New practice in Geneva on the taxation of employee incentive plans
Employee Incentive Plans
EIPs that give participants a position as shareholders are mainly share plans (i.e. the immediate grant of company shares) and stock-option plans (i.e. the deferred grant of shares a exercise). The acquisition of shares, whether immediate (share plan) or deferred (stock option plan), may be granted either free of charge or at an agreed price.
Shares delivered immediately to a participant in a share plan are taxed at grant. Stock-options are not taxed at grant but at exercise, i.e. when the employee acquires the right (vesting) and decides to acquire the shares linked to the options.
The tax treatment described below applies from the moment the employee acquires the company's shares, whether he acquires them immediately (share plan) or following the exercise of options (stock-option plan). The decisive moment for tax purposes is therefore the transfer of ownership of the share to the participant.
General Tax Treatment in Switzerland
When the shares are granted, the participant is taxed on the difference between the value of the share and the price he may have paid. When the participant subsequently sells the shares, which may be years later, any capital gain is in principle tax-free.
In some cases, instead of being tax-free, this capital gain may represent salary. It all depends on the valuation method applied by the tax authorities at the time of grant.
- Fair Market Value (FMV)
If, at the time of grant, the share is valued at fair market value, i.e., based on a recent transaction value, the capital gain exemption at the time of sale is certain. FMV is deemed to be, for example, a substantial sale of shares (more than 10% of the capital), a sale of the company or an IPO.
- Formula Value (FV)
In the absence of a recent FMV, the tax authorities apply a formula value to assess the share (e.g. the practitioners' method). In this case, at the time of a trade sale or IPO, the tax-exempt capital gain corresponds to that determined using the same formula; the surplus is treated as salary. However, the exemption is guaranteed after the shares have been held for 5 years, unless certain events occur during the 5 years that trigger the change from the formula value to the market value. This triggering event can be a financing round, a sale between third parties of more than 10% of the share-capital, a trade sale or an IPO. In this case, at the time of the triggering event, all participants who have received their shares valued according to a FV for less than 5 years will definitively forfeit the 5-year period. The capital gain will for the most part be taxed as salary.
New Practice in Geneva
Geneva's practice is evolving and now differs from other cantonal practices.
Firstly, in Geneva, a substantial sale or a financing round is a triggering event only for the participant-seller and not for those who did not take part in the sale; on the other hand, an IPO and the sale of all the company's shares (trade sale) will have an impact on all participants.
Secondly, the AFC will also allow employers, subject to a request for a tax ruling and if justified by special circumstances, to derive the market value from a valuation of the company in the absence of a FMV based on a transaction. The acceptance of a substitute formula for a FMV will depend in particular on the company's stage of maturity. In this case, the general rule of exemption of the capital gain resulting from a sale of shares, even during the five-year period, will be applicable to the employee-participant. The AFC cites, for example, the Swiss valuation method known as the "practitioners' method", or even formulas based on multiples.
The AFC has finally reached a compromise solution that strengthens the tax advantages of EIPs in Geneva. This will apply in particular to start-ups, scale-ups or small and medium-size companies that are not planning to be sold or go public within the next five years.
With this new tax practice, the legal certainty and predictability of taxation is significantly improved for the employees-participants. They are no longer dependent on decisions to sell shares by other shareholders, in particular founding shareholders and majority shareholders. Only a sale by the employee himself, subject to IPOs and trade sales, can have an impact on their own taxation.
Our tax team helps clients to determine the solution best suited to their needs and is happy to inform you further on this topic.