Direct Federal Tax. Bern, 22 July Circular Letter No. 37. Taxation of Equity-based Compensation Instruments.

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1 This is an unofficial translation. The underlying German version was published by the Federal Tax Authorities and is accessible at Direct Federal Tax Bern, 22 July 2013 Circular Letter No. 37 Taxation of Equity-based Compensation Instruments Table of contents 1 General / subject of this Circular Letter Terms Employee Employer Equity-based compensation Real equity-based compensation instruments Employee shares Freely disposable employee shares Blocked employee shares Employee options Freely disposable employee options Exchange-listed employee options Blocked employee options Employee share awards Phantom equity-based compensation instruments Phantom stocks Stock appreciation rights Co-investments Future developments Blocking period and vesting / vesting period Realisation Foreign currency translation Taxation of employee shares (Art 17b DFT) Fundamental principle Fair market value Exchange-listed employee shares Unlisted employee shares Determination of taxable income Special cases Premature termination of the blocking period (Art. 11 EBCO) Surrender of employee shares (Art. 12 EBCO) Sales of privately held employee shares...10

2 4 Taxation of employee options (Art. 17b DFT) Freely disposable exchange-listed employee options Other employee options Taxation of employee share awards Taxation of phantom (cash-settled) equity-based compensation instruments (Art. 17c DFT) Taxation of equity-based compensation instruments in an international context (Art. 7 to 9 EBCO) General Income tax withholding at source for employee shares and freely disposable exchange-listed employee options General Income tax withholding at source Taxation of blocked or non-listed employee options, share awards and phantom equity-based compensation instruments in an international context General Import of equity-based compensation instruments (Art 7 EBCO) Import of equity based compensation instruments with change of residence Import of equity based compensation instruments without change of residence Export of equity-based compensation instruments (Art. 8 EBCO) Export of equity-based compensation instruments with change of residence Export of equity-based compensation instruments without change of residence Overview of the source taxation of monetary benefits from equity-based compensation instruments that are not taxable until realisation Cooperation and reporting obligations Employer General Reporting re employee shares (Art. 4 EBCO) Release of employee shares prior to expiry of the blocking period (Art. 11 EBCO) Surrender of employee shares (Art. 12 EBCO) Reporting re employee options, share awards and phantom equity-based compensation instruments (Art. 5 and 6 EBCO) Freely disposable exchange-listed employee options Other employee options, share awards and phantom equity-based compensation instruments Further information (Art 17 EBCO) Taxable persons Tax ruling agreed between the employer and the tax authorities General Prerequisites Competence Effective date, abrogations and transitional law...19 PwC Unofficial translation of Kreisschreiben Nr. 37 Page 2 of 34

3 1 General / subject of this Circular Letter With the Federal Law on the Taxation of Equity-based Compensation Instruments of 17 December 2010 (AS ), various changes were made to the way equity-based compensation instruments are taxed. Considered in their totality, the new provisions are intended as a means of restoring legal certainty and this in particular as it pertains to the timing of taxation and in line with the Commentary on the OECD Model Convention for the Avoidance of Double Taxation on Income and Capital (hereinafter, the OECD Commentary ) tax apportionment in an international context. In this connection in particular Article 15 of the OECD Model Convention for the Avoidance of Double Taxation on Income and Capital (hereinafter OECD-MC) is to be considered. The new reporting requirements provided for under Article 129 para. 1 lit. d of the Federal Law on Direct Federal Tax of 14 December 1990 (DFT, SR ) have been elucidated in the Ordinance on the Reporting Obligations for Equity-based Compensation of 27 June 2012 (Equity-based Compensation Ordinance [EBCO], SR ). The Official Notice (BBl ) regarding the new federal law dates back to 17 November 2004, thus the new legislation does not take into account all of the developments in the area of equity-based compensation instruments that have taken place in the meantime. The present Circular Letter and Annexes I to IV are intended to provide an overview of the tax effects of the new provisions 2 Terms 2.1 Employee Deemed to be an employee within the context of this Circular Letter are workers who are under contract with an employer (see Art. 319 para. 1 of the Federal Law on Supplementation of the Swiss Civil Code [Section Five: Code of Obligations; CO, SR 220] and Art. 17 DFT) as well as members of the Board of Directors or of the Management Board, regardless of their domicile/residence. Crucial is whether the income based on the underlying legal relationship qualifies as employment income pursuant to Article 17 para. 1 DFT. Also deemed to be an employee are those future workers to whom the future employer has already granted equity-based compensation instruments in anticipation of the employment relationship or former employees to whom the former employer granted equity-based compensation instruments during their term of employment. Not deemed to be an employee are contractors (see Art. 363 CO), mandatees, brokers or general agents within the context of Article 394 ff. CO as well as shareholders who are not in an employment relationship with the company. 2.2 Employer Deemed to be an employer within the context of this Circular is the company, a group entity or a permanent establishment, at which the worker is employed. This also includes de facto employers. This could cover situations, in which an employee of a foreign subsidiary company is assigned to the parent company in Switzerland, which assumes the costs of the employee. In this case the Swiss parent company becomes the de facto employer. 2.3 Equity-based compensation If the right to equity-based compensation is attributable to the former, current or future employment relationship with the employer, then it qualifies either as real or phantom (merely cash-settled) equity-based compensation. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 3 of 34

4 If the equity-based compensation instruments have been granted to the employee not by the employer but instead by a natural person (e.g. from the personal portfolio of a shareholder), they are not deemed to be equity-based compensation as per Article 17a DFT in a narrower sense. However, it is justifiable to apply the provisions for equity-based compensation instruments analogously to measure the monetary benefit Real equity-based compensation instruments Real equity-based compensation instruments entitle the employee to participate in effect in the equity of the employer. Such participation may be granted directly by means of shares or indirectly by means of options or awards to acquire equity instruments. The most frequent forms of real equity-based compensation are employee shares and employee options Employee shares Deemed to be employee shares in the context of this Circular Letter are equity securities of the employer or of a related entity (cf. Art. 17a para. 1 lit. a DFT and Art. 1 para. 2 lit. a EBCO), which have been transferred to the employee by the employer as a result of the employment relationship, normally on preferential conditions. Other equity securities that enable the employee to participate directly in the company s equity capital in particular, participation certificates [Partizipationsscheine, bons de participation, bouni di partecipatione] or co-operative shares are to be treated like employee shares. Hereinafter, for the sake of simplicity reference will be made solely to employee shares Freely disposable employee shares Deemed to be freely disposable employee shares are employee shares that the employee can sell or transfer without limitation Blocked employee shares Deemed to be blocked employee shares are employee shares which, as a general rule, are restricted as to sale for a blocking period during which the employee may not transfer, pledge or otherwise encumber the shares. The legal foundation for the blocking period is usually the equity participation regulations or purchase agreement between the employer and employee. Not deemed to be blocking periods are mere time windows during which, for example, based on internal policies or securities exchange rules (so-called closed window periods), the employee may not sell the shares Employee options An employee option grants the right to an employee, based on his/her future, current or previous employment relationship, to acquire, normally on preferential conditions, equity securities of the employer within a specified period of time (the exercise period ) at a specified price ( exercise price ) in order to participate in the equity capital of the employer Freely disposable employee options Following their grant, freely disposable employee options can be exercised or sold without restriction at any time Exchange-listed employee options In the context of this Circular Letter, an employee option is deemed to be exchange-listed if it is listed on a stock exchange with a sufficiently liquid trading, whereas trading may not be limited only to employees. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 4 of 34

5 Blocked employee options After their grant, blocked employee options may not be sold or exercised during a prescribed time frame (blocking period) Employee share awards Employee share awards offer the employee the opportunity to acquire a specified number of shares at a later date, either free of consideration or on preferential conditions. In this connection, the transfer of the shares is normally tied to certain provisions, e.g. the existence of an employment relationship. Employee share awards therefore constitute compensation for future services rendered, which is why they can be considered equivalent to real employee options (see in this regard also Section above). Restricted stock units (RSUs) are typical examples of such awards Phantom equity-based compensation instruments Deemed to be phantom (merely cash-settled) equity-based compensation instruments are equity- or share-price-related incentive instruments that in effect do not give the employee a participation in the equity of the employer but, as a general rule, offer only a cash benefit that is determined by the price development of the underlying share. Because as a rule they do not afford the employee further rights, such as voting and dividend rights, phantom equity-based compensation instruments are considered from a tax standpoint to be only expectancy rights until they are actually realised. The most frequent forms of phantom equity-based compensation instruments are so-called phantom stocks (synthetic shares) or stock appreciation rights (synthetic options) as well as certain types of coinvestment Phantom stocks A phantom stock is a notional share that mirrors the value of a certain underlying equity security and puts the owner on a par with a shareholder from a value standpoint. Accordingly, the owner normally receives payments, the amount of which corresponds to the dividend distributions for the actual share. However, a phantom stock does not represent a share in the employer s equity and therefore also membership rights, such as shareholders enjoy Stock appreciation rights A stock appreciation right (SAR) entitles the employee to receive from the employer at a future date a cash payment reflecting the price appreciation of a certain underlying equity security. In contrast to phantom stocks, generally no payments are made that correspond to the amount of the dividends. There is no actual delivery of shares and hence no participation in the equity of the employer Co-investments Co-investments of employees are mainly found within the framework of private equity structures. Here, employees are usually granted instruments that compensate them only when the employing company is sold or taken public. Such co-investments are deemed to be phantom equity-based compensation instruments especially if the related equity does not convey comprehensive ownership rights to the employee (i.e. an unrestricted voting and dividend right, the right to a share of the profits and liquidation proceeds) Future developments In application of Article 16 EBCO, the Federal Tax Administration (hereinafter, FTA) can list and publish in a separate Annex any new types of equity-based compensation instruments that come to its attention subsequent to the entry into force of this Circular Letter. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 5 of 34

6 2.4 Blocking period and vesting / vesting period A blocking period is generally understood to be a contract-based temporarily limited disposal restriction, during which the employee may in particular not exercise, sell, pledge or otherwise encumber the relevant employee compensation instruments. refers to the time span, during which the employee earns an option, in particular by fulfilling certain performance goals or by not terminating his employment contract before the expiry of a certain period.. The end of this time span is defined as vesting (cf. Judgment of the Federal Court 2C_138/2010 dated 2 June 2010, Consideration 2.2). Accordingly, such equity-based compensation instruments are considered to have been granted conditionally and on a suspensive basis until they vest. The actual vesting, i.e. the end of the vesting period, is normally specified in the relevant equity-based compensation plan/contract, as are the conditions that could lead to a premature vesting. If the vesting period expires and all the vesting conditions are fulfilled, this results in the acquisition of legal entitlement to the corresponding equity based compensation instrument. The timing of taxation follows Section 3ff of this Circular Letter. 2.5 Realisation Wherever reference is made in this Circular Letter to the realisation of equity-based compensation instruments, that term indicates in particular the exercise or sale of employee options, as well as the conversion of employee share awards into shares, and the receipt of cash from share-price-related cash incentive programmes (cf. Annex I, Overview of Equity-based Compensation Instruments). 2.6 Foreign currency translation If an equity-based compensation instrument is denominated in a foreign currency, then the details in the reporting must be translated into Swiss francs (hereinafter, francs ). The applicable translation rate is the mean of the bid and ask price for the currency pair on the day of grant, acquisition or realisation of the monetary benefit from the equity-based compensation. In justified cases and by agreement with the competent tax authority a different translation method may be used. 3 Taxation of employee shares (Art 17b DFT) 3.1 Fundamental principle If employee shares are granted free of consideration or on preferential conditions, the positive difference between the fair market value and the issue price represents a monetary benefit to the employee and therefore employment income (see Art. 17 para. 1 DFT). Employee shares are taxed when granted, i.e. at the time of legal acquisition. 3.2 Fair market value Exchange-listed employee shares For exchange-listed employee shares, the official closing price on the day of their acquisition is in principle considered to be the fair market value. As a rule employee shares are legally acquired at the time, at which the employee accepts the employer s offer to acquire shares. For administrative reasons, in particular, the equity-based compensation plan can provide for a specified subscription period during which the employee must confirm his/her acceptance of the offer. If such subscription periods are present, the following applies: PwC Unofficial translation of Kreisschreiben Nr. 37 Page 6 of 34

7 For subscription periods of more than 60 calendar days, the tax-relevant fair market value is deemed to be the closing price on the day the offer is accepted. For subscription periods of up to 60 calendar days, the tax-relevant fair market value is deemed to be the closing price on the first day of the subscription period.in justified cases and by agreement with the competent tax authority, this method of calculating the fair market value may be varied Unlisted employee shares For unlisted employee shares, as a rule a fair market value is lacking. Therefore the applicable value is considered in principle to be the value as determined for the given employer in accordance with a suitable, recognised formula (formula value). Once chosen, it is mandatory that this calculation method be used for the corresponding equity-based compensation plan. If the formula value is calculated only once a year, then it is considered to be the applicable tax value only if the employee shares are granted within six months of the given valuation date. Otherwise, the formula value of the next valuation date is to be applied appropriately. If exceptionally a fair market value is available for unlisted shares, then in principle it is applicable. On an exceptional basis and upon appropriate application by the employer, a formula value may be used despite the availability of a fair market value. However, this is conditioned on the employer s unrestricted right to repurchase the employee shares at a price calculated in the same way. Example: A and B incorporate Newtec AG with share capital of 100,000 francs (100 shares, each with a par value of 1,000 francs). In the course of a capital increase, Z Bank as an investor subscribes for 100 additional shares, each with a par value of 1,000 francs and a share premium of 9,000 francs per share. Thus the fair market value amounts to 10,000 francs per share. A half-year later, Newtec AG wishes to let its employee C participate in the company by granting 10 shares free of consideration. With a fair market value of 10,000 francs, this would lead to taxable earned income of 100,000 francs for C. But because his other wage is very modest, C would not be in a position to pay the income tax due on the equity-based compensation. For this reason, Newtec AG requests the competent tax authority to negate the fair market value and instead in future for tax purposes to use the formula value as the base. This procedure is accepted by the tax authorities, if the employer has an unrestricted right to repurchase the employee shares at a price calculated using the same formula. 3.3 Determination of taxable income The taxation is based on the positive difference between the fair market value of the employee shares and the price at which they are granted. Compared with freely disposable shares, blocked employee shares have a lower value. Article 17b para. 2 DFT acknowledges that fact by allowing a six per cent discount per blocking year, whereby a maximum of ten blocking years can be taken into account. This leads to the following discount table: PwC Unofficial translation of Kreisschreiben Nr. 37 Page 7 of 34

8 Blocking period Discount Reduced fair market value 1 year % % 2 years % % 3 years % % 4 years % % 5 years % % 6 years % % 7 years % % 8 years % % 9 years % % 10 years % % Fractions of blocking years are taken into account on a pro rata temporis basis (see Art. 11 para. 3 and Art. 12 para. 2 EBCO). The reduced (percentage) fair market value is calculated according to the formula (100 : 1.06 n ), where ( n ) equals the number of blocking years still remaining as of the valuation date. The positive difference between the reduced fair market value and the lower cost of acquisition represents the employee s taxable employment income (Art. 17b para. 1 DFT). 3.4 Special cases Premature termination of the blocking period (Art. 11 EBCO) If the blocking period is terminated prematurely, at that time the employee realises a monetary benefit based on his/her employment, i.e. employment income (Art. 17 para. 1 DFT). The reason for the premature termination of the blocking period is just as insignificant as the potential fact that at the time the employee shares were acquired for a price above the discounted, taxable fair market value. The taxable income amounts to the difference between the non-discounted fair market value of the shares when the blocking period is terminated and the discounted value according to the remaining original blocking period. Fractions of remaining blocking years are taken into account on a pro rata temporis basis. Example: On 15 March 2010, employee A was allocated an employee share free of consideration with a blocking period of ten years. On 30 September 2013, employee A takes early retirement. According to the equity-based compensation plan, that event prematurely triggers the termination of the still existing blocking period. Thus, on 30 September 2013, the share that otherwise would have been blocked until 15 March 2020 immediately becomes freely disposable. In other words, at that point in time the share with a remaining blocking period of 6.46 years ( n ) is turned into an unblocked share. If for example the (full) exchange price on 30 September 2013 is 1, francs per share (x), then taking into account the remaining 6.46 blocking years the reduced fair market value (as per Article 17b para. 2 DFT) amounts to only per cent (100 : ) of the full fair market value, or 1, francs. This difference between the full fair market value (1,500) and the reduced fair market value (1,029.50) represents the taxable earned income of francs that must be reported at the time of the premature termination of the blocking period. Mathematically, this calculation is expressed by the formula (x x : 1.06 n ), i.e. (1,500 1,500 : ). PwC Unofficial translation of Kreisschreiben Nr. 37 Page 8 of 34

9 Date Blocking on issue (Remaining) blocking period Fair market value Discount CHF Termination on ,500 1,500 Discounted at years 6.46 years 1, % 1,029 Taxable employment income Surrender of employee shares (Art. 12 EBCO) If an employee has to surrender his/her employee shares to the employer due to a regulatory or contractual obligation upon termination of employment, this can result in either a work-related expense or taxable employment income. If there is a positive difference between the redemption price and the (appropriately discounted) fair market value or formula value, the employee realises taxable employment income and not for instance a tax-free private capital gain. Thus in such cases, a reporting must be drawn up including the details analogous to those prescribed in Article 11 para. 4 EBCO. The taxable employment income at the time of surrender is equivalent to the difference between the (appropriately discounted) fair market value or formula value of the surrendered employee shares and the higher redemption price. In the event of a surrender of employee shares without consideration or below the current fair market value, the employee can claim a deduction from income for the allocated expenses in the tax period in which the employee shares were surrendered. Example: On 15 March 2010, employee A was granted an employee share with a blocking period of 10 years. On 30 September 2013, employee A terminates his employment relationship. In accordance with the equity-based compensation plan, he must surrender the share at the original acquisition price of 800 francs. If employee A had free disposition of the employee share, the share with a remaining blocking period of 6.46 years ( n ) would be converted into an unblocked share. If for example the (full) exchange price on 30 September 2013 is 1, francs per share (x), then taking into account the remaining 6.46 blocking years the reduced fair market value (as per Article 17b para. 2 DFT) amounts to only per cent (100 : ) of the full fair market value, or 1, francs. But because he surrendered the employee share at a price of 800 francs (y), he can deduct the difference of francs as allocated expenses in his tax return. Mathematically, this calculation is expressed by the formula (x :1.06 n y), or (1,500 : ). Date Blocking period Remaining blocking period Fair market value Surrender price Discount Reduced fair market value Allocation years Notice years 1, % (=1,029) 1,029 As the surrender price is 800 francs and the reduced fair market value 1,029 francs, the allocated expenses for tax purposes amount to 229 francs. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 9 of 34

10 3.4.3 Sales of privately held employee shares For Direct Federal Tax purposes the sale of privately held employee shares results in principle in either a tax-free private capital gain (see Art. 16 para. 3 DFT) or a capital loss, which is not relevant for tax purposes. The amount of the tax free capital gain is the difference between the fair market value on allocation and the fair market value at the time of sale or the difference between the formula value on allocation and the formula value calculated in the same way at the time of sale. Any added value, which is the result e.g. of a change in the method of valuation or a change from the formula value to fair market value, is as a rule taxable as income at the time of sale. This applies in particular in the following situation: In determining the taxable income from the allocation of unlisted employee shares, reliance was originally placed on a formula value of the employee shares and the employee shares are later repurchased by the employer at a price based on a different calculation method 4 Taxation of employee options (Art. 17b DFT) 4.1 Freely disposable exchange-listed employee options Freely disposable exchange-listed employee options are taxed at the time of grant. If the employee options are granted free of consideration or on preferential conditions, the positive difference between the fair market value and the issue price represents a monetary benefit to the employee and therefore employment income (Art. 17b para. 1 DFT). With regard to the fair market value of employee options, the provisions under Section of this Circular Letter apply analogously. 4.2 Other employee options All employee options that are not taxable as per Section 4.1 above at the time of grant are taxed at the time of sale or exercise (see Art. 17b para. 3 DFT). The entire sale proceeds or profit from exercise after deduction of allocated costs is taxable. 5 Taxation of employee share awards Share awards are taxed at the time of their conversion into employee shares. The taxation at that time is in accordance with the rules applicable to employee shares (see Section 3 above). 6 Taxation of phantom (cash-settled) equity-based compensation instruments (Art. 17c DFT) Monetary benefits from the grant of phantom equity-based compensation instruments are taxable at the time of their inflow. As employment income, the entire monetary benefit is subject to income tax, i.e. no tax-free private capital gain can result from phantom equity-based compensation. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 10 of 34

11 7 Taxation of equity-based compensation instruments in an international context (Art. 7 to 9 EBCO) 7.1 General Proportionate taxation, as set out in Articles 17d DFT and 7 and 8 EBCO, is applicable in two instances. The first involves cases in which the employee moves to Switzerland from abroad (import: Art 7 EBCO). The second involves employees who move abroad from Switzerland (export: Art. 8 EBCO). In this connection, the equity-based compensation instruments are granted in one country and realised in another. This type of equity-based compensation is usually an employee option, share award or phantom equity-based compensation instrument. Given the various double tax treaties (DTTs), as a general rule Switzerland cannot tax the entire monetary benefit from the realisation of those instruments. Rather, the taxation is to be divided between the countries on the basis of the working days the employee resided in those countries from the time of grant of the equity-based compensation until the exercise right is acquired (Art. 7 and 8 EBCO). It is of no consequence whether or not another country taxes the monetary benefit proportionately. Rather it is decisive which country holds the proportionate taxation right on the income from the underlying employment. Article 7 as well as Article 8 EBCO prescribe what the employer must report in cases of proportionate taxation as per Article 17d DFT. It should be noted that, based on the express reference in Article 9 EBCO, Articles 7 and 8 EBCO are to be applied analogously in special cases such as when an employee moves to Switzerland from abroad, resides here for a short period of time, and then relocates abroad again or vice versa prior to the vesting. The territorial jurisdiction for taxation is governed in Articles 107 and 216 DFT. In keeping with these Articles, the reporting upon outward relocation of an employee (export case) is to be submitted to the competent cantonal authority. In his capacity as debtor for the taxable benefit the employer must in each case settle source tax only on the Swiss element. Deemed to be working days in the context of Articles 7 and 8 EBCO is the period, during which an employment relationship exists between an employee and his/her employer. The vacation days, weekends, legal holidays and other absences (travel days, sickness, military service, maternity leave, etc.) during this period are not deducted from the total. Generally reserved in this regard are the provisions in DTTs or other agreements with other countries, which limit or set aside Switzerland s right of taxation (see e.g. Art. 15a DTT with Germany re taxation of cross-border commuters). 7.2 Income tax withholding at source for employee shares and freely disposable exchangelisted employee options General Employee shares in the sense of Article 1 para. 2 lit a EBCO are, according to Article 17 b para. 1 DFT, always taxable as employment income at the time of acquisition. Blocking periods are taken into account with a discount of 6 per cent per blocking year (cp. also Section 3.3 above). Proportionate taxation is excluded, because employee shares are acquired when granted. There is a proviso, as to cases in which the employee shares are awarded as remuneration for work performed abroad (bonus). Freely disposable exchange-listed employee options in the sense of Article 1 para. 2 lit. b EBCO are also, according to Article 17b para. 1 DFT, taxable as employment income at the time of acquisition. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 11 of 34

12 7.2.2 Income tax withholding at source In an international context it must be taken into account that at the time of acquisition the recipient of the employee shares may be resident either in Switzerland or abroad. In both cases they may be subject to income tax withholding at source, if the requirements of Article 83 or 91 and 97 DFT are fulfilled. This gives the following taxation possibilities: Nature of activity at time of taxation Exclusively employee (E) Exclusively Board member (BoD) Both employee (E) and board member (BoD) Tax residence at time of taxation Switzerland Abroad 1 Cases of Art. 83 DFT: Income from employee shares is taxable at source together with other employment income Cases of Art. 83 DFT: Income from employee shares is taxable at source together with other employment income Cases of Art. 83 DFT: Income from employee shares is taxable at source together with other employment income Cases of Art. 91 or 97 DFT: Income from employee shares is taxable at source together with other employment income. With a proviso as to proportionate taxation of equitybased compensation instruments awarded as bonus (by analogy with Art. 17d DFT) Cases of Art. 93 DFT: Board members who receive employee shares are taxed at source for this service Cases of Art. 91 or 97and 93 DFT: In these cases it must first be determined for which type of activity (E or BoD) the employee shares are awarded. Taxation is governed by the nature of the activity. With a proviso as to proportionate taxation of equity-based compensation instruments awarded as bonus (by analogy with Art. 17d DFT) 1 Decisive for whether taxation can be applied based on domestic law, is the attribution of the taxation jurisdiction by an applicable DTT and other agreements with other states. In the event of export from Switzerland is therefore taxation by Switzerland not excluded. 7.3 Taxation of blocked or non-listed employee options, share awards and phantom equitybased compensation instruments in an international context General Monetary benefits from blocked or non-listed employee options, share awards and phantom equitybased compensation instruments are taxed on realisation (see also Section 4.2, Section 5 and Section 6 above) Import of equity-based compensation instruments (Art 7 EBCO) Deemed to be imported equity-based compensation instruments are employee options, share awards or phantom equity-based compensation instruments that the employee has received while resident abroad and he has realised in Switzerland after his inward relocation (see Art. 7 para. 1 EBCO). PwC Unofficial translation of Kreisschreiben Nr. 37 Page 12 of 34

13 Imported equity-based compensation instruments that are taxed under Swiss law at the time of grant (Sections and , as well as Section 4.1 above) can be realised tax-free in Switzerland. The right to tax employment income resulting from a premature termination of the blocking period remains reserved Import of equity based compensation instruments with change of residence Employment income from imported equity-based compensation instruments that are taxed under Swiss law at the time of realisation is subject to the exemption with progression clause taxed only proportionately (Art. 17d DFT), if between the time of grant and of realisation of the equity-based compensation instruments there has been a change of residence. The monetary benefit taxable in Switzerland is calculated as follows (Art. 17d DFT): total monetary benefit received x number of working days in Switzerland during the vesting period number of days of the vesting period Taxation can be made either under the regular assessment procedure or at source, and the reportings pursuant to Article 7 EBCO are to be provided. This is illustrated by case studies 1 and 3 in Annex II of this Circular Letter Import of equity based compensation instruments without change of residence Employment income from imported equity-based compensation instruments that are taxed under Swiss law at the time of realisation is subject to the exemption with progression clause taxed proportionately also in the case of unchanged residence abroad, if between the time of grant and realisation of the equity-based compensation instruments the employee is employed by an employer domiciled in Switzerland. In these cases the taxation is in proportion to the employment (working days) Switzerland/abroad during the vesting period (analogous application of Art. 17d DFT). The vacation days, weekends, legal holidays and other absences (travel days, sickness, military service, maternity leave, etc.) during this period are not relevant in calculating the applicable working days. The working days for Switzerland are to be reduced by the days in third countries. The calculation is to be made as follows: total monetary benefit received x number of working days* in Switzerland during the vesting period number of days of the vesting period * Possibly taking into account working days in third countries As the employee is taxable in Switzerland as a non-resident, the monetary benefit from equity-based compensation instruments must be taxed at source. The provisions of DTTs or other agreements with other countries which limit or set aside Switzerland s right of taxation (see e.g. Art. 15a DTA with Germany re taxation of cross-border commuters) are to be observed Export of equity-based compensation instruments (Art. 8 EBCO) Deemed to be exported equity-based compensation instruments are employee options, share awards or phantom equity-based compensation instruments that the employee has been granted while residing in Switzerland but are realised in another country after the employee s outward relocation (see Art. 8 para. 1 EBCO). The export of equity-based compensation instruments that under Swiss law are taxed on grant (Sections and and Section 4.1 above) is irrelevant for tax purposes. There is a proviso, as to cases in which the equity-based compensation instruments are awarded as a bonus for work performed in Switzerland and therefore are subject to source tax. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 13 of 34

14 In that case taxation must be at source and the reportings required by Article 8 EBCO must be attached to the source tax declaration Export of equity-based compensation instruments with change of residence The export of equity-based compensation instruments that under Swiss law are taxed on realisation has at that time income tax consequences in Switzerland. If the employee relocates his residence abroad prior to realisation of the equity-based compensation instruments, he must be taxed at source in application of Article 97a DFT. The monetary benefit taxable in Switzerland is calculated as follows (see Art. 17d DFT): total monetary benefit received x number of working days in Switzerland during the vesting period number of days of the vesting period The tax (share Direct Federal Tax) is 11.5 per cent of the monetary benefit taxable in Switzerland (Art. 97a para. 2 DFT). The taxes due are to be collected as source tax also referred to as extended tax at source by the (former) Swiss employer. This obligation applies in particular also if the monetary benefit is afforded by a foreign group entity. The reporting of the equity-based compensation instrument must be attached to the source tax declaration (see Art. 10 EBCO). Despite the change of residence taxation in accordance with Article 97a DFT taxation is not required, if on realisation of the equity-based compensation instrument the employee is still employed by or acts as board member for the same debtor. In this case the source taxation must be in accordance with Articles 91, 97 and 93 DFT. An apportionment pursuant to Article 17d DFT is not permitted (see Art. 13 para. 1 and Art. 14 para. 1 EBCO). Reserved are the provisions of double tax treaties or other agreements with other countries which limit or set aside Switzerland s right of taxation (see e.g. Art. 15a DTT with Germany re taxation of cross-border commuters) Export of equity-based compensation instruments without change of residence The source taxation must follow Articles 91, 97 and Article 93 DFT, if on grant of the equity-based compensation instruments the employee was already resident abroad and between the time of grant and realisation of the equity-based compensation instrument there has been no change of residence. If the employment relationship existed in Switzerland unchanged during the entire vesting period, only days in third countries (i.e. working days outside Switzerland) are to be eliminated from taxation. This applies above all to cases, in which the taxpayer is subject to source tax under Article 91 DFT. For taxation under Article 97 DFT third country days are to be eliminated only for specific groups (e.g. in the international transport industry), whereas source tax pursuant to Article 93 DFT can be undertaken without restriction. If the employee resident abroad has within the vesting period completed a change of employer abroad or ended his employment in Switzerland, source taxation must be undertaken pursuant to Articles 91 and 97 DFT proportionately. This applies also accordingly for cases that are subject to source taxation under Article 93 DFT. Taxation is to be undertaken proportionately according to the ratio of working days (days of appointment as a board member) Switzerland/abroad during the vesting period (analogous application of Art. 17d DFT). The vacation days, weekends, legal holidays and other absences (travel days, sickness, military service, maternity leave, etc.) during this period are not relevant in calculating the applicable working days. The working days for Switzerland are to be reduced by the days in third countries (see previous paragraph). The calculation is to be made as follows: PwC Unofficial translation of Kreisschreiben Nr. 37 Page 14 of 34

15 total monetary benefit received x number of working days* in Switzerland during the vesting period number of days of the vesting period * Possibly taking into account working days in third countries Generally reserved are the provisions of DTTs or other agreements with other countries which limit or set aside Switzerland s right of taxation (see e.g. Art. 15a DTT with Germany re taxation of crossborder commuters). This is illustrated by case study 5 in Annex II of this Circular Letter Overview of the source taxation of monetary benefits from equity-based compensation instruments that are not taxable until realisation In an international context it is to be taken into account that the recipient of these equity-based compensation instruments may at the time of realisation be resident either in Switzerland or abroad. In both cases taxation can be at source, if the requirements of Article 83 and Article 91, 97 or 93 and of Article 97a DFT are fulfilled. Following taxation possibilities are given by this: Nature of the activity at the time of taxation Only employee (E) Tax residence at the time of taxation Switzerland Abroad 2 Cases of Art. 83 DFT: Income from these equity-based compensation instruments is taxable at source together with the other employment income. Cases of Art. 91 and 97 DFT: Income from these equity-based compensation instruments is taxable at source together with the other employment income. Proportionate taxation (Art. 17d DFT) can be undertaken only if the taxpayer has not been taxable on his income in Switzerland for the whole period. Taxation is in accordance with Art. 84 DFT, whereby proportionate taxation pursuant to Art. 17d DFT (Art. 13 para. 1 EBCO) is excluded. Proviso as to provisions in double tax treaties or agreements with other states. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 15 of 34

16 Only board of directors (BoD) Both employee (E) and board of directors (BoD) Neither employee (E) nor board of directors (BoD) Cases of Art. 83 DFT: Income from these equity-based compensation instruments is taxable at source together with the other employment income. Proportionate taxation (Art. 17d DFT) can be undertaken only if the taxpayer has not been taxable on his income in Switzerland for the whole period. Cases of Art. 83 DFT: Income from these equity-based compensation instruments is taxable at source together with the other employment income. Proportionate taxation (Art. 17d DFT) can be undertaken only if the taxpayer has not been taxable on his income in Switzerland for the whole period. Cases of Art. 83 DFT: For persons subject to source tax, who at the time of realisation of an equity-based compensation instrument are neither employee nor board member, taxation is by the debtor in application of Art. 83 DFT. Proportionate taxation (Art. 17d DFT) can be undertaken only if the taxpayer has not been taxable on his income in Switzerland for the whole period. Cases of Art. 93 DFT: Income from equity-based compensation instruments is taxable at source together with the other director s remuneration, if the equitybased compensation instruments were granted in connection with the board appointment. Taxation is pursuant to Art. 93 DFT, whereby proportionate taxation pursuant to Article 17d DFT (Art. 14 para. 1 EBCO) is excluded. The provisions of double tax treaties or agreements with other states allocate taxation to the state, in which the debtor is domiciled. Cases of Art. 91 / 97 or 93 DFT: In these cases it must be determined in advance for what type of activity (E or BoD) the equity-based compensation instruments were granted. Taxation then follows the nature of the activity, i.e. in connection with an employment relationship under Art. 91, 97 DFT or in connection with a board appointment under Art. 93 DFT. Cases of Art. 97a DFT: In these cases monetary benefits from exported equitybased compensation instruments are subject to source tax pursuant to Article 97a DFT. Proportionate taxation in application of Art. 17d DFT is to be ensured. Decisive are the working days attributable to Switzerland during the vesting period and this in comparison with the total days in the vesting period. If there is no change of residence, taxation follows Art. 91, 97 or 93 DFT. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 16 of 34

17 8 Cooperation and reporting obligations 8.1 Employer General As of 1 January 2013, the employer is subject to a reporting obligation as per Article 129 para. 1 lit d DFT. The Federal Council has regulated the details in EBCO. These require that the employer must issue a report for each tax period in which it has granted employees equity-based compensation instruments and for each tax period in which the employees have realised the equity-based compensation instruments in an income tax-relevant manner (see Sections 3 to 6). This obligation also applies if the employee participation plan is administered by a foreign group entity or a third party. The reporting serves in particular as a means of disclosing in a mathematically comprehensible way the basis for calculating the monetary benefit reported in the salary certificate. Pursuant to Article 129 para. 1 lit. d DFT employers must submit a report to the assessment authority for every tax period in which they grant their employees equity-based compensation instruments. In addition the employer must provide the employee with the report as an enclosure to the salary certificate and attach the report to the regular source tax statement, respectively (cf. Art 10 EBCO). Reserved in this regard are varying canton-specific regulations. However, direct submission of the report to the competent cantonal tax authority of the employee s canton of residence is always necessary if the monetary benefit from equity-based compensation instruments is realised after termination of the employment relationship (see Art. 15 EBCO). Employers are generally free to formulate the reports as they desire, provided that it clearly fulfils the minimum requirements under EBCO. Examples of reports can be found in Annex III to this Circular Letter. The FTA and the cantonal tax authorities can, in addition to the information prescribed in EBCO, demand further information from the employer if such is required for proper tax assessment (see Art. 17 EBCO). If a tax ruling with regard to the taxation of equity-based compensation instruments is available, the report must indicate the cantonal tax office that agreed the ruling as well as the date of the agreement (date of conclusion) Reporting re employee shares (Art. 4 EBCO) For employee shares, the reports must be drawn up for the tax period in which the employee acquired the employee shares. It must include the information specified in Article 4 EBCO. If a market price is reported for unlisted employee shares, then the transaction on which that market price is based must be noted in the report. If on the other hand a formula value is reported, then the valuation formula applied must be stated in the report. In exceptional cases, an additional report is necessary for employee shares, namely when an event of relevance to income tax occurs during the holding period of the shares. Such events are described below: Release of employee shares prior to expiry of the blocking period (Art. 11 EBCO) The reporting must be drawn up for the tax period in which the blocking period terminates prematurely. It must include the information specified in Article 11 EBCO Surrender of employee shares (Art. 12 EBCO) The reporting must be drawn up for the tax period in which the employee had to surrender the employee shares at a higher or lower value than the current fair market value. It must include the information specified in Article 12 EBCO. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 17 of 34

18 In the event of an under-priced surrender, however, the employer may not reflect the monetary impairment as a minus wage in the salary certificate and offset it against other taxable income. Rather, this report serves the employee as a means of claiming a deduction for allocated expenses in his/her tax return Reporting re employee options, share awards and phantom equity-based compensation instruments (Art. 5 and 6 EBCO) Freely disposable exchange-listed employee options For freely disposable exchange-listed employee options that are taxed at the time of grant, it generally suffices to draw up a single report. It is issued for the tax period in which the employee acquires the employee options and must include the information prescribed in Article 5 EBCO. An additional report would be necessary only if, during the holding period, the substance of the employee options were changed to the benefit of the employee, as is for example the case with a repricing Other employee options, share awards and phantom equity-based compensation instruments For employee options, share awards and phantom equity-based compensation instruments that are taxed at the time of realisation of their monetary benefit, for direct federal tax purposes two reports are always necessary: the first at the time of grant of the equity-based compensation, and the second at the time of realisation (see Art. 5 para. 2 lit a and b EBCO). In an international context it is possible under certain circumstances that these employee equity participation instruments are taxed only proportionately. If the corresponding requirements are fulfilled as a result of import to Switzerland (see Section ), then on realisation of the monetary benefit the employer must draw up an Article 7 EBCO-consistent report for the employee. Here, it must be ensured that the full monetary benefit is in all cases reflected in the salary certificate. The portion attributable to residence abroad can only be deducted by the employee as income taxable abroad in his/her tax return. If the corresponding requirements are fulfilled as a result of export from Switzerland (see Section ), the report must be attached to the source tax declaration in line with the requirements of Article 8 EBCO. A separate stand-alone report of the realisation to the cantonal tax authorities is not necessary Further information (Art 17 EBCO) The employer is obliged at all times to provide further information on the equity-based compensation granted. For the evaluation of an employee participation plan, shareholder agreements, agreements with third-party investors or with lending banks, etc. may be relevant. 8.2 Taxable persons Taxable persons are responsible for the complete and correct declaration in their tax return of equitybased compensation instruments received and for submitting the employer s reports. All real and phantom equity-based compensation instruments are to be declared in the securities and credit balances list in the tax return. This obligation to declare also applies in particular when the taxation of income is not (yet) imminent. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 18 of 34

19 9 Tax ruling agreed between the employer and the tax authorities 9.1 General Obtaining a tax ruling serves not only the purpose of uniform assessment of the employees, but also the employer s proper tax treatment of its employee participation plan in inter-cantonal and international relationships with the tax authorities. Ultimately, the employees, employer and tax authorities should be able to rely on the tax consequences agreed. 9.2 Prerequisites All relevant plan- and/or contract-related documentation must be submitted to the competent tax authority. On the basis of this documentation and with precise reference to the relevant documentation, the employer must make an appraisal of the tax treatment and lodge a corresponding application. The tax authority s ruling is based solely on the facts described in the application. In principle, the tax authority does not perform a review of the equity-based participation plan, which goes beyond this. 9.3 Competence In principle, the cantonal tax authority of the employer s canton of domicile is competent for agreeing a ruling. However, any such ruling is not compulsively binding for other cantons. If the employees reside in various cantons, it is recommended that the ruling is also submitted to the Federal Tax Administration, which if necessary will give its consent in the sense of a general comment for purposes of Direct Federal Tax. 10 Effective date, abrogations and transitional law This Circular Letter becomes effective on 1 January Simultaneously, the earlier ESTV Circular Letter No. 5 of 30 April 1997 on the taxation of employee shares and employee options, and the Circular of 6 May 2003 on the taxation of employee options with vesting clauses will be abrogated. This Circular Letter applies with regard to: - all equity-based compensation instruments granted after 1 January 2013; - all equity-based compensation instruments granted prior to 1 January 2013 which, also under previous law, are subject to income tax only upon realisation (after 1 January 2013); - all equity-based compensation instruments granted prior to 1 January 2013 which, under previous law, would have to have been taxed at the time of grant or upon legal acquisition (vesting) but for whatever reason were not taxed, if the assessment is not yet time limited and there is no reason for additional taxation pursuant to Article 151 DFT. Tax rulings under the previous law that assured the employer and its employees that taxation would take place upon the grant or vesting of employee options retain their validity, provided the taxation (upon grant or vesting) occurs up to and including the 2012 tax period; i.e. from the 2013 tax period for employee options, such taxation upon grant or vesting (under previous law) is no longer permissible. Tax rulings under previous law that do not correspond with the content of this Circular Letter will cease to have effect as of the 2013 tax period. PwC Unofficial translation of Kreisschreiben Nr. 37 Page 19 of 34

20 Annex I: Annex II: Annex III: Annex IV: Overview of Equity-based Compensation Instruments (upon request) Examples Sample attestations (upon request) Source taxation case studies PwC Unofficial translation of Kreisschreiben Nr. 37 Page 20 of 34