Incentivizing key employees is a key issue for startups. In this context, employees can be granted either virtual shares or real shares. If the decision is made to grant real shares, ordinary GmbH shares or FlexCo enterprise value shares or profit participation rights are available. The following section will examine the suitability of profit participation rights for employee participation programs in more detail.

Design of participation programs

In practice, a basic distinction is made between the following participation programs:

• Debt participation programs (also known as “virtual” participation programs or “phantom stock programs”)

• Corporate participation programs (also referred to as “real” participation programs or “equity participation programs”)

In addition to legal aspects (e.g., voting rights, participation), the economic impact of a participation program on the beneficiaries and the company, or ultimately the shareholders, is crucial when preparing it. From the beneficiary's perspective, the focus is on the tax consequences of granting the participation program, on the one hand, and on the timing of returns from the participation program, on the other. From the company's or shareholders' perspective, however, it is important whether the expenses associated with the participation program are tax-deductible and how the participation program impacts the shareholders economically.

Are profit participation rights suitable for participation programs?

If you decide to grant selected employees actual shares, the primary options are GmbH shares or FlexCo company value shares. Alternatively, however, the granting of so-called profit participation rights (Substantial Participation Rights) is also available. These can also be granted in a GmbH.

The employee enters into a profit participation agreement with the startup. This agreement regulates the percentage of the employee's stake in the startup (as a true equity interest). The issuance of a equity participation right is carried out through a capital contribution, similar to a capital increase in a GmbH.

Holders of profit participation rights do not have voting rights at the shareholders' meeting. However, their participation in the goodwill and hidden reserves is identical to that of a real shareholder.

Tax aspects in connection with substance participation rights

From a tax perspective, there are no differences compared to a genuine GmbH or FlexCo participation: Both profit distributions and capital gains relating to profit participation rights are taxed at 27.5% at the level of the profit participation rights holder. If the profit participation rights are transferred to employees at a reduced price, this is to be regarded as a taxable non-cash benefit (benefit in kind), provided that corresponding value indications exist.

Avoiding a “dry income” can be achieved by agreeing on a negative liquidation preference or by applying the relatively new preferential treatment under Section 67a of the Income Tax Act (provided all application requirements are met), whereby a preparatory tax analysis and appropriate implementation are essential.

Conclusion

Particularly in the case of limited liability companies (GmbHs), so-called profit participation rights are now increasingly being used again – these represent an interesting alternative for employee participation due to the lack of voting rights!

This article was written by David Gloser (Partner, Tax Advisor and Auditor) and Christoph Puchner (Partner and Tax Advisor) of ECOVIS Austria. ECOVIS Austria is one of Austria's leading tax consulting firms in the startup sector. www.ecovis.at