On 14 August 2009, the Government issued draft legislation and associated materials on the ESS previously announced in the 2009 Budget. The former ESS provisions in the Income Tax Assessment Act 1936 will be repealed and a new Division 83A will be inserted in the Income Tax Assessment Act 1997. If enacted, the new law will apply to all ESS entered into from 1 July 2009.
Broadly, any discount to the market value of ESS interests in shares or rights provided under an ESS will be taxed upfront on acquisition. That means that the market value of the discount must be included in an employee’s assessable income for that income year.
The current $1,000 tax exemption is available to taxpayers participating in an employee share scheme who pay tax upfront, if they have a taxable income (after adjustments) of $180,000 or less, and the employee and the scheme meet certain conditions.
We note that the draft legislation does not consider how to determine the market value of the ESS benefits. The Board of Taxation has been asked to consider these issues and the results will be announced by the Government shortly.
Exceptions There are two exceptions to this general rule that the discount to market value is to be taxed up front. For these exceptions, a deferral of the taxing point will apply. However the deferral operates automatically and is not dependent upon any election by the taxpayer.
Firstly there is an exception in circumstances where the ESS interests are at “real risk of forfeiture”. An ESS interest is at real risk of forfeiture if a reasonable person would consider that there is a real risk that the employee would lose the interest, or never receive it, other than by selling or exercising it, or through the market value of the ESS interest falling to nil.
Secondly there is an exception where the ESS interests are acquired under a salary sacrifice arrangement. Certain conditions will apply. These include that the salary sacrifice scheme must relate to shares not to rights, the employee must receive the shares for no consideration payment (discount per share provided through the arrangement is equal to the market value of the share) and the employee must receive no more than $5,000 worth of shares.
The deferred taxing point for shares is the earliest of when:
- there is no real risk that the employee will lose the share under the conditions of the scheme other than by disposing of it and there are no restrictions preventing disposal
- when the employee ceases the employment
- 7 years after the employee acquired the share.
We note that the draft legislation does not consider whether employees of start-up, research and development and speculative type companies should benefit from a tax deferral arrangement despite not being subject to a real risk forfeiture. The Board of Taxation has been asked to consider these issues and the results will be announced by the Government shortly.
The new rules reproduce similar provisions in the current law and introduces a number of new integrity provisions. Those to be noted are as follows:
ESS interests provided to associates of employees, in relation to an employee’s employment will be treated as if the interest was in fact acquired by the employee rather than the associate. (similar to the current law)
When an employee has a beneficial interest in shares in a trust the employee will be taxed as though they were the legal owner of those shares. This is so that employees cannot lessen, delay or avoid their tax liability by interposing a trust. (new law)
There will be withholding tax applicable if an employee does not disclose their TFN or ABN to the employer. (new law)
There are annual reporting requirements for employers who provide ESS interests. (new law)
Deduction for employers
Employers may be entitled to a limited specific deduction (ie maximum of $1,000) on the shares or rights they provide to employees provided specific conditions are met.
Refund of tax for forfeited shares
An employee is eligible for a refund of tax on forfeited shares and rights if the forfeiture was not the result of a choice by the employee or a condition of the scheme that protects the employee against a fall in the market value.
For CGT purposes, the acquisition time and the cost of the share or right is reset to market value on the day after the deferred taxing point. This means that the 50% discount capital gain is not available until 12 months after that time.