Employee shareholdings - a challenge

From an operational point of view, employee participation plans help to preserve the company's liquidity, as employee participation securities are issued instead of cash wages. Due to this liquidity effect, employee stock ownership plans are very popular, especially among start-up companies.

Although there are many advantages of owning participation shares of a company for employees, it should be borne in mind that the issue of preference shares, i.e. shares issued to employees on preferential terms, has tax and social security consequences for employees. The difference between the agreed preferential price and the actual value of the share qualifies as taxable income for the employee.

The FTA has issued the Circular no. 37 for the tax regulation of various forms of employee share ownership. It was revised in 2020 and published on 30 October 2020. The changes came into force on 1 January 2021. They affect, among other things, the taxation of the so-called "excess profit" in the event of the sale of non-listed employee shares. The revision was prompted in particular by various parliamentary initiatives to improve the tax environment for start-ups.

Direct federal tax

Definition of employee share ownership

First, the question arises as to which shares held by an employee qualify as employee shares at all. According to the revised Circular no. 37, shares acquired at the time of the company founding, as well as shares acquired by an employee on terms that would be granted to an independent third party, are explicitly considered not to be employee shares.

Types of employee stock options

In Circular No. 37, the FTA first divides employee stock options into free and restricted employee shares:

Free employee shares

Free employee shares are shares that an employee can manage without restriction. In the case of free employee shares, the difference between the fair market value or formula value of the employee shares and the agreed preferential price is taxed as acquisition income.

Restricted employee shares

As a rule, restricted employee shares are subject to a time limit on disposal (blocking period). During this blocking period, the employee may not sell, pledge or otherwise encumber the share. The legal basis for the blocking period is usually the shareholding regulations or the purchase agreement between the employer and the employee. Blocked employee shares are also taxed at the time they are issued, i.e. at the time the rights are acquired. Either the blocking period is taken into account with a discount of 6% on the fair market value or the formula value is taken into account for each blocking year. The difference between the discounted value and the agreed preferential price is then taxed as income at the time of acquisition.

With regard to fair value, the FTA distinguishes in particular between listed and unlisted employee shares:

Valuation of employee shareholdings

Listed employee shares

The market value of listed employee shares is generally the closing price on the day the rights are acquired. The acquisition of rights takes place at the time the employee accepts the employer's offer of the shares.

Non-listed employee shares

Formula value

As a rule, non-listed employee shares do not have a market value. The relevant value is therefore the formula value calculated according to a method that is suitable for the employer and generally accepted. For the valuation of employee shares according to the formula value, the Circular No. 37 now refers in particular to the valuation methodology according to Circular No. 28 of the Swiss Tax Conference of 28 August 2008 (Guidance on the valuation of securities without market value for wealth tax) as a suitable and recognised method.

From a tax perspective, no taxable income from employment arises if a recognised formula value is used to determine the purchase price of a share in the context of a sale to an employee.

Exception: market value

In the exceptional case when a fair value is available for unlisted employee shares, this value is applicable. This may be the case, for example, if shares are sold to a new investor.

Resale of employee shareholdings

Pursuant to Art. 16 para. 3 DBG, the sale of shares held as private assets generally results in a tax-free private capital gain (or a capital loss that is also not taxable).

If, on the other hand, an employee share is valued at the formula value at the time of acquisition, an important restriction must be taken into account. According to the Circular no. 37, a tax-free capital gain is only possible in the difference between the fair market value at the time of transfer and the fair market value at the time of sale or the difference between the formula value at the time of transfer and the formula value at the time of sale.

The added value resulting from a change from the formula to the fair market value principle, on the other hand, is taxable as income at the time of sale. This is regularly referred to as "excess profit".

According to the revised Circular no. 37, however, the entire capital gain on the sale of employee shares held as private assets by the employee is tax-free if the event triggering the change from the formula to the fair value principle occurs after a holding period of at least 5 years.

This regulation, which was already generally applied by the Canton of Zurich has been newly included in the Circular no. 37 as of 31 October 2020. It standardises the different practices in the Cantons.

State and local taxes

The FTA does not have a supervisory function with respect to state and municipal taxes, and therefore Circular No. 37 cannot be applied directly. The provisions in the Tax Harmonisation Act are, however, identical to the Federal Direct Tax Act with respect to the treatment of employee shareholdings. The taxation practice according to Circular no. 37 should in principle also be binding for the Cantons with regard to state and municipal taxes in the sense of a vertical tax harmonisation.

Conclusion

Until now, there have been considerable differences in the practice of the Cantons with regard to the taxation of employee shareholdings. Fortunately, these differences have now been at least partially eliminated. In this context, the new regulation on the taxation of so-called "excess profits" is particularly positive.

The revised Circular No. 37 nevertheless brings few changes, particularly with regard to the valuation methodology to be applied. In this respect, the Cantons still have considerable discretion in the valuation of start-ups. In this regard, it remains up to the cantonal tax authorities to decide whether the revised Circular No. 37 actually proves to be an attractive and internationally competitive solution for the taxation of start-ups.