ess paper sarah bernhardt - allens 2010-05-07آ an employee was employed by a company which was...
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Employee Share Schemes –
What you Need to Know about the New Tax Rules
As we all know, the Government announced some significant unexpected changes to the taxation of employee share plans as part of the May 2009 Federal budget, which were then significantly revised. Legislation introducing those changes became law on 14 December 2009.
Instead of discussing each of the changes in isolation, this paper will look at the changes on a plan by plan basis, focussing on the key issues that arise under different kinds of plans. Against that background, the topics to be covered are:
(a) Types of ESS plans under the new rules.
(b) Impact of the new rules on restricted share plans and, in particular, good leaver issues.
(c) Impact of the new rules on performance rights plans and, in particular, the interaction of the taxing time with the company's insider dealing policy.
(d) Impact of the new rules on options with an exercise price and, in particular, the practical issues that can arise where options are taxed before exercise.
(e) Impact of the new rules on share purchase plans and, in particular, how strict disposal restrictions have to be to be considered 'genuine restrictions'.
(f) Impact of the new rules on awards granted before 1 July 2009.
(g) The new employer reporting and withholding rule, focussing in particular on the 14 July 2010 deadline to provide employees with their first ESS Statements.
2. Types of ESS plans under the new tax rules
Very generally, ESS plans can now be categorised into the following tax categories.
2.1 Plans to which the new tax rules do not apply
Employee incentive plans which fall outside the new Division 83A may, depending on the circumstances, be subject to fringe benefits tax, PAYG and/or capital gains tax. The three main categories of incentive plans which fall outside Division 83A are:
(a) Where the award is not an ESS interest in a company
Division 83A only applies where there is an ESS interest in a company. An ESS interest in a company is a beneficial interest in a share in the company or a right to acquire a beneficial interest in a share in the company. This means that Division 83A does not apply, for example, to units in a unit trust or to rights to cash settled awards.
It is important to distinguish 'cash settled' awards in this context from:
(i) a right to acquire a share in a company which, in certain defined circumstances, may be cancelled for cash; and
(ii) a right to shares where the shares may, on exercise of the right, be immediately sold on your behalf instead of being delivered.
(b) Where the shares are not in the employer or a holding company of the employer
Division 83A will not apply if the award is not granted in relation to an 'employment' relationship, or if the shares are in the wrong entity.
'Employee' is widely defined to include any individual who provides services to an entity under an arrangement with the entity, notwithstanding those services may not be provided as a common law employee. This means that Division 83A will apply to independent contractors who are hired in an individual capacity. It will also apply to awards made to former employees, and awards made to associates of employees. However fringe benefits tax rather than Division 83A will apply to employees who receive shares in relation to their employment where those shares are not in their employer or a holding company of their employer. For example, if an employee was employed by a company which was only 40% owned by another company (and not a 'subsidiary'), and received an award of shares in the shareholder of the employer, fringe benefits tax rather than income tax would apply to that award of shares.
(c) Where the shares/rights to shares are not provided at a discount to market value
Division 83A will not apply where the employee pays market value consideration for the grant of the award. It is important to distinguish here between consideration on a 'pre-tax' compared with post-tax basis. Where consideration is provided on a 'pre-tax' basis (eg salary sacrificed) the employee will be treated as having acquired the award at a 'discount' under these rules.
This means that Division 83A will not apply where:
(i) shares are purchased at market value by the employee using post-tax funds or by the employee being provided with a loan to purchase the shares at market value; or
(ii) the exercise price of options is more than double the market value of the shares on grant (or lower where the maximum life of the options is 6 years or less).
2.2 $1,000 tax exempt schemes
Under such plans, a participant who satisfies a new $180,000 'income' test is entitled to an income tax exemption for up to $1,000 of shares. Any increase or decrease in the value of the shares is then subject to capital gains tax on disposal of the shares. This may be considered the only true 'concessional' tax treatment which Australia offers to employee share schemes and is a very limited concession by international standards.
Employees are entitled to an exemption for up to $1,000 of shares/rights to shares a year if (s.83A-35):
(a) the shares are ordinary shares in a company which is the current employer (or the holding company of the current employer);
(b) the predominant business of the company is not the acquisition and holding of securities or, if it is, the employee is not employed by the company and a related company;
(c) the scheme is offered on a non-discriminatory basis to at least 75% of Australian resident employees of the relevant employer who have at least 3 years of service with the employer;
(d) there is no real risk under the scheme that the employee will forfeit the shares;
(e) the scheme is operated to not permit disposal of the shares before the earlier of 3 years and cessation of the relevant employment;
(f) immediately after the ESS interest is acquired the employee does not hold a beneficial interest in more than 5% of the shares in the company and is not in a position to cast or control the casting of more than 5% of the maximum number of votes that may be cast at a general meeting of the company; and
(g) the employee has 'adjusted' income of not more than $180,000.
These conditions are very similar to the conditions which applied under the old law, with the exception of the 'income' test. 'Adjusted' income is the sum of taxable income, reportable fringe benefits total, reportable superannuation contributions (generally salary sacrifice superannuation contributions) and total net investment losses (deductions relating to financial investments and rental properties, less gross income from those assets).
It is important to remember that the 75% offer test must be satisfied even if it is likely that more than 25% of employees will breach the income test.
2.3 Taxed up-front schemes
Under such plans, the participant is taxed on the market value of an ESS interest on grant. Any increase or decrease in the value of the award from grant is subject to capital gains tax. If the award is forfeited, a refund of the tax paid on grant may be available.
ESS plans where an amount is required to be included in income in the year shares/rights to shares are granted include the following.
(a) Where the shares are not 'ordinary' shares.
The EM notes that shares that are not 'ordinary shares', such as preference shares, may have less risk associated with them and are therefore less likely to align the employee's interest with that of the company. ATO ID 2010/62 states that shares that have priority as to dividends or distributions in the event of winding up are preference shares and, if shares are not preference shares, they are ordinary shares. It would therefore be expected that 'non-voting' shares which do not have any preference to dividends or distributions would be considered 'ordinary' for these purposes.
(b) Where the employee holds a greater than 5% interest in the employer.
(c) Where the participant is a former employee.
(d) If the ESS interest is a beneficial interest in shares (instead of just a right to get shares), where the employer does not operate a general share or rights plan open to at least 75% of its employees.
(e) Where the shares are acquired under a 'tax exempt' plan but the employee has adjusted income greater than $180,000.
(f) Where neither the real risk of forfeiture test or the $5,000 salary sacrifice deferral conditions are satisfied.
2.4 Real risk of forfeiture tax deferred schemes
Under such plans, the participant is able to defer the taxing time on awards which, on grant, are subject to a real risk of forfeiture.
'Real risk of forfeiture' is not defined. There are a number of non-tax cases where the meaning of 'real risk' is discussed. These cases given the general impression that a risk can be 'real' even if it is considered that there is very little chance of it occurring.
The Explanatory Memorandum to Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 which introduced Division 83-A (EM) explains the 'real risk' of forfeiture test in the following way:
1.156 The ‘real risk of forfeiture’ test does not require employers to provide schemes in which their employee share scheme benefits are at a significant or substant