A government press release on share scheme taxes (#5, in case you wanted to know what the latest count is) on 24th July 2009 indicated the timeframes for the final round of industry consultations on reforms to the taxation of employee share schemes. The Assistant Treasurer, Senator Nick Sherry, also released the Terms of Reference for the Board of Taxation review component.
The Government will undertake a three-stage consultation process. The three stages are:
- A two-week consultation period on a draft Exposure Bill beginning in August;
- A Board of Taxation consultation on technical issues to report to the Assistant Treasurer within approximately one month of the release of the draft Exposure Bill; and
- A comprehensive Board of Taxation review on two further substantive issues to report to the Assistant Treasurer by 28 February, 2010.
The issues before the Board are:
- How to best determine the market value of employee share scheme benefits; and
- Whether shares and rights under an employee share scheme at a start-up, R&D or speculative focused company should have separate tax deferral arrangements
Following the first two stages of this consultation process, it is envisaged that legislation based on the policy statement will be introduced into Parliament in the Spring sittings.
However, it is unclear what impact the outcomes from the Board of Taxation review will have on regulation, and whether further changes will be made. In addition, of course, there is the Productivity Commission executive and director remuneration review report to be delivered to the government on December 19.
Senator Sherry’s press release and Board of Taxation terms of reference can be seen HERE.
Prior to this latest press release, Guerdon Associates was invited to submit to a Senate Economics Committee review of proposed share scheme taxation. So there is hope that further clarification, and further sensible adjustments to government share scheme taxation policy, will appear in final legislation. See our submission HERE
The remainder of this article provides what we trust is a helpful guide to what is is taxed when, and the implications for Australian employee share plans.
The most recent clarification of the changes the federal government proposes to make to the taxation of employee share plans was provided in a media release and policy statement issued by the Assistant Treasurer, Senator Nick Sherry, on 1 July 2009 (see HERE).
Some matters appear to be relatively clear, but are still subject to confirmation when the legislation is passed:
1. Employees will continue to be liable for income tax on the value of any securities to the extent the employee does not pay the full market value to acquire the securities.
2. The tax will be payable in the employee’s tax return for the income tax year in which the securities are acquired, with the exceptions that
− up to $1,000 worth of shares can be acquired tax-free each year under an employee share plan that allows for the $1,000 tax exemption
− tax can be deferred for up to 7 years (previously 10 years) if shares are acquired under an employee share plan that meets the new deferral conditions.
− Tax on up to $5,000 worth of shares can be deferred under employee share plans providing for the acquisition of shares by salary sacrifice where there is no real risk of forfeiture and the rules of the plan clearly distinguish it from a plan eligible for the $1,000 ‘upfront’ tax exemption
For tax exemption or tax deferral to be effective, the relevant plan must use ‘qualifying’ shares or rights (as defined under the previous Division 13A of the Income Tax Assessment Act 1936).
3. The requirements for $1,000 tax-exempt plans will continue with little change, except that participation will be limited to employees with adjusted taxable incomes of less than $180,000 per annum (previously no limit, though in practice few, if any, management or executive employees have participated in such plans).
4. Tax on up to $5,000 worth of shares can be deferred under employee share plans providing for the acquisition of shares by salary sacrifice where there is no real risk of forfeiture and the rules of the plan clearly distinguish it from a plan eligible for the $1,000 ‘upfront’ tax exemption (We assume the $5,000 is an annual limit, but this is not clear in the explanatory material. There was previously no limit on the amount that could be salary sacrificed to acquire shares, and the public policy reason for imposing the $5,000 limit is not obvious; indeed, the limit runs counter to recent corporate governance developments by limiting the scope for using share plans to align the interests of directors and executives with those of shareholders.)
5. Tax can also be deferred under plans where the shares or rights acquired are subject to a ‘real risk of forfeiture’, for as long as that real risk continues (to the maximum period of 7 years). The test is ‘whether a “reasonable person” would conclude that there is a real risk that the share or right will not vest to an employee by a particular time and be forfeited’
− A real risk of forfeiture includes situations where a share or right is subject to a meaningful performance test or the securities will be forfeited if the employee fails to complete a specified minimum term of employment
− A condition that merely restricts an employee from disposing of a share or right for a specified time does not constitute a real risk of forfeiture
6. Deferral ceases and tax becomes payable at the earlier of:
− The time when the securities vest and there is no real risk of forfeiture and no restriction on disposal of the security (including when options become exercisable, rather than when they are exercised as under the previous approach)
− Cessation of employment
− 7 years
(Tax can be deferred beyond the time at which options become exercisable as long as there is both a real risk that the share acquired on exercise may be forfeited and a restriction on disposal of the share was imposed at acquisition [of the option] – previous practice may have been to impose a disposal restriction on the share acquired on exercise of an option, but there was not always a forfeiture risk, and where there was such a risk, it was rarely as strict as the forfeiture conditions now contemplated by the government.)
7. A new annual reporting regime will be introduced for employers offering employee share plans, under which employers will be required to report:
− The number of shares and rights an employee has obtained at both grant date and at the taxing point
− The market value of shares and rights acquired under an employee share plan at the employee’s taxing point
Employers will only be required to withhold tax in cases where an employee fails to provide a TFN or ABN.
Issues and uncertainties
8. The $5,000 cap on salary sacrifice deferral plans will make it impossible to operate non-executive director share acquisition plans without directors incurring an up-front tax liability.
9. The requirement that tax deferral must cease when shares and rights are no longer subject to a real risk of forfeiture means that executives may be liable for income tax on shares that cannot be sold because of insider trading restrictions.
10. The government has indicated that the general principles of market value will apply in determining the market value of listed and unlisted securities. We expect this to mean the continuation of the current approach under which, for example, the taxable value of a vested option over a listed share is the market value of the share less the exercise price less the amount, if any, the employee paid to acquire the option. (We note that some commentators have expressed the view that tax will be payable even if the options are underwater at the taxing time, using a statutory formula valuation. If this is correct, consistency would require the same statutory valuation methodology to be used where options are in the money, which could provide a windfall gain to employees if the statutory valuation is lower than a ‘market’ valuation. Such a result would be at odds with the government’s stated aim of cracking down on ‘rorting’ under employee share plans.)
11. A methodology for valuing unlisted rights and options (at grant date) will be specified in regulations. As an interim measure, the current Division 13A rules for the valuation of unlisted rights will be replicated in the regulations. The Board of Taxation will be asked to review the existing valuation rules.
12. The government will also ask the Board of Taxation to consider whether employee share plan shares and rights provided by start-up, research and development and speculative-type companies should be subject to a tax deferral arrangement, despite not being subject to a real risk of forfeiture. (Our view is that consistent rules should apply for all companies, and that the proposed rules should be changed if they do not work for speculative, etc companies. A simple solution, rejected by the government, would be to tax employee share plan benefits on realisation of value rather than at vesting or cessation of employment.)
13. The circumstances in which a refund of the tax that has been paid if an award is subsequently forfeited also need to be clarified. The government’s announcements to date seem to indicate that a refund of tax will not be available where options are not exercised because they are ‘underwater’.
14. The above matters will need to be confirmed when the relevant legislation is enacted.© Guerdon Associates 2023 Back to all articles