The secondment of employees from U.S. parent companies to German subsidiaries or branches is a well-established tool to enhance cooperation between the offices and promote the exchange of knowledge, experience and cultural understanding. However, the tax issues raised by secondment must be considered carefully. At the level of the parent organization, the formation of a permanent establishment should be avoided. The costs related to the expatriate employees’ functions must be allocated for tax purposes between parent and subsidiary, and this allocation is a crucial issue often challenged by fiscal authorities. The expatriate often receives an attractive package including a top executive compensation (possibly combined with a tax-equalization clause), fringe benefits, payroll slit-models and continued participation in the various plans set up by the employer (deferred compensation, pension, stock options, restricted stock units, etc.)
The taxation of stock options granted before the secondment but exercised in Germany, and the taxation of stock options granted during the secondment in Germany but exercised after the return to the United States, often is addressed during tax audits. On September 14, 2006, the German Federal Ministry of Finance issued a decree that addresses this topic and is being applied to the upcoming tax audits. The taxation of stock options is a crucial issue for employers, because they must withhold wage tax on behalf of the employee on every taxable pecuniary benefit, and are liable if they do not do so.
The decree qualifies the pecuniary benefit derived from a grant of option rights for the acquisition of shares as income from employment. Therefore, the tax rate applied to the benefit is the same individual rate as that applied to any other income from employment. As a consequence, the flat rate for income from capital will not be applied to this pecuniary benefit starting in 2009. Income an employee earns from holding the shares after exercising the option or from the subsequent disposal of the shares, is assessed separately, using the rules for income from capital.
For tax purposes, a distinction must be made between tradable and non-tradable options. An option is tradable if it is traded at a stock exchange. For this delimitation, it is irrelevant whether the option is assignable or transferable by succession, or whether it is subject to a period of non-negotiability under the option terms and conditions. The option can be granted by the employer directly or by an affiliated undertaking. What is decisive is that the grant by the third party constitutes a wage for the employee in consideration for his or her services to the employer, and, from the grantor’s point of view, is rendered in connection with said employment.
If an option is tradable, a pecuniary benefit accrues to the employee already, by virtue of the grant of the option. Because this option usually is granted as remuneration for services rendered in the past, the pecuniary benefit must be classified according to the circumstances of the period for which the option is granted. If during this period the employee was resident in the United States, the pecuniary benefit may be exempt from German taxation pro rata temporis in accordance with the German U.S. Double Taxation Convention, which states that income from employment is taxable in the state where the services are rendered. However, the tax-exempt income is taken into account to determine the progressive tax rate on the income taxable in Germany, according to the exemption with progression rule.
If an employee is granted a non-tradable option to later acquire shares at a specific acquisition price, this constitutes only the grant of an opportunity. The beneficiary does not accrue a pecuniary benefit until the option is exercised and the quoted price of the shares exceeds the acquisition price. The point in time when the employee is first eligible to exercise the option is non-decisive in this regard. The pecuniary benefit is calculated as the difference between the quoted price upon actual exercise and the exercise price paid by the employee.
A non-tradable option usually is not granted to compensate services rendered in the past, but rather to create an additional motivation for the future. It therefore constitutes remuneration for the period between the grant and the time when it first is possible to exercise the option. If the income earned by the employee in that period is tax-exempt in Germany under the Double Taxation Convention because the services are rendered abroad, the pecuniary benefit accrued upon actual exercise of the option must be apportioned to the period between the grant of the option and the time when exercise is first possible, and must be exempt pro rata temporis. The “exemption with progression rule” is applicable to determine the progressive tax rate on the income taxable in Germany.