Standardisation of the practice of employee benefit plans throughout Switzerland

The practice regarding the tax treatment of employee benefit plans will be subject to the following three significant changes effective as of 1 January 2021. The practice update is stipulated in the new version of the circular letter of the Swiss Federal Tax Administration and is the result of the motion 17.3261 of the National Council Commission for Economic Affairs and Taxes (WAK-N) "Competitive tax treatment of start-ups including their employee shares".

1. In the absence of a fair market value, the corporate valuation must be carried out using a suitable and recognized method and the (tax-relevant) fair market value can be determined in the same way as for wealth tax purposes

As from 1 January 2021, non-listed companies implementing an employee benefit plan will be valued based on the so-called practitioner method ((2x earnings value + 1x net asset value) divided by 3). Depending on the canton, other assessment approaches may also be applicable for companies that meet the qualifications of start-ups. Irrespective of this change in practice, companies can still apply a valuation using their own methodology (e.g. an EBITDA multiple), provided that (i) the formula plausibly reflects the business model, (ii) it is comprehensible and (iii) it is accepted in advance by the relevant cantonal tax authorities as "suitable and approved". It is advisable to ensure the acceptance of a separate valuation formula by means of an advance tax ruling.

2. National-wide possibility of a tax-free capital gain after a 5-year holding period

The bad news first: nothing changes for employees and companies operating in Zurich. What previously applied only in the Canton of Zurich will apply throughout Switzerland as from 1 January 2021. After a 5-year holding period, any surplus profit (difference between the value based on the same formula as at the time of allocation and the sales price) will no longer be subject to tax. Thus, the entire difference between the value at the time of granting the shares and the latter sales price qualifies as a tax-free capital gain, save for taxation of violations of the blocking-period in years n6-n10.

This tax exemption for capital gains in principle only applies for sales to third parties. The 5-year holding period remains irrelevant for re-sales to the company or its shareholders, and any surplus profit is subject to income tax and social security contributions in the cantons in question.

The change of practice will undoubtedly apply to new employee benefit plans throughout Switzerland. In a perfect world, the same rules would also be applicable to existing employee benefit plans. Unfortunately – as a result of the Swiss federal system – this is not the case. Depending on the canton, there are different opinions as to how the new nationally applicable 5-year holding period shall apply to existing employee benefit plans. Companies affected will most likely not be able to avoid getting in touch with the relevant cantonal tax authorities to resolve this ambiguity.

3. Shares acquired at third-party conditions or subscribed for during incorporation do not qualify as employee shares

If employees acquire shares of the company at the same terms and conditions as those applicable to third-party investors, their shares do not qualify as employee shares. The same applies to shares acquired by shareholders (so-called "founding shareholders") in the course of the incorporation of the company. Future capital gains realized on such sales are therefore entirely tax-free, irrespective of whether the sale is made to third parties, to the company or to shareholders. However, this requires that no discount due to the blocking period is granted when allocating of the shares.

However, other aspects of the tax authorities' intervention against the tax-free capital gain, such as the qualification of the shares as business assets or the qualification of the employee or founding shareholder as a professional securities dealer, must be considered.

The changes of the practice are highly welcomed. Nevertheless, the effects on existing employee share plans are ambiguous owing to the lack of clear transitional provisions. It is therefore worthwhile for affected employees and employers to consult their tax advisor as soon as possible.