In course of the last decades equity-based employee compensation has consistently grown in relevance in Switzerland. However, due to the lack of a clear statutory basis, equity based employee compensation schemes have been taxed merely based on circulars issued by the Swiss Federal Tax Authorities which has been heavily influenced by the non-consistent practice of the cantonal tax authorities.After a legislative process stretching over a decade the new Federal Act of the Taxation of Equity Based Employee Compensation Schemes finally eliminates the uncertainties of the current inconsistent practice and provides a new legal basis for the taxation of monetary benefits derived from equity based employee compensation schemes. The new statute regulates the time and scope of taxation for such schemes which will be implemented in the Federal Act on Direct Federal Taxation (DBG) and in the Federal Act on the Harmonization of Taxes (StHG). The legal changes will affect employees with regard to direct federal tax and to income tax levied by the Cantons. In addition, the new statute introduces a regime for the taxation of equity based employee compensation schemes in cross-border settings. It will enter into force on 1 January 2013.
Types of Schemes defined by the new Statute
The statute establishes two types of equity based compensation schemes:
Non-qualifying employee participation rights are defined as prospective entitlements of an employee for a cash payment which are also referred to as “phantom stocks”. Such cash payments will be taxed as income of the employee at the time when they are actually received. Qualifying employee participation rights are defined by the statute as equity based securities (e.g. shares, participatory certificates, profit sharing certificates etc.) which are granted to the employees by an employer, its corporate parent or another affiliate, or as stock options on the acquisition of such equity based securities.
Taxation of Employee Shares
Employee shares are divided by the new statute into free employee shares which may be disposed of by the employee without restriction, and restricted employee shares which may not be disposed of during a limited time period.
Corresponding to the current practice, taxation for free and restricted employee shares occurs upon the acquisition of such shares whereby the difference between the market value of the shares less the (lower) purchase price will be subject to taxation as income. In addition, restricted employee shares benefit from a discount of 6% per annum of restriction on the respective market value (during a maximum period of ten years).
Taxation of Employee Stock Options
The new statute differentiates between freely disposable and listed employee stock options on one hand, and restricted or not listed employee stock options on the other hand.
Under the new act, restricted or unlisted employee stock options are generally taxed at the time of exercise whereby the taxable income is defined as the difference between the market value of the underlying shares (or other securities) and the exercise price (and any purchase price for the option, if any). From a tax standpoint it may be disadvantageous for the employee that any potential increase of the value of the underlying shares at the time of exercise may not be realised as a (for Swiss residents) tax free capital gain anymore, which reduces the appeal of such instruments from an employee’s perspective considerably. On the other hand, the new regime eliminates the former disadvantages for employees in situations in which the employee stock options already taxed as income at the time of grant cannot be exercised due to a loss of market value of the underlying shares. The non-exercise of restricted or non-listed employee stock options will not have any tax consequences in the future.
Only free and listed employee stock options will be taxed at the time of grant as taxable income under the new regime. In this case, the employee will be taxed on the difference between the market value of the option at the time of grant and the purchase price for such stock option. An increase of the value of the underlying securities after the exercise of the option will result in a tax-free capital gain.
The new statute further contains rules on the taxation of ‘imported’ and ‘exported’ employee stock options which in the past have been subject to taxation only in accordance with the practice of the cantonal tax authorities. The new statute provides guidance for the treatment of situations in which an employee either moves to Switzerland (i.e. ‘import’ of options) or ceases to be a resident of Switzerland (‘export’) after the grant but before the exercise of such options.
Irrespective of the applicability of any double-taxation treaties the new statute provides for a taxation of restricted or unlisted employee stock options in Switzerland in proportion of the time spent in Switzerland to the entire period between
purchase and vesting of the option (pro-rated taxation). The relevant time for the taxation will be the exercise of the employee stock option.
In order to secure taxation in Switzerland in case of an export of employee stock options, the relevant income tax is stipulated as a source tax to be withheld and paid by the Swiss employer. It is therefore paramount for Swiss employers to
secure that such withholding tax for exported options may be charged to the relevant employee as the tax payment will only fall due after the employee in question has given up residence in Switzerland. On a federal level, the withholding tax will amount to 11.5%. The Cantons will be free to determine their own tax rates for this purpose.
Additional Employer’s Obligations
In addition to the new statute, the new Ordinance on Reporting Obligations for Equity Based Employee Compensation Schemes introduces new reporting obligations for Swiss employers towards the tax authorities as of 1 January 2013. The new ordinance also contains provisions to certain special issues which have not been addressed in the statute, such as the taxation of a premature lapse of selling restrictions or the return of employee shares.
The new legal framework increases the demands on employers and HR departments, due to the new reporting obligations in particular with regard to administrative tasks. New equity based employee compensation schemes must be introduced within the limits of the new legal standards and existing programs must be thoroughly investigated about their compatibility with the new legal standards, in particular in international settings.