NZ is reforming its taxation of employee share schemes
08/05/2017
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On 6 April 2017, the New Zealand (NZ) government introduced draft legislation on proposed reforms of its employee share scheme rules.

There is a range of changes but two significant aspects should be noted by New Zealand employers:

  • an all-employee share scheme with up to $2,000 of discount being tax exempt; and
  • the employer will be entitled to a statutory income tax deduction equal to the amount of ESS discount that is taxable to the employee.

The changes mean that Australian and New Zealand companies can roll out employee equity plans that are effectively the same in structure and form across both countries. For example, this could be a deferred STI plan which provides shares held in trust, an executive LTI share rights plan subject to performance hurdles that permits the rights to be exercised years after vesting, or a start up technology company’s no strings attached option plan in lieu of cash salary.

Background

The NZ government acknowledged that employee share schemes are an important form of employee remuneration in NZ and, while the design and accounting treatment of ESS has evolved considerably over recent decades, the tax rules are considered out of date and not conducive to encouraging employee ownership.

The NZ government said that ESS can have beneficial economic effects and it does not want the tax rules to raise unintended barriers to their use. In some circumstances, the existing rules can result in over-taxation and, in other cases, under-taxation.

The current system in NZ is considered to impede the use of ESS in a number of ways:

  • There is considerable uncertainty about how the current rules apply to taxation of employees and employers, which may deter companies from offering these schemes.
  • The cost to an employer of providing shares directly to an employee is not explicitly deductible. Non-deductibility creates over-taxation, which is a disincentive to using employee share schemes.

At the same time, arrangements have been designed so that certain ESS structures can result in employment income being treated as capital gains which are exempt from tax in NZ.

The following is a summary of the reforms.

Tax neutrality: The Bill proposes new rules to:

  • determine the taxing point for employees who receive ESS interests at a discount; and
  • provide a tax deduction for employers when discounted ESS interests are received by their employees.

These proposals mean the tax treatment of employee share scheme benefits is tax neutral. That is, to the extent possible, the tax position of both the employer and the employee should be the same whether remuneration for employee labour is paid in cash or shares.

Employers that provide ESS benefits to their employees are still required to charge a share-based payment expense to the P&L account. This is a non-cash charge for which there is no tax deduction until the ESS benefit is taxable to the employee.

The Bill is proposing a tax deduction to employers that grant ESS benefits which matches the ESS income of employees in timing and quantity. It would explicitly preserve deductions for the costs of running an employee share scheme, and for the cost of any cash associated with a share scheme paid to an employee. No other deductions will be allowed.

Timing of employees’ taxing point: The proposed amendments ensure the timing and amount of employees’ income from ESS is consistent with cash salary. Benefits provided under an ESS (i.e. the discount) will be taxable in the employee’s hands at the earlier time of:

  • when the ESS benefits are either transferred or cancelled for cash; or
  • when the employee owns the shares in the same way as any other shareholder. This effectively means the time when the ESS benefits are fully vested and the employee has the shares.

This is called the “share scheme taxing date”. Unless an employee first transfers their ESS benefits, or the company cancels them, the share scheme taxing date is when:

  • there is no real risk of forfeiture of the ESS benefits;
  • the employee is not compensated for a fall in the value of the shares; and
  • there is no real risk of a change in the terms of the shares affecting their value.

Amount of taxable ESS benefit: The amount of income on which the employee will be taxed is the value of the shares at the share scheme taxing date less the amount paid for them.

The employee will always be the person who is subject to tax, even where the ESS benefits are granted to an associate of an employee. If the amount paid exceeds the value of the shares, the difference is deductible to the employee.

Impact on Available Subscribed Capital: The new rules will tax ESS benefits that result in the issue of shares in the same way as an equivalent cash payment that is used to acquire shares in the issuing company. Consistent with this principle, the proposed rules provide for an increase in the employer’s available subscribed capital (ASC) by the amount deemed to be paid (plus actually paid) for the shares. The proposed rules also cater for the situation where the employer is not the company issuing the shares.

This taxpayer-friendly measure ensures ESS are not disadvantaged as a form of remuneration compared with an equivalent cash transaction, which would generally give rise to an ASC increase.

 

Tax-exempt schemes: The tax legislation currently provides a concessionary regime to encourage employers to offer shares to employees under certain widely-offered employee share schemes (commonly referred to as “exempt schemes”). Income derived by employees under these ESS is exempt from tax and there is a deemed 10% notional interest deduction allowed to employers who provide loans as part of such schemes.

The government considers the tax laws for these ESS is out of date, complex and no longer fit for purpose.

Accordingly, the Bill is proposing a simplified set of rules for these exempt schemes, with a greater level of exempt benefit able to be provided, and more flexibility in the design of these schemes.

The Bill clarifies that employers offering exempt benefits will not be entitled to a deduction for the cost of providing those benefits. The retention of the tax exemption for exempt schemes is an exception to the neutrality principle, but is justified on compliance cost grounds.

The proposals provide for, among other things:

  • the maximum value of shares that can be provided under an exempt scheme will be NZD$5,000
  • the maximum discount will be NZD$2,000 per employee per annum. This means actual expenditure by an employee will be no more than NZD$3,000
  • the existing tax deduction for a notional 10% interest will no longer be available for employers that give interest-free loans to employees to acquire shares
  • employers will be explicitly denied a deduction for the cost of providing the shares (other than scheme management and administration costs)
  • 90% or more of full-time permanent employees who are not subject to securities law of other jurisdictions must be eligible to participate in the scheme
  • if the scheme has a minimum spend requirement, the amount can be no more than $1,000 per annum
  • any minimum period of service which may be required before an employee becomes eligible to participate must not exceed three years
  • if the employee is required to pay any amount for the shares, then the employer must provide a loan for that amount or allow the employee to pay for the shares in instalments
  • loans to employees for the purchase of shares must be interest-free
  • the shares have to be held for a minimum of three years (either by the employee or by a trustee of a trust on behalf of the employee)
  • if the employee leaves employment before the three years is up, then:
  • if they leave because of death, accident, sickness, redundancy or retirement, they can keep the shares (subject to repayment of the loan) or have the shares bought back for the lesser of market value and cost; and
  • if they leave for any other reason, the shares are bought back at the lesser of cost and market value
  • The exempt scheme is not required to be approved by the Commissioner of Inland Revenue, however, the Commissioner must be notified of the scheme’s existence and the employer must advise the Commissioner when grants are made under the scheme
  • There is no requirement for a scheme to have a trust – many schemes have trusts as a matter of convenience.

Application of new rules: the new rules will not apply to ESS where the shares were granted or acquired before 12 May 2016.

The new rules will not apply to ESS if:

  • the share was granted or acquired before the date that is six months after the date of enactment;
  • the shares were not granted with a purpose of avoiding the application of the new law; and
  • the share scheme taxing date under the new law is before 1 April 2022.

If shares benefits are taxed under both the existing and proposed new rules, the new rules provide the employee with a credit for income recognised under the old rules.

More information on the new rules can be found HERE

© Guerdon Associates 2021
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