Are employee share schemes still sexy?
Tax Telegraph, May 2013
Employee share plans have been used worldwide in attracting, retaining and motivating employees in one form or another for a very long time.
In contrast to purely cash-based performance rewards, share plans can be better at aligning employee motivations with owners by providing a longer-term, more tangible and directly aligned goal with owners – dividends and share price. Options/rights to buy shares are regularly used in place of actual shares to provide a more performance-dependent reward.
Use of share plans can also have significant taxation advantages to both employer and employee.
Tightening the screws
The Australian tax rules around share grants to employees were tightened in 2009. Of significance this involved removing the election available to employees to defer income for up to 10 years.
As a result many companies simply ceased employee share plans or converted to cash-based performance rewards rather than adjust to the new laws. It was seen by many as simply “too complex” and potentially involving risks for both employer and employee. Annual compulsory reporting of share plans to the ATO, which were introduced at the same time, was the trigger point for many.
It’s not all bad news!
Now, a few years on, understanding of the implications of the new rules has improved significantly, bringing down the costs and risks associated with implementation of share plans. As many of the intrinsic tax advantages of employee share plans remain intact under the new rules, employee share plans are squarely back on the agenda in remuneration planning across a wide range of businesses, including smaller privately-owned companies.
Under the current rules the time at which share grants become taxable to an employee is referred to as the “taxing point”. This date is critical as it determines not only the year in which employees become liable to tax, but also the value of the shares or options that are subject to tax.
The taxing point is usually the date of the grant unless the interests qualify for deferred taxation. Subject to satisfying a number of conditions, interests will usually qualify for deferred taxation where there is a “genuine risk of forfeiture”. In essence, there must be a real likelihood that shares or options granted would be cancelled or a period of trading restriction for the taxing point to be deferred. For example, this would be satisfied if shares or rights are cancelled (except for unusual circumstances – e.g. “good leaver” provisions) on cessation of employment.
The taxing point for deferred taxation interests occurs when there is no longer a “real risk of forfeiture”. In majority of employee share scheme grants, this is usually the vesting date.
There may be other circumstances in which interests which qualify for deferred taxation are taxed at an earlier point in time. This usually occurs where the employee sells the interest or ceases employment with the employer who granted the ESS rights.
The clear risk with the defined taxing point under the current rules is that an employee may become taxable on the basis that the taxing point has occurred however, for good reason the employee may not have cash to pay the tax (i.e. they have not actually sold the shares or options).
Further, for rights/options that have a period of time between when get are granted and when they are taxed, the value of the rights/options can increase significantly. In many instances the employee may not have the cash to actually pay tax on this increased value at taxing point. It is therefore desirable to ensure that the taxing point of a share plan is either early enough to ensure nil or negligible value or late enough such that the employee is readily able to cash-in and cover any tax liability.
Fortunately, alternate structures such as loan funded plans can reduce this risk. When set up correctly, the capital growth component of employee remuneration can be maximised then taxed at a 50% discount (under the CGT regime) and/or incentives can be provided to employees without a tax liability arising until later years.
A loan scheme involves issuing shares to an employee by way of loaned funds. The loan is ideally limited to the value of the shares (so that the employee cannot lose money). These schemes are therefore similar to share option plans in that if the share price falls below the loan value, the employee can walk away from the arrangement. Due to the manner in which the legislation is drafted, loan schemes can avoid a benefit provided to an employee under an ESS scheme. Specific exemptions also exist to ensure ESS loans do not get caught by rules controlling employee loans (such as FBT and Division 7A).
Use of loan funded plans are often highly attractive to mid-sized/private businesses as they can be priced to avoid dilution of shares without all shares also rising in value – thereby offsetting any value loss to existing owners. As there is no requirement to report employee expenses, the impact on the profit & loss can also be minimised. This is another potential bonus for those who may be looking to sell their business in the foreseeable future.
While there are some conditions to be eligible for deferred taxation and/or a $1,000 discount (such as a 5% maximum ownership and for share plans that 75% of permanent employees are able to participate), these requirements may not need to be met to achieve outcomes that can lower the tax burden of employees while also providing incentives to perform.
Talk to your local Deloitte Private advisor to determine if such a scheme can work for you.
Tel +61 8 8407 7136
Tel +61 3 6337 7060
Tel +61 8 8950 7220
Tel +61 3 9671 7197
Tel +61 7 3308 7064
Tel +61 2 9840 7277
Tel +61 2 6263 7106
Tel +61 8 9365 7112
Tel +61 8 8980 3028
Editor – Tax Telegraph
Tel +61 2 9322 3593
Tel +61 3 6237 7065