Switzerland is made up of 26 administrative districts known as cantons. Up to now, different cantons provided for different tax and social security treatment on stock options, which caused a particular administrative burden for employers and some uncertainty for employees as to how their options would be taxed. As employees of the same company may be resident in several different cantons, their employer was frequently put to the trouble of obtaining tax rulings from each relevant canton to confirm the correct tax treatment was being applied to the relevant individual’s options. In addition, different cantons had different reporting obligations.
However, a new ordinance issued by the Swiss government will come into force on 1 January 2013 which should harmonise the tax treatment of stock options across all cantons (although the actual rate of income tax will continue to vary from canton to canton). A further focus of the ordinance which may be of particular relevance to the industrial engineering sector is in relation to stock options granted to internationally-mobile employees.
This article summarises the current position in relation to the tax treatment of stock awards and options, and sets out the changes which will apply from 1 January 2013.
No change to taxation of certain stock and restricted stock purchase arrangements
The taxation of stock purchase plans, restricted stock and restricted stock units will not change. Such arrangements are taxed as follows:
Federal income tax at 11.5%, cantonal income tax and social security contributions at the relevant rates will arise at the time of the award of such stock or restricted stock on the amount by which the market value of the stock at the time of the award (taking into account any restrictions) exceeds the price the employee pays for such stock. Where the stock award is subject to a restriction on disposal, a discount to the fair market value of the stock is applied which is commensurate to the length of the restricted period. For example, a restriction on disposal of the stock for one year from the date of grant would give a discount to the market value of the stock of 5.66%, while a five-year restricted period would give a discount of 25.274%.
Restricted Stock Units
Where restricted stock units are granted, federal and cantonal income tax and social security contributions will arise on the date of vesting of such units (that is, the moment when the award holder becomes unconditionally entitled to the underlying stock), on the amount by which the market value of the stock at the time of such vesting (taking into account any restrictions) exceeds the price the employee pays for such stock.
In either case, where the relevant employee is a Swiss citizen or the holder of a “C Permit” (that is, has permanent residence), the social security contributions must be collected by the employer and accounted for to the Swiss authorities, but the federal and cantonal income tax is the liability of the individual who must report it in his or her annual tax declaration.
However, where the relevant employee holds a short-term or “B Permit” which is granted on an annual basis, the employer must collect the federal and cantonal income tax at source.
Sale of Stock
Any subsequent sale of such stock will amount to a tax-free capital gain for employees who are tax resident in Switzerland. Such sales are not subject to social security contributions.
Changes to tax treatment of stock options
Following a Federal Directive of 2003, stock options were officially supposed to be taxed at the moment when the option holder became unconditionally entitled to acquire the stock under option, on the amount by which the market value of the underlying stock at such date exceeded the exercise price. Depending on the wording of the plan this entitlement could be said to occur at the date of grant, the date of vesting or the date of exercise. For various reasons however, certain cantons (particularly those in the French-speaking part of Switzerland) tended to ignore this Directive and tax the stock options at the date of grant regardless, unless a specific tax ruling was in place to defer taxation to a later stage.
Options over unrestricted stock in listed companies will still be taxable at the time of grant. However, options over all other types of stock will generally now be taxable at the point of exercise. This means that options over shares in companies which are not listed or options over shares in listed companies where such shares are subject to restrictions will now generally only be taxable at the point of exercise.
Internationally mobile employees – issues raised by new rules
Where a stock option is taxed at exercise, a particular issue will arise where an employee ceases to be resident in Switzerland before the exercise date. Even if the individual is resident elsewhere, tax will still arise in Switzerland on a proportion of the option gain, pro rata to the number of working days the individual was resident in Switzerland between the date of grant and the date of exercise.
For example, if a Swiss-resident employee is granted an option with a three-year vesting period, and moves to the UK at the end of the first year, Swiss federal and cantonal income tax will be payable on roughly one third of the option gain once the option is exercised.
To assist the Swiss tax authorities in collecting the relevant tax from any such non-resident individuals, new reporting rules will be imposed on the employer. All relevant aspects of any equity-based compensation must be reported each year (usually in the wage statement) to the cantonal tax authorities of the cantons where the relevant employees are tax resident.
Once an employee leaves Switzerland, the employer must provide evidence to the tax authorities as to how many working days the employee has spent in Switzerland during the vesting period so that the proportion of the option gain which will be subject to Swiss income tax may be calculated. The employer is responsible for collecting this tax and accounting for it to the authorities.
Compliance with new rules
Employers must comply with these new information requirements from 1 January 2013. Fortunately, some of the cantons already have standard forms in place which comply with the new rules.
With the effective date of the new changes rapidly approaching, Industrial Engineering companies running stock incentive plans in Switzerland should review their existing stock option plans (and any tax rulings in respect of such plans) to ensure they are compatible with the new tax treatment outlined above.
Companies may also wish to take steps to ensure that all affected employees are informed about these upcoming changes.