Employee participation: Things to consider for taxation

Employee participation as compensation: Here are the tax implications.

Employee participation is highly popular in Switzerland as a means of motivating, compensating, and retaining employees. Find out what alternatives exist aside from employee shares and how they are taxed.

What is the aim of employee participations?

To make employees shareholders. Companies do this by issuing employee participations. For years now, these have been an important part of total compensation for managers in particular. SMEs also use employee participations as part of succession planning.

Employees generally participate on preferential terms, either directly through shares or indirectly through options or contingent rights to shares. If the company does well, employees benefit from the rising value of their participation rights.

Types of employee participation

Employee shares

Awarding employee shares means that employees participate directly in the company's equity capital. Employees can usually dispose of unrestricted employee shares without limitation. When blocked employee shares are awarded, the employer establishes a blocking period during which the shares must not be sold or pledged. 

Employee options

Employee options give the employee the right to purchase shares in the employer within a specified timeframe (exercise period) at a set price (exercise price). Unrestricted employee options can be exercised or sold without limitation, whereas this is only possible at the end of the blocking period for blocked employee options.

Contingent rights to employee shares

Contingent rights to employee shares offer employees the opportunity to acquire a number of shares either at no cost or on preferential terms after a specified timeframe known as the vesting period. Vesting is usually made contingent on requirements such as being in an employment relationship.

Employee participations are typically awarded on preferential terms or at no cost. The resulting discount is part of gainful employment income and is therefore taxable. This should accordingly be factored into personal liquidity planning, particularly when larger participation packages are awarded.

The general tax rules for employee participations are presented below. It should be noted, however, that different rules may apply particularly for employee participation plans that have already been in place for some time due to prior practice. We recommend consulting the employer in this regard. 

Income tax

Taxes on employee shares

Employee shares are taxed immediately, i.e. when awarded to employees. The taxable amount is determined by the difference between the market value of the share and the price at the time of grant. For tax purposes, any blocking period is deducted from the market value as a 6% discount per year, up to a maximum blocking period of ten years.

When employee shares held as private assets are subsequently sold, this generally results in a tax-exempt capital gain or an insignificant capital loss. However, in certain constellations the capital gain may be taxed if a so-called formula value was used on the acquisition date because no market value or market price was available. The respective practice adopted by the canton or the Federal Tax Administration must be observed. 

Employee participation: Taxation of employee shares

Illustration: Taxation of employee shares (type: tax-exempt capital gain upon sale)

Source: Credit Suisse

Taxes on employee options

Unrestricted employee options listed on the stock exchange are subject to tax based on the difference between the market value and the lower price at the time of grant. By contrast, employee options that are blocked or unlisted are not taxed until they are exercised or sold. The amount of tax is based on the difference between the exercise price and the market value of the share, or the proceeds from the sale less any issue price for the employee options.

Employee participation: Taxation of employee options

Illustration: Taxation of employee options (blocked or unlisted)

Source: Credit Suisse

Taxes on contingent rights to employee shares

Contingent rights to employee shares are taxed at the time of vesting. The taxable income is calculated as the difference between the market value of the shares awarded at that time and their issue price.

Employee participation: Taxation of contingent rights to employee shares

Illustration: Taxation of contingent rights to employee shares 

Source: Credit Suisse

Employee participations in an international context

In an international context, Switzerland generally levies a pro-rata tax on blocked or unlisted employee options as well as contingent rights if they are allocated to the employee in Switzerland and exercised in another country, or vice versa. The most important factor in such cases from a tax perspective is the number of days worked in Switzerland during the vesting period.

Pro-rata taxation is generally not applicable to employee shares or unrestricted employee options listed on the stock exchange since they are already taxed at the time of grant. 

Wealth tax

Depending on the instrument, employee participations are also subject to wealth tax collected at the cantonal level. Employee shares and freely disposable employee options listed on the stock exchange must be declared at market value, although in the case of employee shares the value is reduced in accordance with any blocking period applicable. In contrast, contingent rights to shares as well as blocked or unlisted employee options must be included in the tax return only pro memoria and without value.

Employee participations: Win-win for both parties

Companies rely on skilled workers to achieve ambitious goals. Making them partners and allowing them to participate in the success of the company creates a strong bond that benefits both parties.

Whether SMEs or major corporations, companies should take advantage of the latitude in designing employee plans and tailor them to their needs. For the actual plan participants, it's important to fully understand the participation model and to know the tax consequences. Credit Suisse is available to assist you with professional advice.


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