More Australian Taxation Office guidance on taxation of employee share schemes
05/07/2010
mail.png

During June 2010, the Australian Taxation Office (ATO) released several guidance notes for employers and employees on employee share scheme taxation.  The guidance covers matters ranging from administration to discussion on what constitutes a real risk of forfeiture for tax deferral purposes. 

This article summarises what now constitutes a real risk of forfeiture for tax deferral purposes. 

From the start, the new employee share plan tax regime introduced with effect from 1 July 2009 has suffered from complexity and uncertainty (see our summaries HERE

 and HERE).  Assuming all of the other conditions are met, deferral of taxation, for example, is possible if shares or rights are subject to a ‘real risk of forfeiture’.  Deferral can be continued past vesting if the shares or rights are subject to a ‘genuine disposal restriction’.  But little definitive guidance has been provided on the meaning of these terms.

The most recent explanations issued by the ATO on 16 June 2010 provide some additional guidance on when the ATO considers the shares (or stapled securities) or rights provided under employee share schemes to be at a real risk of forfeiture and what it considers to be genuine disposal restrictions (and when they cease to apply).  The ATO guidance is available HERE. Unfortunately, the situation is still far from clear.

Real risk of forfeiture

Risks of forfeiture include conditions where retention of the shares or rights granted under an employee share scheme is subject to performance hurdles or a minimum term of employment, but will not be ‘real’ risks if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility. 

Uncertainty continues because whether or not there is a real risk of forfeiture depends on the facts and circumstances of each scheme and the individual circumstances of each employee participating in the scheme.

According to the ATO, a condition that an employee will forfeit their shares or rights if they are dismissed for fraud or gross misconduct does not introduce a real risk of forfeiture (although this was a standard approach under the previous employee share plan tax regime in Division 13A of the Income Tax Assessment Act 1936).

Performance hurdles will not necessarily constitute a real risk of forfeiture – the ATO will consider the likelihood of the company meeting the hurdles.  According to the examples provided by the ATO, a relative total shareholder return test can provide a real risk of forfeiture even for a company that has regularly achieved a high TSR relative to its peer group.  But a condition that rights will lapse unless a company’s current year sales do not exceed the prior year sales does not provide a real risk of forfeiture if the company has increased its sales by more than 10% in each of the preceding five years and has recently taken over a major competitor (the example does not indicate whether this test would be acceptable in the absence of the takeover, or if previous annual sales growth had been less than 10%).

Minimum term of employment

The ATO accepts that there will be a real risk of forfeiture where an employee will forfeit shares or rights if they do not complete a specified period of employment – with a minimum service period of at least 6 months supporting deferral for up to 3 years, and a minimum term of employment of at least 12 months supporting deferral for up to the maximum 7 years.

For shares and rights acquired outside these parameters, the ATO will consider all the facts and circumstances to determine whether a real risk of forfeiture exists.

According to the ATO’s examples, a scheme under which a minimum term of employment must be served before rights vest will support deferral where the company has the discretion to vest some or all of the shares or rights in the event of a takeover bid for or a change in control of the company, as long as the company was not subject to a takeover bid at the time the share or rights were granted. 

A real risk of forfeiture will also exist where a scheme requiring a minimum term of employment to be completed before rights vest contains ‘good leaver’ conditions that allow rights to be retained in the event of death, invalidity or bona fide redundancy, unless the scheme routinely allows employees to retain rights regardless of their reason for ceasing employment.

Whether a real risk of forfeiture exists where a good leaver condition allows employees to retain their employee share scheme rights or shares if they cease employment after age 55 to retire from the workforce permanently apparently depends on whether or not, at the time the rights were acquired, the employee had a clear intention to retire within the service period.  In the example where, prior to the time rights with a 2-year service condition were granted, a 59-year old employee had advised the employer she intended to retire on her 60th birthday, the ATO says there is no real risk of forfeiture.  However, there would be a real risk of forfeiture where, at the time rights are granted, a 55-year old employee does not intend to retire during the service period (which means deferral would apply until the rights vest when the employee subsequently retires during the 2-year service period).

Both performance and service conditions can be taken into account to determine whether there is a real risk of forfeiture on acquisition of shares or rights.  Where there is some doubt about the service conditions alone satisfying the real risk of forfeiture test, the ATO will also consider whether the performance conditions satisfy the test. 

If only a portion of the shares or rights received under an employee share scheme are subject to a real risk of forfeiture, only the portion that is at real risk will be eligible for tax deferral.

Genuine disposal restrictions

According to the ATO, a restriction can only be a genuine disposal restriction if it is in the conditions of the employee share scheme at the time the employee acquires shares or rights.  A disposal restriction on a share acquired on exercise of a right must have been in place when the employee acquired the right.

The conditions can be contained in the plan rules or other documents governing the scheme, offer documents, documented company policies the employee must comply with or the employee’s contract of employment.

A genuine disposal restriction can be:

        A condition of the scheme prohibiting disposal of a share for a fixed period of time, enforced by a holding lock or through a trust

        A condition of the scheme (or documented company policy) prohibiting disposal of shares or rights or exercise of rights where this would be in breach of the Corporations Act insider trading provisions

        A condition of the scheme prohibiting the employee from disposing of the shares or rights, providing there are serious and enforced consequences for breaching the condition.

The ATO:

        Will only consider a company’s internal share trading policy prohibiting disposal of shares and rights to be a genuine disposal restriction if there are serious and enforced consequences for breaching the policy. 

        Will consider a disposal restriction that can be lifted in special circumstances or in cases of financial hardship to be a genuine disposal restriction if it otherwise meets the conditions to be a genuine disposal restriction

        Considers that a scheme does not genuinely restrict disposal if the employee can take action to dispose of the shares or rights

        Will not accept a requirement that an employee must make a request to the board or a delegate of the board for approval to dispose of shares or rights as a genuine disposal restriction if such requests are routinely approved.

The ATO regards genuine disposal restrictions as being lifted on the first day on which an employee has an opportunity to dispose of their employee share scheme shares or rights, whether or not they choose to do so (e.g. if a trading restriction is lifted to allow share trading during a ‘trading window’, and the restriction is then re-imposed at the end of the trading window, the disposal restriction is lifted at the start of the first trading window in which the employee has the opportunity to trade their shares – it does not matter that the employee does not trade his or her shares during the first available trading window).

The subjective nature of these tests, and the uncertainty this poses for employers and employees may further discourage the use of employee share schemes and make revenue collection more difficult and costly than it needs to be.

© Guerdon Associates 2021
read more Back to all articles