Owning shares in the company you work for can be a major incentive to employees looking to join a startup. If all goes well, even a <1% equity stake can end up being worth some serious cash.
But, when it comes to selling shares, employees don’t always make as much money as they might expect. Even before cashing out, there can be hidden costs.
Equity incentives are subject to tax, and there’s no common framework across Europe — every country has its own systems and laws.
Some offer tax-optimised schemes to make equity more appealing, but in others, tax can considerably reduce the amount of money you take home.
Naël El Berkani, cofounder of equity management startup Easop, warns employees to get to grips with the potential tax implications before accepting any equity incentives.
“Ask around and inform yourself before you make any decisions,” he says.
There are two primary considerations. The first is when you get taxed: is it only at the point of sale (i.e. when you are able to liquidate your shares)? Is there an additional tax to pay when exercising stock options or when shares vest? Or, are you going to be taxed immediately when stock options or shares are granted?
The second is how much you’re going to get taxed. Some countries tax equity as income tax, which can be as high as 50%. Others do so at a capital gains tax rate, which is often, but not always, lower. And some have additional taxes to pay.
Here we outline some of the different tax systems in use across Europe, from the worst for equity incentives through to the best.
Belgium & Germany
A worst-case scenario is that employees are taxed at their full income tax rate twice: first when exercising their stock options (or, in the case of restricted stock units, when they vest), and again when they come to sell them.
In the first instance, tax applies to the difference between the strike price and the current market value of the stocks. As no liquid assets are received by the employee, it is referred to as dry income tax. El Berkani says this is a hidden cost employees have a tendency to overlook.
“Typically employees exercise [their options] when they leave a company because they believe in its long-term success but don’t want to stick around until an IPO,” he says.
“But then they realise how high the tax bill associated with the exercise is. So they don’t do it.”
Belgium is one of the least tax-friendly countries for employee equity. In fact, in a ranking compiled by VC firm Index Ventures, Belgium comes last.
Employees are taxed at exercise as income tax (up to 50%), plus social security contributions and local taxes.
Belgium does offer a tax scheme for startup stock options, which may prove more favourable for employees but comes with a significantly higher risk. Under the Belgian Stock Option Act of 1999, employees can choose instead to be taxed when options are granted.
This means:
- No further taxes will be due by the employee at exercise or sale.
- The taxable benefit is normally equal to 18% of the market value of the underlying shares, assuming the exercisable period is five years or less. For every year beyond this, the taxable benefit increases by 1%.
- The value is taxed as income tax, but no social security contributions are usually made.
But it is a gamble. An employee is typically granted options when they join the company. How confident can you be when joining a company that your shares are going to be worth something when you leave?
“You accept being taxed on something which could potentially end up being worth nothing at all,” El Berkani explains.
Germany joins Belgium at the bottom of the Index Ventures list.
Employees are also taxed at both at exercise and at sale, at the following rates:
- At exercise, employees pay income tax (14-45%), social security contributions (around 20%), solidarity surcharge (5.5% of income tax) and church tax (8-9% of income tax, though this tax can be avoided).
- At sale, employees pay a tax rate of 28%.
To get around this, startups in Germany have instead been offering virtual stock options. These are not “real“ shares but legally binding contracts that promise employees the cash benefit of their virtual shares during any liquidity event, such as an exit. As a result, employees are only taxed at sale as income tax, plus any additional contributions.
This is the system that equity management platform Ledgy uses for its German employees.
“If you have real stock options it’s simply not worth it at all. So in Germany, it’s actually more advantageous to revert to a cash-based scheme,” says cofounder Yoko Spirig.
More than 70% of shares currently issued in Germany are virtual shares, according to research by the German Startups Association.
But the situation is set to change.
On 16 November, the German Bundestag recommended passing a law that will introduce a flat 25% tax rate, increase the annual tax-free allowance to €5,000 and provide better flexibility to defer taxation and avoid dry income tax.
Christian Miele, chairman of the German Startups Association, says the new rules are “probably the biggest startup reform” the country has seen.
“Good employees are critical to the success of startups,” he says. “That is why [this] law will become an important accelerator for the growth of startups and scaleups in Germany.”
UK & France
Germany’s move to create a more tax-friendly environment for employee equity incentives follows in the footsteps of the UK and France, both of which offer schemes to further their appeal as startup hubs.
These schemes allow employees to pay significantly less tax than they would on a cash bonus, says Ledgy’s Spirig.
In the UK, most tech startups use the Enterprise Management Incentive Scheme (EMI), introduced in 2000.
With EMI:
- Employee tax is deferred to the point of sale.
- Every employee is allowed an annual tax-free capital gains allowance of £11,700. Anything that exceeds that is subject to the 20% capital gains tax.
- A reduced 10% tax rate will be applied if EMI options are held for more than two years after grant.
However, there are limitations. It can only be used by private companies with less than 250 employees globally and gross assets under £30m.
Tax-advantaged schemes for larger startups, including CSOP (Company Share Ownership Plan), Growth Shares and SIP (Share Incentive Plan) are less advantageous.
Outside these schemes, the default in the UK is to pay income tax and national insurance when exercising options and capital gains tax at sale. It is therefore important that employees know which scheme, if any, their shares fall under.
France also offers a favourable tax scheme for startups: BSPCE (Bons de Souscription de Parts de Créateur d’Entreprise).
Under BSPCE:
- Employee tax is deferred to the point of sale.
- Tax is applied at special rates (19% for those employed by the company for over three years at the time of sale, 30% for anyone else), with an additional 15.5% social tax.
Like EMI, BSPCE also has its limitations: the scheme can only be used by private companies under 15 years old, in which individuals hold 25% of the share capital.
The company also has to pay corporate income tax in France.
The Baltic states
According to the Index Ventures ranking, the most tax-favourable European countries for stock options and equity are the Baltic states: Latvia, Estonia and Lithuania.
In these countries, where startups such as Printify, Wise and Vinted were founded, employee taxation is almost always deferred to the point of sale and is generally no more than 20%. This applies to all private companies, no matter the size.
Now the founder of her own fintech company, Grünfin, Triin Hertmann previously worked at Estonia-based fintech Wise. She liquified some of her shares in a company buyback programme around six years ago, prior to the startup’s $11bn IPO.
“I know in some countries, like Germany, it’s really difficult for people […], but in Estonia, it’s super simple,” she says.
In Estonia:
- Employee tax is deferred to the point of sale.
- The difference between the strike price and sale price is taxed according to income tax (20%).
Latvia’s tax scheme, introduced in early 2021, is slightly more flexible than Estonia’s and the country ranks higher with Index Ventures.
- Employee tax is deferred to the point of sale (as long as any stock options are held for at least a year before exercising).
- The difference between the strike price and sale price is taxed according to capital gains tax (20%).
Additional considerations
As Germany’s decision this week proves, tax conditions for employee equity are becoming increasingly favourable.
“There is really a movement in European countries towards more beneficial taxation of shares schemes — for early-stage companies at least,” says Easop’s El Berkani.
But it’s not just tax rates employees need to familiarise themselves with before accepting equity incentives.
First, you need to know whether your plan is going to be in a tax-optimised scheme or not.
Living in a country that offers such a scheme doesn’t mean your options or shares will be issued under it — often a business needs to set up a legal entity in the country to qualify.
You also need to understand your company’s liquidation preferences. What valuation does it see itself exiting at and therefore how much would your shares be worth post-tax?
“It’s part of your due diligence as an employee when you join a company to ask those questions,” says Spirig.
Failing to do so could result in an unexpectedly nasty tax bill.
