The Australian Tax Office steps in to assist in the clarification of share scheme tax law

The absence of certainty in the employee share scheme tax legislation has meant that the Australian Tax Office (ATO) has had to make clear what the law does not.  Relative to what companies and their employees have come to expect, the first result is not too bad.  In fact ATO Interpretative Decision (ID) 2010/61 (see HERE) is a welcome development as it provides some much needed guidance on the meaning of a “real risk of forfeiture”, and allows companies to consider new employee equity plans aimed at attracting and retaining skills likely to be in very short supply.


The facts considered by the ATO

Employees were granted rights to acquire shares under an employee share scheme that works as follows –

·          One third of the rights vest automatically 1, 2 and 3 years after grant date provided the employee is still employed by the company at the time


·          The employee cannot dispose of the rights


·          The employee does not pay anything for the shares received on vesting of the rights


·          There are no restrictions on the employee disposing of the shares acquired on vesting of the rights


·          Unvested rights are forfeited on cessation of employment unless


        the employee ceases employment more than 6 months after grant date because of death, invalidity, bona fide redundancy or retirement (in which case the rights will still vest according to the vesting schedule) or

        the employee retires more than 6 months after the grant date


·          Retirement is defined as ceasing employment with the company when the employee is at least 55 years of age and has completed at least 10 years service with the company.


The ATO’s decision


The test applied by the ATO was whether a reasonable person would consider that there is a genuine connection between the forfeiture condition and aligning the interests of the employee and the employer.   There needs to be more than a mere or rare possibility of forfeiture.  If the risk of forfeiture is over a very short period of time to gain access to a relatively long period of deferral the risk will not be considered real.

On the facts before it, the ATO decided that rights will be subject to a real risk of forfeiture where:

         for employees who were not eligible for retirement at the date the rights were granted, the minimum term of employment is 12 months or more; and


         for employees eligible for retirement at the date the rights were granted, the minimum term of employment is at least 6 months and the maximum period of deferral is 3 years or less.


The ATO decision does not address the extent to which the inclusion of a discretion to treat a person as a “good leaver” where vesting would not otherwise apply would remove the “real risk of forfeiture”. Such discretions are commonly used by companies to provide flexibility to deal with unforeseen circumstances in equity plans.


Possible application of the decision


The ATO ID confirms that unvested equity granted under employee share schemes can be at sufficient risk of forfeiture to qualify for tax deferral without being subject to forfeiture all the way through to vesting.  That is, deferral can continue after vesting where equity is subject to a disposal restriction (such as a holding lock) that was imposed at grant.  Deferral can also continue on unvested equity that ceases to be subject to forfeiture, until the later of vesting or the time at which disposal restrictions no longer apply.


The ATO ID also shows that the ATO has accepted that a 6-month service condition can be sufficient to support deferral for up to 3 years.


The ATO ID thus provides some assistance for employers where service-based equity plan makes sense.


While providing limited assistance, at least this decision allows companies in supply-constrained industries (e.g. construction, resources) to put in place tax deferred plans that follow these prescriptions for critical employees.


The significance of the ATO ID is limited by the particular facts and issues the ATO was asked to consider.  This, and the lack of certainty in the law, means we are dependent on more guidance from the ATO. More general guidance on the government’s interpretation of ‘real risk of forfeiture’ is provided in the Explanatory Memorandum issued when the draft legislation was released (see HERE).


We look forward to further interpretations from the ATO on the new employee share plan tax rules.

© Guerdon Associates 2024
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