The new Employee Share Scheme (ESS) contained in Tax Laws Amendment (2009 Budget Measures No 2) Bill 2009 and Income Tax (TFN Withholding Tax (ESS)) Bill received Royal Assent on 14 December 2009.
The new ESS rules will be contained in Division 83A of the Income Tax Assessment Act (ITAA) 1997 and will apply from 1 July 2009.
Please find below a brief overview of the new ESS regime.
Overview of new regime
The ESS rules only apply where the share or right is issued at a discount to its market value.
The normal taxing point will be at acquisition (i.e. it is taxed upfront) and must be included in an employee's assessable income for that income year.
A $1,000 tax exemption is available to an employee participating in an ESS who pays tax upfront, if they have an adjusted taxable income of $180,000 or less, and the employee and the scheme meet the following conditions:
- the employee must be employed by the company offering the scheme, or one of its subsidiaries;
- the scheme must be offered in a non-discriminatory way to at least 75 per cent of Australian resident permanent employees with three or more years service;
- the shares or rights provided must not be at real risk of forfeiture;
- the ESS interests offered under the scheme must relate to ordinary shares;
- the shares or rights must be required to be held by the employee for three years or until the employee ceases employment; and
- the employee must not receive more than 5 per cent ownership of the company, or control more than 5 per cent of the voting rights in the company, as a result of participating in the scheme.
The new law provides for a refund of tax paid in relation to ESS interests in certain circumstances where:
- an amount of employee share scheme discount has been, or would be, included in the employee's assessable income;
- the employee has either forfeited the ESS interest or, in the case of a right, the employee has lost the right without having disposed of or exercised it; and
- the forfeiture or loss is not the result of:
- a choice made by the individual (except when that choice was to cease employment), and
- a condition of the scheme that has the direct effect of wholly or partly protecting the employee from a fall in the market value of the ESS interest.
Deferral only available in limited circumstances
An employee will no longer have the ability to defer the ESS taxing point, except in limited circumstances.
For the deferred tax rules to apply, the ESS interests must be:
- subject to a real risk of forfeiture; or
- acquired under a salary sacrifice arrangement and the employee must receive no more than $5,000 worth of shares under those arrangements in an income year.
The deferred taxing point for shares is the earliest of when:
- there is no real risk that the employee will forfeit the share, or lose the share other than by disposing of it; and there are no genuine restrictions preventing disposal; or
- when the employee ceases the employment in respect of which they acquired the share; or
- seven years after the employee acquired the share.
Similar rules apply in respect of rights.
The term "real risk of forfeiture " is not defined within the legislation, but the accompanying Explanatory Memorandum contains numerous examples of what Treasury considers to be "real risk of forfeiture".
These examples are helpful, but we expect activity in this area over the next few years as additional clarity is sought.
Capital Gains Tax (CGT) treatment
For ESS interests that are taxed upfront, the interest is taken to have been acquired for its market value from the point at which the employee initially acquired the ESS interest.
For tax deferred ESS interests, the ESS interest is taken to have been reacquired for its market value immediately after the ESS deferred taxing point.
Please note the asset must be held for 12 months from this acquisition time in order to qualify the 50% CGT discount.
Impact on Expatriates
The new rules will also have impact on employees coming to or from Australia.
Australian resident taxpayers will be subject to Australian income tax on all discounts they receive under employee share schemes regardless of whether they received it in relation to employment in Australia or outside Australia.
Foreign resident taxpayers will only be subject to Australian income tax on discounts they receive under employee share schemes to the extent that the discount relates to the employment in Australia.
The following example is taken from the Explanatory Memorandum accompanying the legislation:
Bob is a foreign resident and works for a multinational company, Mimosa Co in Hong Kong.
Bob receives 1,000 shares in Mimosa Co under Mimosa Co's employee share scheme for no consideration. The 1,000 shares relate to Bob's employment with Mimosa Co over the next 24 months and have a market value of $5,000. The shares are subject to forfeiture conditions.
One year after acquiring the shares under the employee share scheme, Mimosa Co transfers Bob to Australia for five months to work in Mimosa Co's Australian operations in Darwin. After the five month posting, Bob returns to Hong Kong.
At the end of the 24 months, the forfeiture conditions cease to apply and Bob and no disposal restrictions exist. The shares at this time are subject to an ESS deferred taxing point. The market value of the shares is $10,000 at the taxing point.
Bob notionally includes in his assessable income the full $10,000. The ESS rules attribute $2,083 (5/24) to be from an Australian source and $7,917 (19/24) to be from a foreign source.
As Bob is a foreign resident, only the $2,083 is included in his taxable income.
Temporary resident taxpayers will only be subject to Australian income tax on discounts they receive under employee share schemes to the extent that the discount relates to the employment in Australia.
In a positive move, the new legislation has removed much of the capital gains tax complexity associated with the former rules.
Consistent with the treatment of other CGT assets held by temporary residents, CGT will NOT apply to shares or rights acquired under an ESS, provided those shares or rights are not treated as Taxable Australian Property
The Board of Taxation will consider and report to the Government
The best method to deter the market value of employee share scheme benefits; and
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 of forfeiture.
The Board of Taxation will report to Government on these issues by the end of February 2010.
Michael van Schaik, Associate Director, Employment &
Phone: +61 (0) 3 8635 1835
Shannon Burdeu, Manager, Employment & Remuneration
Phone: +61 (0) 3 8635 1859
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