The Australian government announced new measures in the 2009-2010 budget to confine eligibility for the employee share scheme tax concessions to those earning under $60,000 which it suggests are expected to provide an additional $200 million over the forward estimates.

According to the government, ” …[t]he new measures will remove the inconsistency which currently exists between the two types of employee share schemes: qualifying shares schemes and non-qualifying share schemes…and will maintain the incentives for low and middle-income earners to access such schemes.”

We note that under the current legislation it is not schemes that are qualifying or non-qualifying, but the shares or rights granted under an employee shares scheme, given that this can vary between participants in the one scheme.

The government also says that “Under the current arrangements, employees who take part in employee share schemes are required to pay tax on any discount on the full value of a share or option they receive from their employer. This is currently the case in relation to both qualifying shares schemes and non-qualifying share schemes. The tax law currently provides two ways for an employee in a qualifying share scheme to have tax on the discount assessed:

1. The employee can elect to be assessed in the income year the shares or options are acquired. If so, the employee can access an upfront tax exemption of up to $1,000 on discounts received each year.

2. If an election is not made, taxation of the discount is deferred until a later time (such as when the employee disposes of the share).

In comparison, if the shares or options are issued under a non-qualifying scheme, the employee is taxed on the discount when he or she acquires the shares or options. This means they do not enjoy the tax benefits associated with qualifying employee share schemes.

Further, it appears that some taxpayers are able to avoid paying tax on the discount by using the deferral method of assessment and then not declaring the discount at the appropriate time.

Under the new arrangements announced today, all discounts on shares and options provided under an employee share scheme – either qualifying or non-qualifying – will be assessed in the income year in which they are acquired. That is, employees acquiring shares or options under qualifying employee share schemes will no longer be able to elect to defer taxation on their discount to a later time. This will ensure that all forms of remuneration are taxable in the year the remuneration is received.”

“The Government will also limit access to the $1,000 upfront concession. The $1,000 upfront tax exemption will be limited to those employees with a taxable income of less than $60,000 after adjustment for fringe benefits, salary sacrifice and negative gearing losses.”

“All of these measures will apply to shares and options acquired after 7.30pm [on Tuesday 12 May 2009]. The measures will not affect shares or options already held by employees.”

The Budget Papers No. 2 description is HERE.

There are numerous issues in these statements. However, taken at face value, it appears that all share and option grants will be taxed at the grant date even if they are subject to performance conditions and disposal restrictions.

If this is correct, then this is the end of performance share rights plans because tax would be payable on the full market value of a share for all rights granted. The implications are slightly less severe for options grants, given the lower value of an option compared with a share and the fact that some employees have elected to pay tax upfront on options under the current tax regime. But many employees will not be prepared to do this.

If these amendments proceed as announced we could see a resurgence in the use of loan-backed share plans. Share appreciation rights (which have the same reward dynamics as options) may also be used more often. Cash LTI plans, with all their accounting advantages, may also find favour.

These outcomes will appal governance groups, proxy advisers and many boards, which prefer share rights plans as a “safe” way to incentivise employees in volatile markets, and an effective way to ensure employees become better aligned with shareholders.

It will kill any equity plans in the APRA regulated sectors, given that option plans will be contrary to the conservative risk management likely to be required under new regulations.

However, it could be that the government either has not realised the full implications of its announcement, or as we saw with the successive government press releases on termination pay regulation, that critical and material details will undergo refinement and subsequent publication.

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