.

Date of application, Section 52 Para. 27 EStG-E

The new regulation is to apply from 1 July 2021, the date of transfer of the shares being decisive. Whether this refers to civil law effectiveness or the transfer of economic ownership is not specified. It would seem appropriate to refer to the transfer of economic ownership. 


The subsequent taxable events referred to in paragraph 4 may not be appropriate in all cases. 

  • It is therefore incomprehensible why ten years since transfer should form a rigid boundary. Firstly, there may be cases where the shareholding has to be held longer. In this case, the law uses a guillotine to force the emloyee to obtain liquidity without any apparent reason. After all, according to the wording of the law, one share may be almost twenty years old, whereas shares of newly founded start-ups must be realized before the ten years have expired. 
  • It is also doubtful why the termination of the employment relationship should be a triggering event for taxation. As a result, a leaver would either have to have a lot of liquidity or would have to squander his shares. Is such an incarceration effect intended? It does not make sense even after long consideration. 
  • The same applies in the case of inheritance. Here too, subsequent taxation would be triggered. But there is no reason why one should not wait until the actual realization. 
  • But even in lifetime there is the threat of adversity. Since any transfer is harmful, even those in the course of divorce are likely to lead to taxes and thus to liquidity needs.

Effects on design practice?

  • The problem of dry income outlined above has so far led to alternative arrangements in practice. In essence, an attempt is being made to reduce the tax value of the shares to such an extent that it is possible for employees to join the company.

    These arrangements will no longer be necessary because the taxation of the non-cash benefit will be deferred. It is also to be welcomed that the draft provides for a cap on deferred taxation to the value applicable later. This means that in the event of decreasing values, the employee is not trapped in the higher original value.

    In this respect, a switch to virtual investments (VSOP but also ESOP) is no longer necessary and is even disadvantageous from a tax perspective - from the employee's point of view.

    However, this only applies as far as the definition of SMEs is sufficient. In all other cases, the existing issues remain.

    There will therefore be two systems. The first will be for eligible SMEs and the second for all other (growth) companies.
  • Since the draft law only covers certain forms of employee financial participation, all "insufficient" programs or structures are likely to be reorganized soon. This applies, for example, to virtual shareholdings, which were only introduced to avoid taxation of dry income. Or option programs (ESOP), which also lead to full taxation as wages if the option is only exercised on exit.
  • In the light of the new legislation, many option holders would probably look closely at whether they could exercise their options before the exit. This would be attractive from a tax point of view - and "free of charge". 
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