Blog post: Taxation of employee shareholdings
At some Swiss companies, it is customary to offer employees shares in the company as a partial component of their salary. Shares are a common form of participation, but not the only one. The taxation of employee shareholdings is subject to special regulations, which repeatedly leads to uncertainty among the taxpayers concerned. This article is intended to remedy this situation and clearly show you what is included under employee shareholdings, how and when they are taxed, and what you need to bear in mind.
What are employee stock options?
Employee share ownership refers to the part of the salary that compensates the employee’s work effort not in the form of money, but in the form of participation in the direct or indirect performance of the company.
The purpose of employee share ownership is to motivate the employee to a particular degree to participate in the success of the company by directly sharing in the company’s profit (or loss). Employee shareholdings are also intended to strengthen loyalty to the company.
How do employee shareholdings work?
A distinction is made between genuine and non-genuine employee stock ownership plans. In the case of the former, the employee actually becomes a shareholder or is given the prospect of becoming a shareholder by way of an entitlement.
In the case of non-genuine participation, the employee does not receive a share package (or the prospect of one) and therefore does not become a shareholder. However, he or she receives cash payments that depend on the performance of the share and thus participates indirectly in the success of the company.
There are different types of participation in both genuine and non-genuine employee shareholdings, which we will present to you in the next sections.
Genuine employee shareholdings
In the case of genuine employee shareholdings, there are three ways in which employees of a stock corporation can participate in the company.
1. Employee shares
If the employee receives a block of shares in the company, he or she participates directly in its equity. There are two different types of employee shares:
Free employee shares
The employee may freely dispose of these, i.e. he may freely sell or pledge them after receipt.
Restricted employee shares
If the shares are subject to a lock-up period, the employee may not sell or pledge them until this period has expired.
2. Employee options
Under this agreement, the employee is granted the right to purchase shares in the Company. The purchase must usually be made by a predefined exercise period. The shares are then purchased at a fixed exercise price.
Here, too, a blocking period may be agreed during which the employee may not sell the acquired shares.
3. Entitlements to employee shares
A vesting period offers the employee the prospect of acquiring shares at the end of a certain period (so-called vesting period). It is either agreed that the shares will be given to the employee free of charge or that they can be purchased at a preferential price. The entitlement is often linked to the duration of the employment relationship.
Non-genuine employee shareholdings
This type of participation is a fictitious share that reflects the performance of the real share. From an economic point of view, the employee is therefore on an equal footing with an actual shareholder, as he or she participates in the same way in the performance of the share, but without owning one of them.
If the management of a company participates in its performance without having ownership rights in the company, this is referred to as a co-investment.
Taxation of employee shareholdings
Employee shareholdings result in benefits because in most cases they are acquired either free of charge or at a preferential price. This means that there is a difference between the issue price and the fair value of the investment. From a tax perspective, this difference (benefit) is added to the earned income, so that taxes and social security contributions must be paid on it. The greater the difference, the higher the tax burden.
Taxation of employee shares
Employee shares are taxed immediately upon issue of the share package. The difference between the issue price and the fair market value serves as the basis for assessment. In the case of listed shares, the closing price on the day of purchase is deemed to be the fair value. In the case of unlisted shares, the fair market value is calculated by the employer.
A lock-up period is taken into account as a value-reducing factor when calculating the tax rate. A discount of 6% per vesting year is deducted from the fair market value, which reduces the difference (and thus the taxable income). A lock-up period of up to 10 years or 44% is deductible.
Taxation on sale
If the vesting period has expired and the employee wishes to sell his share package, which is now part of his private assets, a capital gain is tax-free or a loss is not deductible.
Taxation of employee stock options
Free employee options for listed shares are taxed at the time of issue. The same rules then apply as for the taxation of employee shares.
Blocked employee options, or those that are not listed on the stock exchange, are only taxed upon exercise (acquisition by employees) or sale. The proceeds from the sale or the gain on exercise are taxable.
Taxation of vested rights to employee shares
Vested rights to employee shares are not taxed until the vesting period has expired. The difference between the fair value of the shares at that time and their transfer price is taxed against income.
Taxation of non-genuine employee shareholdings
Non-genuine employee stock options are taxed at the time of inflow, i.e. when the employee receives the non-cash benefit. The entire non-cash benefit is then taxable with income. In the case of non-genuine employee shareholdings, it is therefore not possible to achieve a tax-free, private capital gain as is the case with genuine employee shareholdings.
« However, it becomes problematic when determining the fair value, as this is not sufficiently known because it is based on future profits. There is still no uniform regulation on how the fair market value of start-ups is determined. Different cantonal tax authorities use different calculation methods.»
Special case: employee shareholdings in start-ups
Employee share ownership is “common practice” at many startups because it preserves the young company’s liquidity by paying employees a lower salary but allowing them to share in future performance.
In the case of a genuine employee participation in the start-up, the same rules are applied as for an already established company. This means that the difference between the issue price and the market value is also added to the taxable income.
However, it becomes problematic when determining the fair value, as this is not sufficiently known because it is based on future profits. There is still no uniform regulation on how the fair market value of start-ups is determined. Different cantonal tax authorities use different calculation methods.
To ensure that employees do not suffer any tax disadvantages, they should contact the local tax authorities in advance and clarify how taxation will apply in such a case.
Tax experts can also help you with questions or problems relating to the topic of “employee participation” and show you your options so that you do not experience any tax disadvantages or even unpleasant surprises of hefty additional payments at the end of the tax year.
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