Taxation of Employee Participation – Part 3: Timing and Assessment of the Tax Valuation of Restricted Employee Stocks

Employee stocks are especially common in young companies or large firms. They can make up a large part of the salary or simply be an offer for all employees. In almost all cases, however, they are tax-relevant. Findea therefore dedicates a series of articles to employee participation. This article explains the peculiarities of employee stocks that are locked for a certain period of time.

Discount on locked employee stocks

‍Employee stocks are often issued locked. This means that during the lock-up period, the employee may not sell, pledge, or otherwise encumber the stocks. This is agreed upon contractually. However, taxation still occurs at the moment of legal acquisition, as explained in the second article. This represents a decrease in value of the stocks. This is accounted for in Art. 17b Para. 2 of the Federal Act on Direct Federal Tax, which states that for a lock-up period of max. 10 years, a discount of 6% per year on the market value is allowed. Partial lock-up years are considered proportionally. The calculation is therefore based on the formula 100 : 1.06^n. The "n" stands for the lock-up years still to be awaited after the cut-off date. The following table arises: Lock-up Period | Discount | Tax-reduced Market Value 1 Year | 5.660% | 94.340% 2 Years | 11.000% | 89.000% 3 Years | 16.038% | 83.962% 4 Years | 20.791% | 79.209% 5 Years | 25.274% | 74.726% 6 Years | 29.504% | 70.496% 7 Years | 33.494% | 66.506% 8 Years | 37.259% | 62.741% 9 Years | 40.810% | 59.190% 10 Years | 44.161% | 55.839%

Early termination of the lock-up

‍Occasionally, the lock-up period ends prematurely. This regularly happens when someone retires or is retired. Why the lock-up falls away is irrelevant from a tax standpoint. Since the deduction, which applied for the entire lock-up period, was used at the time of acquiring the stocks, insufficient taxes were levied. This leads to a subsequent taxation. In such cases, the difference between the non-discounted market value of the stock at the time of the termination of the lock-up and the value discounted according to the remaining lock-up period is regarded as taxable income. The formula then used is: "x - x : 1.06^n". The "x" in this case stands for the market value on the date of the lock-up's termination, "n" for the lock-up period that has been dropped.

Detailed information can be found in Circular 37 of the Federal Tax Administration.

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