Michael Forer
Technical

Taxation of Employee Share Schemes

By Michael Forer

On Budget night the Government announced sweeping changes to the taxation of employee share schemes. The changes were proposed to affect both exempt and deferred employee share schemes.

Under the announcement, the tax assessability of all shares and/or rights received under a deferred plan would no longer be able to be deferred. The value of the asset for tax purposes would be assessable in the financial year they were received.

In addition, access to the exempt $1,000 share schemes would be limited to those employees with a taxable income of less than $60,000.

We commented in the TechConnect Federal Budget Review that the changes to the tax treatment of employee share schemes had us scratching our heads and clearly we weren’t alone.

Following a post Budget backlash, the government announced an industry consultation and as a result the following changes were announced on 1 July 2009:

  • The $1,000 exemption threshold was increased – the income tax threshold for eligibility to the exempt scheme has been increased to $180,000, to align it with the top marginal tax rate threshold.
  • Extension of the deferral concession – tax deferral for schemes will be allowed but only when the employee receiving the shares has a "real risk of forfeiture".
  • Allowing the deferral of tax on the first $5,000 in shares under salary sacrifice employee share schemes even if the scheme does not have a “real risk of forfeiture”.
  • Removing the reporting requirement for employers to report the market value of employee share scheme benefits in the year of grant, if this is not the year in which the employee is taxed.
  • Cessation of employment remains a taxing point.

The amendments to the Budget proposals have been well received and effectively mean the proposed changes are more like the existing rules. However, significant issues remain that have not yet been addressed by the Government.

The definition of “real risk of forfeiture” will be clarified further in an explanatory memorandum and ATO material, however many believe that it would have been better for guidance to be included in the legislation. This would minimise the need to obtain rulings from the ATO and provide greater certainty.

The test of "real risk of forfeiture" is whether a reasonable person would conclude that there is real risk that the share or right will not pass to an employee by a particular time and be forfeited. The consultation paper notes that real risk includes situations in which a share or right is subject to meaningful performance hurdles, or where the securities will be forfeited if a minimum term of employment is not completed. Contrived schemes, where the risk is highly unlikely to arise, will not qualify. As an example, a scheme that states, 'your shares are forfeited if the company's value falls by 95 per cent during the next 12 months' is not a “real risk of forfeiture.”

In addition, a condition that merely restricts an employee from disposing of a share or right for a specified time carries with it no real risk of forfeiture. This will potentially lead to cash flow difficulties for some employees as they will be liable for tax on the share or right granted despite the fact they are unable to realise the value to pay the tax. For example, an employee is granted 5,000 shares valued at $2 each, however a restriction is placed on the employee from trading these shares for three years. Assuming the employee is on a 31.5% marginal tax rate, they will be liable for tax of $3,150 this financial year, yet they cannot sell any shares to pay this tax liability.

The Board of Taxation has been asked to consider how best to determine the market value of employee share scheme benefits. In the Assistant Treasurer’s press release he has foreshadowed that this may lead to a more positive outcome for start up, research and development and speculative-type companies as they should be subject to a tax deferral arrangement, despite not being subject to a real risk of forfeiture. Many believe that all unlisted companies should receive these concessions.

The initial Budget measures virtually made employee share schemes a thing of the past. Whilst the 1 July amendments are generally positive it will be interesting to see what the future holds. The Assistant Treasurer has committed to consult on exposure draft legislation and on the implementation of the new tax treatment. The existing law will apply to all shares and rights acquired before 1 July 2009 and the Government will introduce the legislation during the Spring Sittings of Parliament.