The new Section 19a EStG offers employees of young, growing companies the opportunity to postpone the actual taxation of a taxable benefit-in-kind derived from the transfer of shares.
Nevertheless, the requirements to make use of this new statutory provision are very strict and application is therefore very limited. Section 19a EStG is currently only applicable to so-called micro-, small-, and medium-sized enterprises (so-called “young SMEs”)2 that were founded less than 12 years ago. The use of the new regulation is elective and there is no obligation to make use of it.
The benefit would be achieved by postponing the taxable event until the realisation of a “substitute fact.” A substitute fact is an event which is considered relevant for taxation purposes in place of the moment when the employee acquires economic ownership of the shares.
According to the new regulations under German tax law the following events will be considered a substitute fact:
a. Sale of the shares
b. Termination of the employment relationship
c. Expiration of twelve years from the transfer of shares.
Ideally, taxation would only take place when the employee realises a profit via liquidation of the shareholding. (This would constitute substitute fact a. above.) In this case, an employee could be provided with shares from equity-based plans without having to cover wage tax that might otherwise be due upon transfer of the shares to the employee. However, in case of termination of the employment relationship or the expiration of 12 years (substitute facts b. and c.), any tax would become due although the shares have not been disposed of. In this case, the problem of “dry income” would only be postponed, rather than eliminated. This may be seen as problematic by companies and employees because there may still be situations where the employee will have to fund a tax payment for income that has not yet been realised (so-called “dry income”).
The deferral of taxation does not apply for social security purposes, because the new regulation is not considered to be applicable under the German Social Security Compensation Directive (Sozialversicherungsentgeltverordnung). This means that the deferred taxable benefit-in-kind should be considered to be subject to social security contributions with no deferral; i.e., social security contributions will be due upon receipt of the incentive income. In return, no social security contributions should arise on the taxable benefit-in-kind in the year that the substitute event takes place. The different treatment for social security purposes should only have impact if the ceilings for social security purposes are not already exceeded with other employment income.
Section 19a EStG also includes the requirement that non-taxed benefits-in-kind must be confirmed with the tax authorities by means of a free-of-charge binding ruling for wage tax purposes initiated by the employer. Differences between tax office and companies or employees, such as the valuation of benefits-in-kind, should be clarified in a timely manner and not only when a substitute fact occurs.
Potential Impacts of Section 19a EStG
The deferral of taxation under 19a EStG is not achieved by means of an interest-free tax deferral; rather, it is assumed that the monetary benefit only arises at the time of a substitute event. Consequently, the taxpayer’s circumstances at the time of the substitute event are relevant. For employees with lower taxable income in the year of deferral and higher income in the year of the substitute event (e.g., sale of shares) the applicable tax rate could be significantly increased. This means, assuming that salaries increase over the years, the application of Section 19a EStG could even be negative in terms of the overall tax burden due to the progression of German income tax.
The overall picture and situation of the employee should be considered when making use of this new regulation. Therefore, the new statutory provision stipulates that this ruling concerning the wage tax withholding procedure is only applicable with the consent of the employee.