When implementing schemes for stock options, HR is most familiar with the tax consequences for non-tradable options. This year a German finance court has given the first indication that tradable options can be treated in the same manner as non-tradable. Christian Levedag of Deloitte & Touche gives the background.

Over the past few years the discussion of the tax treatment of stock options in Germany has focused on the tax treatment of non-tradable stock options. Two landmark decisions in 2001 by the Federal Finance Court stated that non-tradable options are taxable when the options are exercised.

In April 2003 the German tax authorities agreed and published a concurring ordinance that non-tradable stock options are taxable at exercise on the spread between fair market value of the underlying shares and the exercise price payable by the German employee. The tax authorities define the fair market value of the underlying shares as: the value on the day when the shares are debited from the employer’s or his agent’s account to the employee’s account. 

The court reasoned that in the case of a non-tradable option a benefit in kind did not crystallize for the employee before the employee actually realised the spread by either receiving the shares as an asset or by cash in a cashless exercise – whereby the employer disposes of the underlying shares and sets off the employees liability to pay the exercise price.

Further, the ordinance distinguishes between non-tradable options and tradable options as follows: tradable options are only options that can be traded on a public exchange; all other forms of stock options are treated as non-tradable options.

Until recently, German commentaries commonly understood that tradable stock options should be taxable at the grant date since the employee received a benefit in kind already at grant because the tradable option formed a disposable asset. Neither court decisions nor rulings of the tax authorities had been issued with regard to tradable options before the following decision by the Finance Court Muenster

New court ruling for tradable stock options

The Muenster Finance Court held in a recent decision, as of 9 May 2003 (Az. 11 K 6754/01 L, FG 2003, S. 1172), that tradable stock options are also taxable at exercise only.

The plaintiff, who was employed by a German subsidiary, participated in his foreign head company’s stock option incentive scheme involving tradable stock option rights.

The competent tax authorities qualified the grant of tradable stock options as a taxable benefit in kind at grant date and computed the tax base by multiplying the number of options by the fair market value of the underlying shares at grant date. For the plaintiff, this led to taxation of a ‘paper gain’ since, due to a dilution of the share price, the exercise never happened.

The Muenster Finance Court clarified that the German employee neither derived a taxable benefit in kind at grant or at end of the vesting period. The Court refused to accept the tax authorities’ view that a taxable benefit in kind had already crystallized at grant date and pointed to the interests of the parties.

Tradable and non-tradable stock option rights were, according to the Court, only taxable at exercise, as it was the intention of the parties to grant the underlying shares subject to the vesting period to the employee.

Please note, however, that the Muenster Finance Court assumes a taxable benefit in kind at grant date if the employer buys stock option rights in the open market and transfers these to the employee. In the latter scenario, the interests of the involved parties indicate that the employee receives remuneration for his services via the tradable options at grant date.

October 2003

Christian Levedag is a tax lawyer with Deloitte & Touche in Düsseldorf, Germany. He can be contacted at clevedag@deloitte.de