The Federal Government is in the process of tightening the rules on employee share schemes and option plans. In particular, since handing down the Budget in May 2009 the Federal Government has released a Consultation Paper, Draft Legislation and most recently a Final Policy Statement on proposed new measures. Below is a discussion summarizing the proposed new rules and subsequent modifications which will now take effect from 1 July 2009. It is important to note that existing shares and options granted before 1 July 2009 are not affected by these new measures, and draft legislation to implement the final position is expected to be tabled before the 2009 Spring sitting of Federal Parliament.
Federal Budget Announcement – Original Proposal
In May 2009, it was announced in the Federal Budget that all discounts and options provided under an employee share scheme, whether qualifying or non qualifying, would be assessed in the income year in which they are acquired. Under the original proposal, employees would no longer be able to elect to defer taxation on the discount on shares or options received under an employee share scheme. In addition, access to the $1,000 upfront concession would be limited to those employees with an adjusted annual taxable income of less than $60,000. Finally, it was originally intended that the changes would apply from the date of the Budget.
Consultation Paper and Draft Legislation
The original proposal announced in the Budget led industry leaders and employer groups to voice their concerns about the future tax effectiveness of employee share schemes once these changes were legislated. In response to these concerns, on 5 June 2009, the Federal Government issued a Consultation Paper and Draft Legislation.
The Consultation Paper proposed the following changes :
- raising the income threshold for the $1,000 tax exemption up to $150,000;
- introducing a limited deferral of the taxing point for schemes where there is a “genuine risk of forfeiture”, so as to protect employees who have a real risk of being taxed on a share or right that they might never get full title to;
- modifying the taxing point (“deferred taxing point”) for shares, stapled securities and rights;
- introducing an annual reporting requirement and associated withholding arrangements;
- reviewing the existing valuation rules; and
- modifying the rules relating to the refund of income tax for forfeited benefits.
Final Policy Statement
On 1 July 2009, the Assistant Treasurer released the Federal Government’s Final Policy Statement. In effect this is third announcement from the Federal Government on the changes to occur to the taxation of employee share schemes.
The main points arising from the latest announcement include:
- increasing the income tax threshold for the upfront $1,000 exemption from $150,000 to $180,000;
- tax on the discount for shares and rights acquired under an employee share scheme will be paid upfront except where there is a real risk of forfeiture (discussed below);
- the deferral arrangement applying to a capped salary sacrifice based scheme will be limited to $5,000 worth of shares (discussed below);
- eligibility for the deferral treatment will flow from the structure of the scheme rather than from a choice made by the employee (discussed below);
- a new annual reporting requirement will be introduced for employers offering employee share scheme (discussed below);
- the maximum time for deferral of tax is to be reduced from 10 years to 7 years; and
- the changes to the taxation of employee share scheme are effective from 1 July 2009.
The real risk of forfeiture
The real risk of forfeiture test operates to deny employees the opportunity to defer tax on the discount of shares or options unless a reasonable person would conclude that there is real risk that the share or right will not come home to an employee by a particular time and be forfeited.
Examples of real risk of forfeiture include under an employee share scheme include:
- an employees will receive 1,000 shares in 3 years if he/she is still employed by the company;
- an employee will receive 1,000 shares in 3 years, the earlier of, leaving employment or due to an unexpected reason, e.g. sickness, invalidity or to raise children (i.e. a good leaver clause);
- an employee will receive 1,000 shares in 1 year if the company increases its market share
Examples of where the real risk of forfeiture under an employee share scheme will not be met include:
- an employee will receive 1,000 shares in 3 years unless dismissed for fraud or gross misconduct;
- an employee will receive 500 shares in 1 year if the company increases its market share or not.
Deferring the tax point
The general principle is that deferral treatment will flow from the structure rather than by election by the taxpayer.
The deferral taxing point will be the earlier of:
- in the case of shares, where there is both no longer a risk of forfeiture and no restriction preventing the taxpayer from disposing of the shares;
- in the case of options, there is both no longer a risk of forfeiture and no restriction preventing the taxpayer from disposing of the options- however if after exercising the right the underlying share is subject to forfeiture/restrictions it is the point the shares are no longer subject to real risk forfeiture and there is no restriction preventing the taxpayer from disposing of the share which will be the tax point;
- cessation of employment; or
- 7 years from date of grant
For salary sacrifice based employee share schemes offering no more than $5,000 worth of shares, the deferral is where there is no real risk of forfeiture and the scheme’s governing rules clearly distinguish those scheme eligible for the upfront tax exemption.
Additional features
- a new annual reporting requirement will be introduced for employers offering employee share schemes in that the employers will only be required to estimate the market value of shares and options acquired under an employee share scheme at an employee’s taxing point but will need report the numbers of shares and options granted to employees at an employee’s taxing point;
- a limited form of withholding will be introduced in the case where an employee fails to provide their employer with a TFN or ABN; and
- employee share schemes will not have to be approved by the Tax Office or the Australian Prudential Regulation Authority to qualify for concessional tax treatment;
Future Amendments
- appropriate refund rules to cover forfeited shares are still to be drafted;
- the Board of Taxation has been asked to consider whether start up, research and development and speculative companies should be provided with additional deferral arrangements; and
- the Board of Taxation will also be asked to review existing valuation rules.
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