Alternative ways to implement employee share schemes

Many employers endeavour to bind employees to the company over the long term. At the start of 2024, there were legislative changes with respect to so-called real employee shares and we reported on these in the 02/2024 issue of the PKF newsletter. For employers there are however still other possible ways to enhance long-term employee retention whereby, under certain circumstances, shares can be granted free of tax. The Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) provided an update in this regard in its circular of 31.5.2024.
Silent partnership
Under the terms of granting a (typical) silent partnership in a company, employees receive a share in the company’s profits or losses in return for providing a fixed amount of capital; sharing the losses can however also be excluded. Silent partnerships in a company would confer legally established information and control rights on employees, yet no direct voting rights. As the degree of participation is limited by having a fixed amount, employees would be precluded from participating in an increase in the company’s value.
The share of the profits of the silent partners would constitute operating expenses for the company in the year for which the share of the profits is paid. The company would have to withhold capital gains tax for the share of the profits and pay it to the local tax office. The granting of a silent partnership would be tax-privileged if the capital was provided to a German commercial enterprise.
The employees would generate income from capital assets from the share of the profits. The inflow principle (Zuflussprinzip) would be applicable here; the share of the profits would have to be taxed on the part of the employees in the year of the capital inflow.
Employee loan
In the case of an employee loan, an employee would give a loan out of their own funds to the company in return for contractually agreed interest. If the interest was calculated on the basis of profits or revenues then this would be deemed to be a profit participating loan. In contrast to a typical silent partnership, it would not be possible to agree to sharing the company’s losses. Participation in an increase in the company’s value would not ensue from giving the loan. At the level of the company, the interest costs would constitute operating expenses. In the case of a profit participating loan, the employer would have to declare and pay the capital gains tax. The employees would generate income from capital assets in the year of the inflow.
In order for the loan to qualify for tax concessions the receivable has to be against the employer or a company that controls the employer and the loan agreement has to safeguard the employee’s claims.
Virtual shareholdings in the company
A further variant consists in the employer granting its employees so-called virtual shareholdings in the company. An agreement with the employees in accordance with the German law governing obligations would regulate the employees’ entitlement to remuneration, which is usually in the form of a share of the potential proceeds from the sale of the company. Employees would not receive shares in the company under German company law.
In this case, a notional issue price (notional acquisition cost) for the virtual shareholdings is agreed and this would have to be deducted from the sale proceeds to calculate the gain for the shareholding. Virtual shareholdings can also comprise performance-dependent components, for example, dividend arrangements.
Granting virtual shareholdings has no tax implications for companies and, initially, not for employees either. Each inflow from the virtual shareholdings will then however result in payroll taxation for the employees on the date of the inflow. Here, it does not matter whether this constitutes profit shares/dividends or the share of the proceeds at the time of the sale. For the company, the remuneration that is paid would constitute operating expenses.
The granting of virtual shareholdings to an employee could result in a tax-privileged event on the date of the inflow, for example, through the exercise of a share option or other use of the option right.