Orrick Legal Ninja Snapshots
9 minute read | November.27.2025
Today, many German companies have embraced the "Delaware flip" or established U.S./German holding structures from inception, seeking to tap into international capital markets and adopt "Silicon Valley-style" equity practices. But here's the million-dollar question (sometimes literally): How do you make a U.S. Employee Stock Option Plan (ESOP) work tax-efficiently for your German employees? The answer lies in understanding Section 19a of the German Income Tax Act (EStG) and its recently introduced "group privilege." This isn't just legal fine print – it's the difference between your German team celebrating their equity upside and wondering why they're paying nearly half their gains in taxes.
If you've flipped your German start-up into a Delaware structure or are considering it, you're in good company. As we detailed in our comprehensive guide OLNS#7 "Flip it Right", this structure offers some advantages for international fundraising and M&A. But there's another often-overlooked benefit: this structure might allow you to implement a tax-efficient, scalable equity program for your German team without the tax burdens and governance complexities that still plague domestic German incentive schemes.
As we detail in our upcoming comprehensive guide OLNS#8 "ESOPs, VSOPs & Co.", the German equity compensation landscape continues to evolve rapidly but still presents founders with an uncomfortable set of trade-offs. Virtual programs (VSOPs) are straightforward to understand and implement but tax-inefficient for employees. Real shares don't scale well within a GmbH structure—though ManCo structures can help, they add cost and complexity. Profit participation rights (Genussrechte) promise tax efficiency without the corporate governance calories, but remain poorly understood outside Germany (and sometimes even within it).
But what if for German start-ups in a two-tier US/German holding structure there was an alternative structure? What if you could leverage an internationally established U.S. ESOP structure that allows your German employees to enjoy favorable capital gains taxation while maintaining the simplicity and scalability that makes Silicon Valley equity programs so effective?
The stakes are high. In today's war for talent, German tech companies compete not just locally but globally. Our deeptech start-ups are fishing in the same talent pool as their well-funded Silicon Valley competitors. The companies that master these cross-border structures today will have significant advantages in tomorrow's global talent competition.
Section 19a EStG was Germany's answer to the notorious "dry income" problem – the cruel irony of owing taxes on equity you can't yet sell. Think of it as Germany's attempt to level the playing field with Silicon Valley's tax-advantaged stock options.
Here's how it works: instead of paying wage tax (up to 47%) on your equity grant immediately, Section 19a EStG allows you to defer that tax until you actually have liquidity – typically at an exit event. Even better, any appreciation beyond the initial grant value gets taxed at the much friendlier capital gains rate (around 26-28% depending on the size of the equity stake).
The real game-changer for international structures is the "group privilege" (Konzernprivileg). This provision recognizes that modern start-ups don't operate in neat, single-entity boxes. Your German employees can now benefit from Section 19a EStG even when receiving equity from a U.S. parent company – provided the entire group meets certain criteria.
The key requirements:
These thresholds must be met at grant or, for the employee headcount and annual revenue or balance sheet thresholds, within the preceding six years – giving growing companies some breathing room.
The award must be granted in addition to regular salary (i.e., not as a salary replacement) and the beneficiary must be an employee (i.e., Section 19a EStG does for example not apply to freelancer or EoR-employees) by the granting company or a qualifying group company. In addition, the employer must be subject to German wage tax obligations, i.e., must have a German nexus such as seat, central place of management, a permanent establishment or a permanent representative in Germany. The latter is obviously the case if the beneficiary is employed by the German subsidiary of a U.S. company as is typical in flip situations.
Here's where theory meets practice, and where standard US market practices shouldn’t simply be adopted for the German employees. Under a typical US ESOP, the plan usually allows for the granting of stock options and restricted stock. The former are rights to acquire shares at some point in the future against payment of the strike price and the latter are shares that are purchased for low value right away and that can be clawed back under certain circumstances, in particular in case of a leaver during the vesting period. In the U.S., granting stock options is the standard while restricted stocks are relatively rare. However, for the German employees this will usually not be the best choice and here is why.
The timing of when employees actually receive shares under Section 19a EStG makes all the difference.
Imagine your company is worth €10 million when you grant restricted stock to your German CTO. Under Section 19a EStG, she will have to pay deferred wage tax on that €10 million valuation at some point. Fast forward three years to your €100 million exit – Your CTO's pro rata share of €90 million appreciation gets taxed at capital gains rates, not wage tax rates. That's the difference between keeping roughly 74% versus 53% of her equity gains.
Now consider the same scenario with traditional stock options. Your CTO doesn't "receive" shares until she exercises her options – often that might be just before the €100 million exit. Under Section 19a EStG, she now owes wage tax on her full pro rata portion of that €100 million value, with only future appreciation (if any – remember the exit is near and her shares will likely be sold) qualifying for capital gains treatment.
If you've already granted stock options to German employees, there might still be some silver line. Simply canceling and re-granting as restricted stock can trigger immediate tax consequences. However, restructuring existing options to allow early exercise – even of unvested portions – may provide a path to Section 19a EStG benefits. The key is acting before your valuation skyrockets.
While the Section 19a group privilege opens compelling opportunities, implementing a cross-border ESOP structure requires navigating several practical challenges. Here's what German founders and their investors should anticipate:
U.S. entity shares present valuation challenges for German tax purposes. The standard 409A valuations that satisfy U.S. tax compliance may require additional documentation or methodology adjustments for German authorities. German tax offices often demand more detailed explanations of valuation methodologies, particularly for early-stage companies where traditional financial metrics may not fully capture value.
Managing a cross-border equity program requires coordination between German and U.S. tax advisors, HR teams, and legal counsel. This isn't a set-it-and-forget-it proposition. Regular communication between your German and U.S. advisors becomes essential, particularly around tax reporting, regulatory changes, and employee departures that might trigger different consequences in each jurisdiction.
The intersection of U.S. securities law, German tax law, and employment regulations continues to evolve. Recent changes to Section 19a EStG demonstrate how quickly the landscape can shift (remember that the tax deferral in Section 19a EStG only came into effect in 2022 and has since then already been amended several times). What works seamlessly today may require adjustments tomorrow as regulators in both jurisdictions refine their approaches to cross-border equity compensation.
German employees may be unfamiliar with U.S.-style equity programs and their interplay with Section 19a EStG, requiring more extensive education about how stock options, restricted stock, and vesting work. Clear communication becomes crucial – not just about the mechanics, but about the tax implications and timing considerations that make the program valuable.
The convergence of U.S. corporate structures with German tax efficiency isn't just possible—it's becoming standard practice for internationally ambitious German start-ups. The Section 19a EStG group privilege has opened doors that were previously locked, allowing German employees to participate in Silicon Valley-style equity upside without the traditional German tax penalties. But success requires intentional structuring. The difference between restricted stock and stock options isn't just semantic—it can determine whether your equity program becomes a powerful retention tool or an expensive tax lesson.
And as good lawyers do, here comes the disclaimer: This article provides general guidance on complex cross-border tax and legal issues. Every company's situation is unique – consult with qualified German and U.S. advisors before implementing any equity compensation strategy.
In this context, please also refer to the following OLNS Snapshots:
For further reading on the topic of dry income and how to deal with it, please see OLNS#14 on Growth and Hurdle Shares in German Start-ups.