Further consultation on employee share scheme proposals
Tax Alert - October 2016
By Jayesh Dahya and Brad Bowman
In June 2016, we outlined key proposals included in an Officials’ issues paper, entitled Taxation of employee share schemes (“original paper”) which amongst other things were aimed at ensuring discounted shares received by employees are taxed as employment income when the employee ”receives” the shares.
On 1 September 2016, the Policy & Strategy Group released a consultation paper, Taxation of employee share schemes - further consultation (“further consultation paper”). The further consultation paper sets out Officials’ thinking following submissions received in relation to the original paper.
This article provides an update on where Officials have landed on the key proposals included in the original paper.
Taxation of employees
The further consultation paper does not propose any change to the “general thrust” of proposals relating to unconditional employee share schemes (“ESSs”), conditional ESSs or option-like arrangements. That is:
- Benefits that depend on continued employment will be taxed when the employment conditions are met;
- Benefits that are subject to contingencies will be taxed when all “substantial conditions” relating to the shares have been met (i.e. when the employee holds the shares on the “same basis” as a non-employee shareholder); and
- Benefits from options will be taxed when the option is exercised.
Officials have provided a number of examples to illustrate the concepts that are to be applied in determining when the taxing point will arise and, to put it simply, the proposals will bring to an end the benefits from ESSs that provide employees with protection from the economic risks associated with owning shares.
Despite standing firm, Officials have amended proposals in relation to grandparenting benefits from existing schemes as taxpayers transition to the new rules. Broadly transitional relief will be extended to benefits:
- Granted before the date six months after enactment in accordance with the terms of any ESS in existence before the release of the issues paper on 12 May 2016; and
- Where the taxing point for the benefits under the new law is before 1 April 2022.
Concessions for widely-offered ESSs
The current rules provide a concessionary regime for widely-offered or “all employee” ESSs. The two primary benefits are:
- Employees are not taxed on the value of benefits received under the widely-offered ESS; and
- The employer is allowed a notional 10% interest deduction on loans made to employees to buy shares.
Among other criteria, the current concessionary regime applies to widely-offered ESSs where the scheme is equally available to all employees and the cost of the shares to the employee does not exceed $2,340 in a three-year period with no limit on the discount that is offered. While Officials did not include any proposals in relation to the concessionary regime, the original paper sought submissions on whether the rules should be repealed, retained or modernised.
The further consultation paper notes that submissions supported a continued exemption for benefits provided under widely offered ESSs and criticised various aspects of the current rules. Officials have therefore opted to “modernise” the concessionary rules to make them less restrictive and simpler to operate.
While some aspects of the existing regime would remain unchanged, Officials propose that the cost of shares to the employee would need to satisfy three requirements: 1) the cost can be no more than $5,000 per annum, 2) the discount can be no more than $2,000 less than the market value, and 3) the cost can be no more than the market value. Additionally, where there is a cost to the employee in acquiring the shares, the employer must provide an interest-free loan facility to be repaid over the vesting period.
While employees will not be taxed on any benefits from widely-offered schemes, Officials have stated that employers will not be entitled to a deduction for the cost of providing the shares and intend on removing the notional 10% interest deduction on the loans made to employees (although loans made before the effective date of the new legislation would be grandparented).
It will no longer be a requirement for employees to seek Inland Revenue approval for widely-offered schemes, rather taxpayers will simply need to register the scheme with Inland Revenue
The original paper considered offering a “concession” for start-up companies, which would have enabled employees to defer taxation until the shares are either sold or listed. In the further consultation paper, Officials note that there was little support for the concession and any benefits would likely be outweighed by the concession’s resulting complexity. Officials therefore do not propose any special rules for start-up companies.
Deduction for cost of shares provided under an ESS
The original paper proposed that employers should be allowed a deduction for a deemed cost of the shares provided under an ESS. This deduction would occur at the same point as the income is taxed in the hands of the employee and would be based on the amount that is taxable for the employee. The further consultation paper notes that submissions were largely in favour of the proposal and that there is no change to this proposal.
If you have any questions or comments in relation to the further consultation paper, please don’t hesitate in contacting your usual Deloitte advisor.
Tax Alert October 2016 Contents:
- It’s feasible that feasibility expenditure may still be deductible… sometimes
- Thinking of gifting food and drink for Christmas? Be aware!
- Further consultation on employee share scheme proposals
- Tax residency: Life after Diamond - the new era begins
- Government releases significant and complex proposals to tackle hybrid mismatch arrangements
- A snapshot of recent developments