Investment in Progress
More and more companies are considering to let their key-employees participate in the success of their company. This is also common practice among start-ups – but what models and tax barriers are there?
1. Employee programs for the GmbH
Most of the start-ups are founded as a GmbH – therefore, it’s a common possibility to make the employee a shareholder: Employees will get shares from the founders or enters via a capital increase and thus “dilutes” the founders. It is also possible to already include the key-employees as shareholders from the foundation process on.
Attention! Even though many important decisions are taken without the minority-shareholder, certain shareholder rights still remain, e.g. the right to convene a general meeting, right to inspect books, etc. If therefore a founder or investor does not want having employees with such rights of co-determination, other employee-programs are more preferable.
2. Difficult valuation
In practice, the valuation of the employee’s benefit is not easy at all, because start-up shares are rarely “traded” and there is no share price in general. Apart from this, the future potential is also difficult to predict. So how shall someone value a 10% share of a e.g. FinTech start-up?
According to the tax authorities, the value of such shares can be determined in a simplified way using the so-called “Vienna Method” (“Wiener Verfahren”), a mixed income and net asset value method. If shares were sold close to the time of the employee participation program (e.g. due to an investment round), the purchase prices realized in the process may provide an indication of the value.
FinTech “NoTax” offers an employee who is essential to the success of the company the opportunity to acquire a 10% shareholding in the company. FinTech “NoTax” has an average profit of the last three years of TEUR 40 and an equity of TEUR 50 (thereof TEUR 10 paid-in capital). This results in a company value according to the Vienna method of approx. TEUR 172.5, thus the acquisition costs for a 10% shareholding would amount to TEUR 17.25.
3. Shares for free or at a reduced price?
The shares are often transferred for free or at a reduced price. However, the tax authorities qualify the transfer of shares for free or at a reduced price as a contribution in kind to the employee. Thus, the amount of the benefit is subject to income tax and social security contributions.
Continuation of example:
The founder of FinTech “NoTax” will sell 10% for TEUR 1 to the employee. The advantage from the transfer therefore amounts to TEUR 16.25 (TEUR 17.25 fair value minus acquisition cost TEUR 1). This financial benefit of TEUR 16.25 is subject to wage tax and social security. In addition, various payroll related wage costs have to be paid by the GmbH (e.g. municipal tax [KommSt], employer’s contribution [DB], supplement to the employer’s contribution [DZ], etc.). In total, the tax burden amounts up to more than 50%.
However, there is a possible tax benefit: Up to an amount of TEUR 3, the advantage resulting from the transfer of capital shares free of charge or at a reduced price remains tax-free if the employer grants this benefit to all employees or at least certain groups of its employees (e.g. all department heads). In addition, a minimum retention period of five years must be observed.
4. Isn’t there any other way to avoid paying that much taxes immediately?
A later taxation would only be possible if the employee does not immediately become the beneficial owner of the shares, i.e. if he cannot freely dispose of his shares. As soon as the employee becomes beneficial owner, the taxation is due.
The only thing to keep in mind is that a later acquisition of beneficial ownership of a shareholding often results in an even higher tax burden, provided that the value of the company has increased further. After all, increases in value occurring after the acquisition of shares are “only” subject to the special tax rate of 27.5% on disposal.
5. What happens to the employee’s shares in case of an “exit”?
If the start-up is well developed and agrees to be taken over by an investor within the framework of a sales process, the founders and the remaining co-partners (including the employees involved in the start-up) will be compensated for their previous efforts through a participation in the capital gain. Any capital gain from the sale of a shareholding in an Austrian GmbH underlies the special tax rate of 27.5%:
Continuation of example:
The start-up FinTech “NoTax” has developed excellently in recent years and an investor would like to acquire all shares in the start-up for TEUR 2.000. Due to his 10% shareholding in the start-up, the employee involved receives sales proceeds of TEUR 200. Consequently the employee generates a capital gain, which is subject to the special tax rate of 27.5%:
6. What other forms would be possible?
Other common ways to let employees participate would be e.g. stock options or profit participation certificates, etc. These kind of employee programs we will analyse in our upcoming Jodler.
With regard to the taxation of “Phantom Stock Programs” – we highly recommend our Jodler from June 2018: https://aaia.at/aaia_blog/taxation-of-phantom-share-programs-in-austria
David Gloser, Partner, Chartered Accountant and Tax Advisor
Barbara Hölzl, Tax Advisor from ECOVIS Austria