Equity shares as incentives may trigger taxes

For more than 50 years, the granting of equity participations has proven to be a good way to motivate key executives to perform to the best of their abilities and with the long term in mind. Yet, income and gains resulting from these types of incentives trigger tax and social security consequences as well as reporting obligations which may significantly vary from one jurisdiction to another. As far as Switzerland is concerned, the cantonal tax authorities' practice may even vary from one canton to another on certain points.

Unfortunately, it is not uncommon for such tax and social security consequences to be overlooked or not properly understood, and that reporting obligations may not be complied with by employers and/or employees. This can result in additional taxes being imposed retrospectively, interest for late payment and possible penalties.

Failure to properly monitor tax consequences can be illustrated in light of a case which was ruled on 16 January 2023 by the Federal Administrative Court in the area of the transfer stamp tax.

This case involved a Swiss company that had granted Performance Share Units (PSU) and Restricted Stock Units (RSU) to some of its executives, whereby the latter were entitled to receive company shares for free after a blocking period of three years.

Following an audit, the Swiss Federal Tax Administration (hereinafter referred to as SFTA) considered that the transfer of shares triggered the payment of the transfer stamp tax and taxed the company in the amount of CHF 1,6 million.

As a reminder, the Swiss Confederation collects a stamp duty on the transfer for consideration of securities where a Swiss security dealer is involved in the transaction. The rate of the stamp tax can be either 0.15% (Swiss securities) or 0.3% (foreign securities). In the present instance, the company qualified as a security dealer because it had taxable securities on its balance sheet in excess of CHF 10 million.

In this decision, the concept of the onerous nature of the transaction was at the forefront of the litigation. The company argued in essence that because the employees did not have to pay anything to acquire the shares, the transfer was made for no consideration and was not subject to the transfer stamp tax. The SFTA on the other hand believed the granting of the RSU/PSU and the subsequent transfer of the shares were closely linked to the employment relationship and that it represented a compensation for work carried out by the executives. Hence, the SFTA concluded that the transfer of shares was made for a consideration and triggered the payment of the tax.

The FAC agreed with the SFTA's argument and ruled in its favor. The company appealed against this decision at the Swiss Supreme Court.

While not every Swiss company would qualify as securities dealer for transfer stamp tax purposes, this case emphasizes the importance of carefully monitoring the tax and social security consequences of management incentive plans. In the area the income tax for example, whether a gain resulting from the transfer of shares will be exempt or not may depend on the features of shares at stake, on the occurrence of specific events (such as a financing round or an IPO) as well as on the local tax authoritie' practice.

Failure to understand and monitor such consequences may trigger significant financial implications at corporate and personal levels. This can be quite disruptive for any business and run against the retention purpose of an incentive plan.

In case of doubts, employers would therefore be well advised to consult with their advisors and perform a proper "health check".