Practical examples: Real and virtual employee shareholdings

With real and virtual employee stock ownership plans (ESOP/VSOP), employees can participate directly in the success of "their" company. As an employer, you not only increase your attractiveness on the labor market, but also create constant performance incentives during the ongoing employment relationship. These can be significantly strengthened by contractual agreements. Let's take a look at the details surrounding employee participation.

What is actually an employee share ownership plan?

In employee share ownership, the employee directly or indirectly participates in the employer's company. The latter is regularly a corporation such as the GmbH. It has a share capital of at least 25,000 euros, which can be distributed among individuals as desired. The distribution can be made, for example, according to the following scheme:

The contractual basis: ESOP agreement

With an Employee Stock Option Plan (ESOP), employer and employee regulate the conditions for a transfer of company shares. The agreement also stipulates whether the employee merely receives a so-called call option or actual shares. In the former case, for example, he has the option of acquiring the shares on particularly favorable terms. Two time requirements are particularly relevant here: 

• Cliff period: It prescribes how long the employee must be part of the company in order to be entitled to a corresponding option in the first place
• Vesting period: It specifies on which key dates the employee can exercise which option

If the cliff is, say, one year and the vesting period three years, the employee is entitled to - for example - one percent of the shares after one year at the earliest. After the second year, he receives a further one percent, and after the third year a third percent. At most, he can achieve a shareholding of three percent even if he remains with the company for four, five or six years.

If the employee leaves before reaching the cliff, he or she is not entitled to an option right in the first place. This is already clear from the German translation of the term, "Klippe".

The employee acquires shareholder rights in line with his percentage shareholding. This means, for example, that he acquires a three percent

• participates in profit distributions,
• participates in any gain on disposal or transfer, and
• can exercise voting rights.

Alternative to ESOP: Virtual Employee Stock Ownership Plans (VSOP)

A real alternative to employee share ownership under company law ("real share ownership"; ESOP), is the Virtual Stock Option Plan (VSOP). This is a virtual shareholding whereby the employee is placed on an equal financial footing with an actual shareholder by means of a separate contract (VSOP agreement). However, he or she does not receive any real shares in the company's capital stock or share capital; these remain the property of the existing shareholders.

Incidentally, VSOP Conditions also generally provide for a cliff and vesting period. Here is a brief overview of some of the biggest advantages for employers:

• Legal proceedings under company law are no longer required. No notarized transfer of shares in the company is necessary.
• In the case of the contractual agreement, there are significantly more structuring options, as company and corporate tax law do not impose any restrictions
• There are de facto no hidden costs, as a simple agreement between employer and employee is sufficient

Example: The employee acquires five percent of the share capital as a virtual shareholding through a VSOP agreement. The conditions stipulate that the participation is based on profit distributions and sales proceeds. The GmbH distributes 500,000 euros. One year later, it is sold for 10,000,000 euros.

Solution: The distribution flows in full to the shareholders. The virtually participating employee receives 25,000 euros from current income. The same applies to the proceeds from the sale, although 500,000 euros must be taken into account as selling costs. These also accrue to the employee after deduction of taxes.

Tax treatment of real and virtual employee stock options

When it comes to tax treatment, fundamentally different rules apply to real and virtual investments:

• ESOP: Distributions are investment income within the meaning of section 20(1)(1) of the EStG, which is subject to the maximum 25 percent final withholding tax. Sales profits are also subject to income tax under either section 20(2) or section 17(1) EStG. § Section 17 EStG only applies if the employee holds at least one percent of the share capital.
• VSOP: From the employer's perspective, distributions are operating expenses (Section 4 (4) EStG). At the level of the employee, they are current wages and salaries that are subject to regular income taxation in accordance with Secs. 8 (1) and 19 (1) no. 1 EStG

The transfer of real shares sometimes results in a non-cash benefit (Section 8 (2) of the German Income Tax Act (EStG)), which is also taxable. This problem does not exist with virtual shares, as the increase in the employee's assets only occurs at the time of payment. 

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Disclaimer: The contents of the information offered at esop-direkt.de do not constitute legal advice. If you require a legal review of your individual case, please contact our specialized team: beratung@esop-direkt.de