FocusOn - Employee Share Acquisition Scheme

Receiving shares or options from your employer may have significant tax consequences.  If you pay less than market value for the share or option, the discount is included in your tax return as assessable income.  This is the case even if you salary sacrifice in order to receive the shares or options.  The amount of this discount and when it is assessed depends on various factors, as discussed below.

Application of the rules

The rules apply if you obtain a share or option as a result of your employment.  There need not be a formal scheme in place.  However, if you pay market value to acquire the share or option, the provisions do not apply.

If an associate such as your spouse receives shares or options as a result of your employment, the income in the form of the discount is still assessed to you.

New rules effective 1 July 2009

As announced in the 2009/10 Federal Budget the Employee Share Scheme (ESS) rules have taken on some significant changes.  The legislations introducing the ESS reforms have received Royal Assent on 14 December 2009.

The new rules are applicable to ESS undertaken from 1 July 2009.

In summary, the main changes proposed in the bill are:

	Whether a share or right is subject to taxation upfront or at a later point is dependent on the structure of the scheme and not an election by the employee.
	Discounts derived through ESSs will generally be taxed upfront and only in limited circumstances will the discount be taxed at a later time.
	The maximum deferred taxing point is seven years (previously ten years).
	The $1,000 exemption is only available to employees with adjusted taxable income of less than $180,000.
	Employers will be subject to reporting requirements and may be required to withhold tax in cases where the employee fails to provide their TFN or ABN.

When is the discount calculated

From 1 July 2009 onwards, the default position is to include the full amount of discount from the share or option acquired under an ESS as assessable income and it is taxed at the individual’s marginal tax rate in the year the share or option is granted.  The discount will be taxed at a later time only in the following circumstances:

	The shares or options provided are at a real risk of forfeiture and meet certain conditions; or
	The shares provided through a salary sacrifice arrangement offering no more than $5,000 worth of benefits to an employee.

The discount where it is taxed at a later point will be taxed the earlier of when:

	there is no longer a real risk of forfeiture and there are no restrictions preventing disposal,
	employment ceases, or
	seven years from when the shares/options were granted.

Under this new regime, the employee can no longer make an election for the discount to be taxed upfront or deferred.

Real risks of forfeiture

The ‘real risk of forfeiture’ test is based on whether a reasonable person would conclude that there is a real risk the share or option will be forfeited.  ‘Real’ is regarded as something more than a mere possibility and must not be contrived.

Examples of real risks include situations in which granting of a share or option is subject to meaningful performance hurdles or a requirement for a minimum term of employment to be completed.

Simply having a performance hurdles as a condition of granting share or option will not necessarily result in a ‘real risk of forfeiture’.  A ‘real risk’ is a question of fact and circumstance.

Similarly a minimal risk contrived to gain deferral such as a very minimum term of employment (e.g. three months) is consider not to be a real risk.

Determining whether a share or option is at a real risk can be difficult.  If in doubt please contact us to discuss.  Ultimately, under the new ESS, your employer is responsible for informing you of when the shares you acquired are subject to tax.

Tax Upfront

There is no significant change to how the discount from ESS benefits is to be calculated under the new rules.

Assessable Discount:
Market value on acquisition date - acquisition price of share or option

The method for calculating the value of an ESS interest can also be specified by regulation in the Income Tax Assessment Regulations 1997 (the Regulations).  If there is an alternate method of valuation specified in the Regulations, that method must be used instead of the market value.

To date the government has only proposed that the existing rules in relation to unlisted rights be replicated in the Regulations as an alternate method of valuation.

Exemption for first $1,000

The new rule contains an exemption similar to the old rule in that you are eligible to treat the first $1,000 of the assessable discount as exempt for shares or options that are taxed upfront.

However, the conditions to be eligible for this exemption have changed. The most significant change being that the exemption is only eligible to taxpayers with adjusted taxable income of less than $180,000.  Other conditions that need to be satisfied to be entitled to this exemption are:

	At the time of acquiring the share or option the employee must be currently employed by the company granting the share or option or its subsidiary,
	the shares or options granted relate to ordinary shares and must not be at real risk of forfeiture,
	shares or options granted must be subject to a minimum holding period of the lesser of three years or when employment ceases,
	the interest received must not result in the employee having significant ownership or voting rights in the employer, and
	The scheme must be non-discriminatory.

Adjusted taxable income is your taxable income plus any reportable fringe benefits, reportable superannuation contributions and net investment losses.

Significant ownership or voting right is taken to mean more than 5% ownership of the company or control more than 5% of the voting rights in the company.

Non-discriminatory scheme is taken to be one that is offered to at least 75% of Australian resident permanent employees with three or more years of service.

Deferred Tax

Assessable Discount:
Market value at deferred taxing point - cost base of share or option

Cost base
Cost base is acquisition cost adjusted for any incidental costs, holding costs etc. such as brokerage fees and any return of capital.

Other conditions for deferral
For the discount on a share or option that is deferred on the basis of a ‘real risk of forfeiture’, the scheme will also need to meet all the following conditions:

	relate to ordinary shares,
	be offered on a non-discriminatory basis, and
	the employee must not have significant ownership or voting rights in the employer.

For an ESS interest that is at real risk of forfeiture but does not meet any of the above conditions, it will be taxed upfront and will not be eligible to the $1,000 exemption.

Salary Sacrifice Scheme
The assessable discount for ESS interest acquired under a salary sacrifice scheme is the market value of the interest at the deferred taxing point less cost base (if any).

Deferral of tax on ESS interest offered under a salary sacrifice scheme is only available for shares granted to an employee in which the total value is not more than $5,000 per employment within a corporate group and is acquired solely under a salary sacrifice arrangement.  Further, the rules of the scheme must explicitly state that the tax will be deferred.

Tax Refund for Forfeited Interests

Under the new scheme, you may be entitled for a tax refund in limited circumstances where your ESS interests are forfeited after you have been taxed on the discount.  The refund is only available where:

	the forfeiture was not your choice (except when that choice was to cease employment), and
	the conditions of the scheme were not constructed to protect the employee from market risk.

There will be no tax refund if the forfeiture was due to you disposing of an ESS interest or choosing not to exercise a right as a result of market risks such as the market price being below the exercise price.

There is no time limit to amend an assessment to claim back tax paid on ESS interest that was forfeited.

Capital Gains Tax

A share or option can be subject to the ESS rules once only.  Once you have been taxed on an assessable discount, any subsequent gain in the value of the share or option will be taxed at the time of sale under the Capital Gains Tax (CGT) rules.

Provided you have held the asset for at least 12 months, only 50% of the capital gain is taxable.  Note that if you exercise an option and immediately sell the share, you are not entitled to the 50% CGT concession as you have not held the share for at least 12 months.

30 -day rule
Further, where ESS interests are not taxed upfront and are disposed of within 30 days of the original deferred taxing point, the taxing point is then moved to the time the interest is disposed of. The assessable discount is worked out using the market value at the time of disposal.

None of the gain will be subject to CGT and therefore not eligible for the CGT discount.

Employer's reporting obligations

Under the new ESS regime, the employer will be required to disclose the number of share or options granted and acquisition costs paid by the employee in employees’ PAYG payment summaries.

Further, in the year when the discount is to be taxed (upfront or deferred), the employer will also need to provide an estimated market value of the ESS interests.

Employers will also be required to report in employees’ payment summaries qualifying shares/options under the old regime which was not taxed upfront and where the cessation date occurs after 1 July 2009.  These shares or options will still be taxed at cessation time under the old rule being the earliest of:

	When the share/option is sold
	When the restrictions cease
	When your employment ceases, or
	10 years from the date of issue.

Published : 6 January 2010