Federal Minister of Justice Marco Buschmann and Federal Minister of Finance Christian Lindner presented the key points of the Future Financing Act at the end of June. With this new law, the coalition government aims to improve the tax framework for employee share ownership, for example: The tax allowance will increase to 5,000 euros, more than triple the current amount. In addition, the plans include expanding the regulations in Section 19 of the Income Tax Act (EStG) regarding the deferred taxation of non-cash benefits from employee shareholdings. Furthermore, the employee savings allowance for capital-forming benefits will also increase.
Not a fair-weather instrument
Employee share ownership programs already offer companies numerous advantages: The sense of being part of the enterprise often enhances innovation and further development. This can be highly important, especially in view of the digital and green transformation at companies. Studies have repeatedly shown that employee participation has a positive impact on both the performance and survival of companies. These are not simply fair-weather instruments. Instead, these models can even help companies to survive times of crisis by improving their financial flexibility. However, medium-sized companies, in particular, have often been wary of going this route because they are concerned about the administrative overhead and costs. This does not necessarily need to be a problem if companies find the model that suits them best.
There is no one-size-fits-all solution when it comes to transforming employees into co-entrepreneurs. The solution companies choose depends on diverse factors:
- Employee loans represent a straightforward model for small and medium-sized enterprises (SMEs) with any legal form. A participatory loan with a profit- or sales-related interest rate can be agreed as a means of creating incentives, for example. At the same time, it is important to note that employee loans have to be secured against insolvency and banking regulations must also be observed. This makes employee loans less attractive to employers than debt financing via the free market.
- Silent partnerships are the standard model in the SME sector, according to the German Employee Participation Association. The formalities involved are not extensive and employees do not become entitled to co-determination rights under corporate law. Instead, the employees only receive information rights. This can be a decisive argument for family businesses, in particular. The employees participate in both profit and loss and do not appear externally as shareholders. A silent partnership is regarded as a mezzanine, namely a hybrid solution consisting of both equity and debt capital. Whether they are more likely to be classified as equity with a positive effect on the rating or as debt depends on the following factors: Do the capital providers share in the loss? How long is the investment available to the company? Depending on how it is implemented, positive tax effects can also be achieved.
- Profit participation rights are participations under debt law that are also often a suitable solution for SMEs: The employees cannot exert any influence on the management. They have neither rights nor obligations. Depending on the design, they share in the profit and loss. If participation in any losses is provided, this may help to achieve greater understanding if cuts become necessary. As with silent partnerships, profit participation rights are considered a mezzanine solution. If implemented properly, they can strengthen equity.
- Employee shares transform employees into co-owners. They participate in the Annual General Meeting and are granted information rights. The participation rights are limited because the shares are generally preferred shares with dividend entitlement. As employee shareholders, they bear a risk of loss equal to the amount of their investment. In the case of a limited liability company, the model functions in a similar manner via the acquisition of shares. The disadvantages include: Shareholders’ voting and control rights delay decision-making processes. A notary’s appointment is required when transferring shares in a GmbH or UG. Due to the strict legal requirements, work involved and the costs, the model is less suitable for medium-sized businesses. At the same time, valuation issues with corresponding tax risks arise, especially for non-listed companies. Start-ups, for example, face another disadvantage: The current shareholders “dilute” their shareholding.
- Virtual stock options or virtual shares can be used to replicate a share in equity. Using this method, employees do not receive any actual shares or share options but rather only asset rights. Furthermore, they are entitled to very few information or control rights and have no say in decisions. Nor do they have an ongoing entitlement to the annual profit. Instead, they participate in distributions, liquidation proceeds or company and share sales in the same manner as a shareholder, depending on the arrangements. That it is why startups frequently use this model. Employees participate in the future value of the company by being placed in the same position as a co-owner in the event of an exit. However, the acquisition of shares often gives rise to difficult issues regarding the company valuation.
Combination with capital-forming benefits
In many cases, the participation can be combined with capital-forming benefits. This enables employees to receive additional share certificates, for example.
Tax factors play an important role when deciding on a specific model: To what extent is the employees’ income from the programs privileged? To what extent can the employer declare the benefits as a business expense? This gives rise to challenges, particularly in an international context.
Take into consideration co-determination
Employee programs can be regulated through individual contracts between employer and employee. However, they are generally concluded with the employee representatives as a voluntary works agreement pursuant to Section 88 No. 3 of the Works Constitution Act (BetrVG). Under certain circumstances, the right of co-determination pursuant to Section 87 (1) no. 10 of the Works Constitution Act (BetrVG) comes into play.
Caution: The General Equal Treatment Act applies!
At the same time, it is important to note that if the participation program is not also open to third parties outside the company, companies are required to comply with the General Equal Treatment Act (AGG). Therefore, it must be offered to all employees in general.
When choosing an employee participation model, companies have to carefully consider human resources, legal, tax and accounting aspects. Implemented correctly, the programs are straightforward and easy to organize. Particularly in view of the digital and green transformation of the economy, employee participation can serve as a useful instrument for anchoring a mechanism for entrepreneurial thinking and activity within the company. This also boosts the employees’ identification with the company along with employee loyalty. Considering the improvements provided by the Future Financing Act, now is the perfect time to implement a program of this nature.