Legislation to simplify the collection of tax on employee share schemes has just been passed, and much more fundamental change is in the pipeline through an IRD issues paper released last month.
These follow recent changes to securities law which make it more cost effective for companies to offer staff shares or options.
Listed issuers will almost certainly face stronger reporting requirements around executive remuneration, including equity incentive plans, as a result of the current NZX consultation on corporate governance.
We explain the new tax law change and summarise the reform proposals the IRD has put up for discussion.
Tax simplification changes
- allow employers to choose to withhold tax using the PAYE system on employment income received under employee share schemes. The choice to withhold can be made on an employee by employee basis and is revocable, and
- if an employer chooses not to withhold PAYE, the employer will be required to disclose the value of benefits employees receive under employee share schemes.
Previously, income arising under employee share schemes was not subject to tax at source (PAYE and FBT). Some employers chose to deduct PAYE but that was technically not permitted by the tax law. For example, if an employer wishes to issue employees shares instead of a cash bonus the tax on the bonus could not strictly be withheld.
The new rules will apply from 1 April 2017. However, they will have retrospective effect (from 1 April 2008) if an employer has already chosen to pay PAYE. This validates positions taken in the past, and provides an opportunity for employers to opt in now if they wish.
The regime does not apply to share schemes approved by the Commissioner under section DC 12 or to income arising when an employee (or an associate of the employee) disposes of rights to acquire shares to a non-associate.
More fundamental changes proposed
Broadly, the proposals in the IRD issues paper seek to align the tax treatment of benefits under employee share schemes with the treatment of income paid in cash (e.g. bonuses).
Where shares are provided subject to future conditions (e.g. vesting conditions remain unsatisfied or employees are protected from loss through limited recourse loans or a right to transfer shares back to the employer), the taxing point moves to the point in time when the employee holds the shares free from substantive conditions. This is a similar treatment to options.
The taxable value of the benefit to the employee would be measured as the market value of the shares at this point, less what the employee pays for the shares. In cases where the value of shares increases, this will result in greater taxable income than that arising under the existing rules (which tax the employee at the time the shares are acquired).
No change in taxing point is proposed for schemes where shares are provided free from further conditions. Taxable income will continue to be determined at the time shares are acquired (or options are exercised for option schemes).
Other proposed changes include:
- allowing the employer a tax deduction equal to the amount of income taxable to the employee
- possible repeal of the section DC 12 scheme regime, and
- special rules for start-up companies that defer the taxing point until shares are sold or listed.
A three year transitional period is proposed for existing schemes, although only when the taxing point under the current rules has occurred before enactment.
Both the PAYE changes and issues paper reform proposals raise some practical implications that warrant consideration now.
- Ensure that documentation for new employee share schemes contains mechanisms to allow employers to withhold tax in the event they choose to do so. Amendments could be made to existing scheme documentation to allow the same where possible.
- Be aware that employers can choose to withhold PAYE now – there is no need to wait until 1 April 2017.
- Check new or existing schemes with vesting points greater than three years out to determine whether the proposals in the issues paper could impact adversely on the tax treatment of employees.
- The proposals in the issues paper will put option schemes on a similar footing to conditional share schemes from a tax perspective. Option schemes (or conditional share schemes) that provide flexibility to accelerate the exercise of options (or vesting) may be an attractive scheme design under the new rules. For example, if there is a degree of confidence today that shares will be worth more in the future, exercising an option today (rather than exercising at a later date) should result in tax being determined based on today’s share value rather than the future, increased, value.
Recent changes to securities law brought about by the Financial Markets Conduct Act 2013 have made it much more cost effective to offer staff shares, options or other forms of equity participation. A number of our listed and unlisted clients have already taken up the opportunity.
This can now be done with a simple ‘health warning’ notice to employees, a summary of the key terms and limited other information, rather than a formal product disclosure statement. Some technical gaps in this relief are about to be filled by a Financial Markets Authority exemption notice.
For NZX listed issuers, it is pretty clear from the weight of submissions and need to lift minimum standards that one outcome from the current NZX review of corporate governance will be a requirement that boards provide more information around executive remuneration, particularly for the CEO.
For equity incentive plans, this is likely to include an explanation of key vesting conditions and the reasons for them.