In common with many countries, Germany generally taxes an employee stock option at the time the option is exercised, rather than at the time it is granted. After all, that’s when the value is realised. A recent decision of the German Federal Fiscal Court opens up the possibility of reducing the tax cost to employees by realising the value of the stock option at an earlier time.
The Court ruled that the non-gratuitous assignment of a stock option right amounted, in reality, to the realisation of the value of the stock option, even where the assignee was a company that was wholly owned by the employee. While the value paid for the assignment triggered a tax charge for the employee, it was determined that no further tax would be payable by the employee when the option was exercised at a future date. This favourable ruling takes the approach that the employee has realised the economic value of the option at the time of the assignment.
The ruling seems to offer the enticing prospect of assigning the stock option to a company shortly after it is granted, before it has accumulated much value. When the option is exercised, the value accrues to the employee’s company. The company will be taxable on a future sale of the shares acquired on exercise of the option but the effective tax rate would be around 1.5%. Even if the company then distributes the gain to its shareholder, the tax rate for the employee would only be taxed at 25% plus the solidarity surcharge.
Now, of course, many stock option plans do not allow for the assignment of options. And it is not yet known how the German tax authorities will view this type of planning. However, the ruling may offer a route to maximise the after tax return on stock options for some German employees.