Beware of the Tax Implications from Participating in Employee Share Schemes
(Part 1 securities acquired pre-2009 Financial Year)
An employee share scheme (ESS) provides employees or their associates with the opportunity to acquire “securities” (in the form of shares or rights) in their employer’s company by virtue of their employment relationship. These securities are either offered as part of an employee’s remuneration package, or under a broad based employee share plan offered to the employees of the company at a particular point in time. These schemes motivate employees by aligning the interests of the employees with future company performance, as ownership of security interests in the employer company will enable employees to directly receive financial benefits proportional to the company’s future profit and growth.
Security interests often come with conditions and restrictions attached preventing their immediate transfer or disposal, but they are generally offered:
1. at no cost to the employee (particularly if they are part of a remuneration package), or
2. at a heavily discounted price from the interests’ market value.
Given the restrictions in place, most employees would therefore view these interests as middle to long term investment opportunities to be cashed in at a later date when the company’s value hopefully increases further.
This e-alert is the first of a two part series on the potential tax implications you should be aware of if you are considering participating in an Employee Share Scheme. The tax laws governing employee share schemes were amended at the end of the 2009 financial year but it should be noted that securities acquired prior to 1 July 2009 will continue to be subject to the old tax rules.
This article discusses the tax implications in relation to shares or rights acquired before 1 July 2009, while part 2 of the series will consider the tax implications for shares or rights acquired after this date.
The Tax Sting
While most taxpayers may be aware that capital gains tax implications may arise on disposal of these shares, the sting is that the ‘discount’ received on the security interests (that is, the difference between the market value of the shares and any consideration paid to acquire the interests) also needs to be included as part of the employee’s assessable income. This is where the tax implications become complex and nuanced depending on the shares or rights the employee holds and whether they meet certain conditions to be classed as “qualifying” shares or rights.
Provided all conditions are met and the shares or rights are qualifying shares or rights, the employee can choose to apply one of two tax methods or “concessions”, in relation to the tax treatment of the discount amount:
1. Upfront assessment (section 139E election) – where the discount amount is assessed upfront in the income year the security interests are acquired; or
2. Deferral of the discount – where the discount amount is deferred to be assessed when the cessation time is triggered in a later income year, up to a maximum of 10 years
Employees may be able to claim a $1,000 exemption from tax which is only available if the upfront assessment method is elected. However, the ATO considers the deferral option to be the default concession applied, so an employee wishing to elect an upfront assessment would need to do so in the income year the interests were aquired, or the option to choose is lost. Therefore, immediate professional advice should always be sought in relation to participating in an employee share scheme as early decisions may need to be made to implement the most tax effective strategy to minimise future tax implications of owning these interests.
As deferral of tax is the default method, the tax sting to employees is even greater when the cessation time arrives, often outside of their control, foresight or tax planning strategy and suddenly it is time for the tax on the discount to be assessed.
Identifying the cessation time is a technical and complex exercise as this depends on whether the interest held is a right or a share, and whether the shares have restrictions and conditions attached. Broadly, some examples of when the cessation time is triggered include:
• when shares without restrictions are acquired;
• when shares with restrictions or conditions are disposed;
• when rights are exercised to acquire shares and the last of the restrictions or conditions cease to have effect
• on cessation of employment in respect of the acquisition of the shares or rights
• ten years from the date of acquisition of the shares or rights
In some instances, these events occur as a result of an arbitrary period of time elapsing (as in the case of restrictions ceasing to have effect) which may occur without the employee’s knowledge or any pro-active action taken by the employee in respect of their security interests. The sting is only fully uncovered when the ATO conducts an audit, or issues a notice reassessing an employee’s taxable income from a prior income year along with an assessment of shortfall tax and penalties and interest now owing.
For employees holding security interests acquired before 1 July 2009 who have not elected upfront assessment, and a cessation time has not occurred in respect of the interests held, separate transitional measures apply to ascertain the tax liability.
Given the complexity of the tax implications of participating in an employee share scheme, it would be prudent to contact a tax or accounting professional immediately to implement a tax planning strategy to manage and legally minimise your tax liability.
Stay tuned for part 2 of this series which will outline tax implications to consider for securities acquired after 1 July 2009. Here at The Quinn Group, our dedicated team of experienced Lawyers and Accountants are able to assist you with all your Tax related queries. Complete and submit our online enquiry form or call us on 1300 QUINNS (1300 784 667) +61 2 9223 9166 to arrange an appointment.