Germany: Employee Incentives

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This country-specific Q&A provides an overview to tax laws and regulations that may occur in Germany.

This Q&A is part of the global guide to Employee Incentives. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/practice-areas/employee-incentives/

  1. What kinds of incentive plan are most commonly offered and to whom?

    Incentive plans have become an increasingly popular element of remuneration. In practice, there are various forms and possibilities. Start-ups often offer share programmes due to their very limited own capital, while listed companies often grant virtual options to key employees. Small and medium-sized entities motivate their employees mainly by bonus and target agreements or by granting participation in annual net profit.

  2. What kinds of share option plan can be offered?

    German law does not prescribe any special form of share option plan. In practice, the following types of share option plans, which are to be divided into equity and non-equity plans, can mainly be found. In the absence of legal requirements and based on the principle of contractual freedom, the flexibility of non-equity plans is extremely high, whereas equity-based plans must meet regulatory requirements:

    Equity-based share option plan:

    • A stock corporation may offer share options or convertible options to their employees. The company must meet the requirements of the German Stock Corporation Act. The company provides the employees with a corresponding number of share options, which the company has purchased or created through an increase of capital. Generally, stock corporations grant such share options at a lower purchase price than the fair market value to their employees.
    • The company may introduce different vesting periods with the share option plan in order to achieve different objectives (known as restricted share option plan) within a specific and extended period of time. This form of share option plan provides the employee with an ongoing incentive to high performance. Generally, three types of vesting conditions as incentive elements may commonly be found: the plan may provide that the employee remains a certain period of time with the company before being granted a first batch of share options or the granting is linked to annual performance criteria. Another plan type may provide the possibility to accelerate the vesting period by achieving predetermined goals.
    • Instead of issuing options on its shares, the company can also implement a share option program for which the company acquires issued or to be issued options on its shares (in the market) from third parties (usually credit institutions or investment banks) and forwards them to the beneficiaries.

    Non-equity share option plan:

    • In case of a phantom share/virtual share option plan, the employee is contractually entitled to a payment if early agreed exercise conditions are met. Usually in such a standard plan, the employee is then entitled to a cash payment in the amount of the difference between the agreed base price and the share price at the time of exercise (instead of transfer of shares). The payment can be linked to the expiration of a certain period of time, such as the distribution of profits at the end of the financial year, or to the occurrence of an exit event (e.g. sale of the company or parts of it or in case of a “good leaver” termination). Virtual share option plans have no direct influence upon the capital structure of the company or the composition of the group of shareholders. They do not directly dilute the share price.
  3. What kinds of share acquisition/share purchase plan can be offered?

    There are no specific kinds of acquisition/purchase plans under German law. Nevertheless, purchase plans exist in a one-time or a deferred purchase manner.

    • A stock corporation must meet the requirements of the German Stock Corporation Act to grant shares to their employees in the same way as for share options (mentioned above under question 2). The share purchase plan itself may be subject to the grant of shares or convertible bonds.
    • Limited liability companies (Gesellschaften mit beschränkter Haftung) may transfer shares to the employees to make them shareholders or may grant a subscription right to the employees to own shares in the company. This is very uncommon, since the grant of shares in a limited liability company requires notarial recording in each case.
    • The company may link the share purchase plan to different vesting periods as mentioned above. The possibilities mentioned are applicable to share and share option plans.
    • The company can offer a possibility to the employee to invest an amount or percentage of the employee´s monthly income in shares of the company. The company usually retains the agreed amount from the monthly amount of remuneration paid and the shares will be passed to the respective employee. Thus, the parties usually agree on a cap on the investment.
  4. What other forms of long-term incentives (including cash plans) can be offered?

    Besides the plans mentioned above, the company can offer:

    • Bonus or target agreement (within one year)
    • Company profit participation (also within a one year circle)
    • Company pension scheme
    • Annual working time credit
    • Sabbatical
  5. Are there any limits on who can participate in an incentive plan and the extent to which they can participate?

    Under German law, there are generally only few restrictions on who can participate in an incentive plan (see below regarding supervisory board). However, the framework of an incentive plan may be designed for employees only or management. However, for the status of the respective persons it is important to define the membership to one group. For instance, a freelancer can participate, but might then bear the consequences of being classified as an employee, which leads to a different legal handling of the contractual status in respect of taxes and social security contributions. The remuneration of the Supervisory Board members by options on shares of the company is inadmissible, regardless of whether the option program is backed by repurchased own shares or by conditional increase of capital. In contrast, members of management and the board of directors can be participants.

    Employees can participate in equity plans to the extent of the regulations of the German Stock Corporation Act, whereas the total nominal value of shares in respect of options may not exceed 10 percent of the nominal share capital (Section 192 para. 3 and Section 71 para. 1 no. 2 German Stock Corporation Act).

    Mostly, share plans include a restraint on disposal so that the employees are bound to the shares and are not allowed to trade or sell other than stated in the plan.

    There are no regulations for virtual share option plans. For the protection of the employees, German law prohibits to compose the employee´s remuneration predominantly by shares, share options or bonds (Section 108 para. 2 Trade Code). The jurisdiction has not clarified yet to what extent the remuneration can be composed by shares. This does not apply to management board members.

    For the extent of participation the company must comply with the principle of equal treatment. This allows a differentiation by groups of the beneficiaries. A differentiation based on gender, disability, ethics or part time work or other criteria of anti-discrimination is prohibited.

  6. Can awards be made subject to performance criteria, vesting schedules and forfeiture?

    Performance criteria, vesting schedules and forfeiture can be subject to agreement. In case of a share option plan (equity)the waiting period before exercising is at least four years (Section 193 para. 2 No. 4 Stock Corporation Act). In this case as well as in the case of a virtual share option plan the parties usually agree on conditions for forfeiture in case of termination of the employment relationship and for vesting-periods. In practice, performance criteria is more commonly a subject to bonus agreements. Nevertheless, the determination of vesting-periods itself may be made subject to performance. In this respect, acceleration clauses may be included in the contract. The acceleration clause stipulates that the vesting period is shortened if initially specified performance criteria are met.

    Forfeiture clauses may be included in the incentive plan. The participation in the incentive plan can be linked to the continuation of the employment relationship. In this matter the forfeiture clause must be clearly and comprehensibly worded, otherwise it risks being deemed invalid. The cases in which forfeiture might occur must be precisely identified and listed (to prevent invalidity due to Section 307 para. 1 German Civil Code). A forfeiture clause usually differentiates between the reason for the employees leave (differing between “good” and “bad” leavers). In cases, in which the employee leaves on his or her own responsibility, the entitlements might forfeit without compensation entirely or only with respect to vested rights. The forfeiture clauses are legitimate due to the purpose of the participation program, which requires the existence of an unterminated employment relationship. However, the agreement of the aforementioned forfeiture clause in case of a “bad” leaver contains an obstacle for termination by preventing the employee from termination in order not to lose the monetary benefit. In this respect the clause must be limited in time. A forfeiture period of up to five years is permissible, but the employee must be reimbursed for respective expenses incurred. This also applies in cases, in which the company terminates the employment relationship.

    It is also possible that the parties agree on a reduction in the number of shares or share options if the employee is absent within the subscription period (reduction pro rata temporis). However, if the employee is absent due to illness, Section 4 of the Continued Remuneration Act must be taken into account, which stipulates that only a quarter of the employee's remuneration may be reduced due to absence.

    Also the performance of the company (e.g. net profit goals) itself can be chosen as a criteria to be taken into consideration to reward the employee in case of a successful year, e.g. by granting a specific amount or a percentage of the annual profit.

  7. What are the tax and social security consequences for participants in an incentive plan including: (i) on grant; (ii) on vesting; (iii) on exercise; (iv) on the acquisition, holding and/or disposal of any underlying shares of securities; (v) in connection with any loans offered to participants (either by the company operating the incentive plan, the employer of the participant (if different) or a third party) as part of the incentive plan.

    In general, any income from employment is taxable and subject to social security contribution. Depending on the type of incentive plan, different time frames in which taxes and social security contributions are raised and social security contributions must be paid, are notable. The general rule is that the tax burden occurs if and when the beneficiary receives something of immediate value (something he/she can turn into money (e.g. trade)). The same applies in general for the obligation to pay social security contributions on the payment.

    (i) on grant:

    The requirements for taxation and social security contributions depend on the type of incentive plan. In case of a share plan, income taxes (up to 45 % of gross income) and social security contributions must be paid at the time of the grant (ca. 19,4 %).

    Shares granted by a parent company might not be classified as remuneration due to the fact that the parent company is not the employer. While the obligation to pay taxes remains out of discussion, the question whether social security contributions must be paid is discussed controversially. The Federal Fiscal Court classifies share options as income, some argue that shares or share options are to be seen as remuneration in the sense of social security law even if paid by a parent company;

    (ii) on vesting:

    The vesting period might be an event, where taxes or contributions must be paid. This event occurs as a subject to taxation and social security contributions if the shares and share options become transferable and therefore tradable after the vesting period (then taxation and obligation to pay social security in the same way as the granting of shares);

    (iii) on exercise:

    The benefit from exercising a share option is taxable. The income taxation refers to the difference between the market value and the exercised price of the shares at the time of exercise. The employee is obliged to pay income tax, nevertheless usually the company retains the disbursement from the employee´s remuneration. Social Security contributions, in contrast, must be withheld by the company and have to be contributed to social insurance agencies at latest by the third last banking day of the month of exercise.

    In case of exercising convertible bonds, taxation will take place in this phase as well, so that the employee must pay taxes on the monetary benefit;

    (iv) on the acquisition, holding and/or disposal of any underlying shares of securities:

    The acquisition of shares in execution of an option is a taxable event (as mentioned above), while holding the shares through the vesting-period has no effect on the obligation to pay taxes or social security contributions.

    Notable in this context: At the time of disposal of shares the amount based on the difference between the purchase and selling price is taxable as well (any increase of gains). This event is subject to capital gains tax based on Section 43 Income Tax Act, although the grant of shares has already been taxed. In this model participants must face a two-phased taxation obligation. Thus, this scenario has no effect on the participant as an employee, but is a general obligation in the case of gains;

    (v) in connection with any loans offered to participants (either by the company operating the incentive plan, the company of the participant (if different) or a third party) as part of the incentive plan:

    For the participant a company´s loan is mostly an advantageous way of receiving an incentive at a good rate of interest. If the company grants a loan at more favourable conditions than prevailing on the market, the interest advantages are deemed to be a monetary benefit which is therefore taxable and subject to social security contributions. However, an advantage of interest is only recognizable if the monetary advantage does not exceed 2,600 EUR at the end of the remuneration period. In every other case, the granting of a loan itself does not constitute taxable income for the employee. Only if the company waives his right to repayment of the loan, the cash flow is deemed to be remuneration and therefore subject to tax and social security contributions.

  8. What are the tax and social security consequences for companies operating an incentive plan?

    (i) on grant:

    For the company the issuing shares is recorded as personnel expense under equity within the balance sheet. The granting must be included in the balance sheet, even if the employee does not exercise the options;

    (ii) on vesting:

    The vesting-period is not an event for taxation or social security contributions for the company;

    (iii) on exercise:

    The exercise of share options or a non-equity-based incentive plan is taxable for the employee. Social security contributions for both the company and the employee must be paid on the reference date of exercising. The company is responsible for deducting the respective taxes and for forwarding them to the tax authorities. The balance sheet recognizes the issuing of share options or the exercise of a virtual share option plan as personnel expense under liabilities;

    (iv) on the acquisition, holding and/or disposal of any underlying shares of securities:

    For the employer no further obligations occur other than to deduct the taxes and social security contributions for the employee and to forward them to the respective authorities;

    (v) in connection with any loans offered to participants (either by the company operating the incentive plan, the company of the participant (if different) or a third party) as part of the incentive plan:

    Company loans have a positive effect on cash flow.

  9. What are the reporting/notification/filing requirements applicable to an incentive plan?

    There are no specific requirements regarding incentive plans.

    Nevertheless, the German banking supervision law stipulates to comply with protection against insider trading for listed companies. Also the vesting-period itself is supposed to grant protection against insider trading. In this context companies are obliged to comply with the Securities Trading Act (Wertpapierhandelsgesetz). The Federal Financial Supervisory Authority (BaFin) controls the processes.

    Within the process of granting (or exercising) incentives the International Financial Reporting Standards (IFRS 2) by the International Accounting Standards Board (IASB) must be fulfilled. The IFRS 2 is applicable in Germany. Therefore, all domestic companies whose securities trade in a regulated market are required to use IFRS Standards as adopted by the EU in their consolidated financial statements. IFRS Standards as adopted by the EU are required in their consolidated financial statements except a foreign company whose home jurisdiction’s standards are deemed by the EU to be equivalent to IFRS Standards may use its home standards.

  10. Do participants in incentive plans have a right to compensation for loss of their awards when their employment terminates? Does the reason for the termination matter?

    Generally, the employee is not entitled to compensation for loss of his or her awards if the employment relationship ends, unless a compensation for such an event (scenario) has been contractually agreed upon. The loss of options is not deemed disadvantageous at least as long as the options have not yet been vested. Other incentive plans not related to share options or securities, such as bonus agreements, lead to an entitlement to payment in the proportionate amount (pro rata temporis).

  11. Do any data protection requirements apply to the operation of an incentive plan?

    On May 25th, 2018 the new General Data Protection Regulation (2016/679) came into effect. At the same time the new German Federal Data Protection Act came into force. Ever since, any incentive plan must comply with the EU and German data protection law. Of importance are the provisions about processing data of the employee in respect of transparency, limitation of use to a specific purpose and for a specific time.

    For the execution of an incentive plan, the company faces higher requirements on transmitting personal information to a third party or third country (outside the jurisdiction of GDPR). The employee must give his/her consent to the transfer of his/her data.

  12. Are there any corporate governance guidelines that apply to the operation of incentive plans?

    The German Corporate Governant Codex (GCGC) applies to share (option) plans. According to the GCGC, subsequent changes to the performance targets for share option plans shall be excluded (No. 4.2.3 (2) sen. 8 GCGC). The structure of a share option plan is to be announced in advance. It is recommended that the share options are based on demanding and relevant comparison parameters (No. 4.2.3 (2) sen. 7 GCGC). The Corporate Governance Report shall contain specific information on share options and similar securities-based incentive systems of the company, insofar as this information has not been provided in the annual financial statements, consolidated financial statements or remuneration report (No. 7.1.3 GCGC).

  13. Are there any prospectus or securities law requirements that apply to the operation of incentive plans?

    Even though the issuer of shares of publicly listed companies under certain circumstances must prepare a prospectus in accordance with the German Securities Prospectus Act (Wertpapierprospektgesetz) and consider further regulatory aspects, this does not apply to employees´ participation programs (please see question 14.).

    German regulations prohibit the direct or indirect use of insider information when trading in certain financial instruments (section 14 (1) German Securities Trading Act, Wertpapierhandelsgesetz). This prohibition is necessary, due to the fact that employees might have access to further inside information of the company. This prohibition includes trading in share options, even if the company is not listed, provided that the underlying shares are listed. The restrictions shall not apply to phantom shares or other virtual programmes according to a non-binding statement of the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht).

  14. Do any specialist regulatory regimes apply to incentive plans?

    The legal obligations and restrictions are exempted in cases, in which shares or options are granted to employees or board members. The further requirements are:

    • The issuing company has his headquarters in a member state of the European Economic Area (EEA), the shares are being offered publicly, and shares of the issuing company have already been admitted to trading at a EU or EEA stock exchange, or – under certain specific additional conditions – at a stock exchange outside of the EU (Section 4 (1), No 5 German Securities Prospectus Act).
    • The issuing company is seeking admission for trading. Moreover, the shares are of the identical class as any other shares of the issuing company that are already admitted to trading on the same EU or EEA stock exchange (Section 4 (2) No. 6 German Securities Prospectus Act)

    Furthermore a prospectus is not required under the following conditions (Section 3 (2) German Securities Prospectus Act):

    • Less than 150 employees are participating
    • The cumulated price of all shares granted in the EEA is below EUR 100,000 within the period of 12 months.
  15. Are there any exchange control restrictions that affect the operation of incentive plans?

    For transfers of amounts abroad exceeding EUR 12,500 a formal notice must be made to the German Federal Bank, if the amount is supposed to be used for purchasing shares in a foreign parent company.

  16. What is the formal process for granting awards under an incentive plan?

    Formal requirements regarding the process of granting awards exist depending on the incentive plan itself and whether they are equity or non-equity-based.

    • Within equity-based plans the formal process requires, generally, a formal decision and the entry of the new shareholder structure into the commercial registry.

      The strict requirements and formal process for capital increase for a stock corporation are laid down in Section 192 ff. of the German Stock Corporation Act. The main steps are: Creation of the conditional capital by resolution of the Annual General Meeting to increase the capital, registration and entry of this resolution in the commercial register and publication of the entry, submission of a subscription declaration by the beneficiaries before payment of the full consideration for the subscription shares to the corporation. As a result the share capital of the company increases immediately by the nominal value of the new shares issued. The capital increase has to be entered in the commercial register. The shares must be issued to the employees within one year of their acquisition. The conditional increase of capital for providing shares to the employees may result in a dilution of of the value of the shares. Convertible bonds may only be issued on the basis of a resolution passed by a three-quarters majority of the Annual General Meeting (Section 221 para. 1 sent. 2 German Stock Corporation Act). If the convertible bonds are not granted by a conditional, but a regular capital increase, the capital increase shall require a formal subscription in addition to the above mentioned subscription declaration.

      The employee participation in a limited liability company may simply be achieved by transferring shares to the employee, but must be notarized each time. If an increase in the share capital is resolved in the limited liability company, a notarised or certified declaration by the transferee is also required for taking over each share in the increased capital (Section 53 ff Limited Liability Companies Act) as well as the entry of the capital increase into the commercial registry.

    • Non-equity based incentive plans are not subject to formal process requirements. Requirements are limited to precise contractual regulation. Only pension schemes are furthermore regulated under German law.
    • Generally, within the process of granting an incentive plan co-determination and information rights of an existing works council must be respected (Section 87 para. 1 No. 10 Works Constitution Act). A company and works council (if established) may agree upon the granting of an incentive plan through an agreement between the parties. If shares are granted by a parent company, the works council´s rights may be excluded due to the fact that the incentive plan has not been subject to the company´s decision. The mere participation in the implementation of a share option program without influencing the structure of the remuneration performance by the parent company cannot trigger a right of co-determination. At least it is required to have a limited room for manoeuvre, which is granted by the parent company through the granting of rights of co-determination and rights of proposal.
  17. Can an overseas corporation operate an incentive plan?

    A foreign parent company can grant incentives with facing the consequence that the employee is entitled to a payment by the parent company and not by the company himself, which can lead to difficulties regarding judicial enforcement in the case of conflict. Entitlements towards a parent company might exclude the obligation to pay social security contributions due to the fact that the payment is not to be seen as remuneration.

  18. Can an overseas employee participate in an incentive plan?

    Overseas employees can participate in an incentive plan. Significant for the participation is the question whether the employee is a German tax resident in Germany. Depending on this, the respective employee must face the German tax regulations on taxation of income at the time of exercising the incentive payment. The obligation to social security contribution also depends on the existence of treaties or EU-provisions to regulate the obligation.

  19. How are share options or awards held by an internationally mobile employee taxed?

    If the employee is a German tax resident while exercising shares, the employee is subject to German income taxation. The requirements as to when an employee is deemed to be a German taxpayer depend on various circumstances, e.g. duration of stay in Germany.

  20. How are cash-based incentives held by an internationally mobile employee taxed?

    In general, cash-based incentives are taxable in Germany as soon as they are paid to German tax residents, no matter if the employee is actually located in Germany.

  21. What trends in incentive plan design have you observed over the last 12 months?

    The trend is leaning to virtual based incentive plans. Incentive plans under the German Stock Corporation Act are subject to a formal process, which becomes more unattractive. For share-price-dependent participation models, however, any accounting obligation could generally be regarded as unattractive, as in addition virtual share options plans are more advantageous in regard of taxation.

  22. What are the current developments and proposals for reform that will affect the operation of incentive plans over the next 12 months?

    The International Accounting Standards Board (IASB, responsible for the applicable IFRSs) has published a Discussion Paper (June 2018) on how companies issuing financial instruments should classify them in their financial statements for public comment. It remains to be seen which changes will result for the accounting of employee share option plans.