The new circular letter provides an overview of the corporate income tax consequences of shared based payment transactions at the employer level. Author: Marco Mühlemann
On May 4, 2018, the Swiss Federal Tax Administration (SFTA) published circular letter 37A addressing the corporate income tax consequences of share-based payment transactions, granting shares or stock options and similar instruments to employees at the level of the employer and other involved group companies (usually the group parent company). The new circular letter supplements the rules for private individuals that are addressed by circular letter 37 which has been in place since more than 5 years.
The new circular letter deals with the most common structures that are seen in practice and includes 7 practical and numerical examples of statutory accounting entries (from the perspective of the SFTA) and the tax implications.
Apart from corporate income tax, the circular letter does not address any other taxes, for example, the securities transfer tax. However, it makes some comments as regards to capital contribution reserves.
The new circular letter does not include any transitional provisions and enter into effect immediately. It is understood that the SFTA made several changes compared to the draft version published last year as mainly EXPERTsuisse (the Swiss Expert Association for Audit, Tax and Fiduciary and one of the most important bodies for the interpretation of statutory accounting regulations) had not agreed with several proposed accounting entries. In its draft version, the SFTA had tried to incorporate several international accounting rules for share-based payment transactions (e.g. IAS 12) into the statutory accounting framework. However, EXPERTsuisse had not seen any conceptual basis for such an approach and had challenged several accounting examples in the draft version.
Tax deduction requires statutory expense
The circular letter confirms the general principle of Swiss corporate tax law that expenses are only deductible in Switzerland if they are recorded in the statutory income statement and are in line with the at arm’s length principle. As a consequence, there is still no matching principle like in the US where the company obtains a tax deduction once the employee earns taxable income. In Switzerland, there might still be a difference between the taxable income of the employee and the tax deduction of the employing company. The only exception to this general principle is treasury stock accounting where gains and losses might be taxable or tax deductible even without a statutory accounting entry. However, this rule is not new and has been in place since the adoption of the revised Swiss statutory accounting law.
Intragroup recharge of personnel costs
Regarding recharging of costs between group companies, usually between the group parent company and the local affiliate employing the people that participate in these plans, the circular letter states that these costs need to be at arm’s length. However, as regards stock options and similar instruments with a vesting period, the circular letter offers two options for the determination of the recharge balance:
- Groups may either use the fair value at grant, i.e. the amount that is calculated for IFRS or US GAAP purposes or
- The fair value at exercise.
Groups can therefore decide whether the risk of stock price changes should be borne by the group parent company or by the local employer.
Additional capital contribution reserves
The second example in the circular letter is interesting. This is where a company, in this case just a single company and not a parent/subsidiary relationship, is using an ordinary or conditional share capital increase to provide shares to the employee. In this example, the employee is paying CHF 200 to subscribe for new shares that have a fair market value of 1,000. The SFTA believes in this example that the company should be entitled to record a liability of 800 on the income statement (personnel expenses). This liability and the payment of 200 from the employee are subsequently used to create new shares with a nominal value of 100 and capital contribution reserves of 900. It is noted that EXPERTsuisse had challenged this approach in its consultation answer and argued that the capital contribution reserves should only increase by 100 (i.e. the total equity increase is 200). The SFTA apparently refused to change the example. It remains to be seen whether this approach will actually work in practice from both a legal and accounting perspective.
Assuming a parent-subsidiary relationship with a (listed) parent company and a subsidiary employing the people participating in these share or stock option plans, the situation occasionally arises where the parent company uses a share capital increase to provide shares to its employees. In such a set-up, the new shares are often subscribed by the subsidiary. The circular letter confirms that this approach may create new capital contribution reserves at the level of the parent company, but only at the point in time when the new shares are allocated to the employees.
Assume that a subsidiary needs to pay 1,000 to subscribe for new parent company shares with a nominal value of 100. The employee will subsequently receive these shares from the subsidiary for 200, so for 800 less than the capital increase. In this example, the parent company is entitled to record and declare capital contribution reserves of 900 once the shares are allocated to the employee. Costs that are related to the capital increase (e.g. the one-time capital duty) need to be deducted from the capital contribution reserves.
At the subsidiary level, the difference between the subscription price of 1,000 and the payment of 200 by the employee is a tax-deductible expense, i.e. 800 in this example. However, the current fair market value is irrelevant. Assuming that this would be 1,100 due to a share price increase during recent days, the difference between the 1,100 and the 1,000 is irrelevant for tax purposes as it is not recorded in the statutory income statement and does not therefore result in an additional deduction for the subsidiary.
Allocation of personnel expenses
As outlined in the example above, the local subsidiary that employs staff will usually have to pay substantial costs to its parent company once the instruments are exercised by employees. The circular letter confirms that the local subsidiary is entitled to record a tax-deductible liability for these costs during the vesting period. There are partially contradictory comments in the circular letter as to whether the accrual of the liability needs to be spread over the vesting period or whether the full recognition of the liability at grant is permitted:
- In subparagraph 5.1, the circular letter provides an accounting policy that is right for both approaches
- In subparagraph 5.3, however, the circular letter says that the costs need to be allocated during the vesting period. Examples 6 and 7 are also based on that approach.
These contradictory statements might be the result of additional input from EXPERTsuisse. It is understood that in the draft version, the SFTA had proposed a mandatory allocation during the vesting period whereas EXPERTsuisse believed that the company should have – taking into account the prudence concept of Swiss accounting law – an accounting policy option.
In addition, the circular letter confirms the following points:
- Costs of stock options that are acquired on the market are tax deductible. The only exception are LEPOs (Low Exercise Price Options) that do not qualify as options from a tax perspective.
- Hedging costs in connection with the share-based payment obligation are also tax deductible.
- An employee might be obliged to return shares to his company, for example because he is leaving the company, and the sales price might be higher or lower than the current fair market value of the shares. In such a case, any gain or loss will be taxable or tax deductible once it is recorded in the statutory income statement of the company. If the employee is returning his shares to the group parent company and not to his local employer, any gain or loss will also be allocated to the local subsidiary and not to the group parent company.
The circular letter is silent as regards the corporate income tax implications for companies that employ internationally mobile staff. As such, there are no comments in the circular letter addressing – for example – the allocation of the resulting expense among the companies concerned if an employee only spends a portion of the vesting period in Switzerland.
In summary, the circular letter largely confirms what has already been applied in practice. However, there are a few points to remember, namely the question as to whether a company is entitled to increase its equity by issuing new debt (example 2 in the circular letter). Furthermore, the subscription of new shares by a subsidiary may lead to additional capital contribution reserves at the level of the parent company even if the employee is paying substantially less or even nothing for the new shares that are subscribed by the subsidiary.
Lastly, it is still important to understand that Swiss local accounting and tax rules are different to the rules applied under IFRS and US GAAP. Additionally, a company can only realize a tax-deductible expense if such an expense is recorded in the statutory income statement.