New employee share scheme tax rules – its time to review your scheme

The proposed new tax rules make significant changes to the taxation of ESS, particularly conditional share schemes.
New Zealand Tax
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The Taxation (Annual Rates for 2017-18, Employment and Investment Income, and Remedial Matters) Bill, introduced today, changes the tax treatment of benefits provided under employee share schemes (ESS) and of widely offered ESS.

Given the breadth of the proposed changes, and the complexity of the proposed transitional rules, it will be important to determine how current ESS will be affected. It would make sense to review the new ability to apply the PAYE rules to ESS benefits. Changes to scheme documents may be required to permit withholding.

Proposed changes

  • A new definition of "employee share scheme" ensures the new rules apply to shares issued or transferred to past, present and future employees, shareholder-employees and associates.
  • An employee share scheme does not include:
    • Acquisition of shares for market value on the taxing date, or
    • An arrangement where the employee acquires shares for market value and puts the shares at risk, with no protection against a fall in value. For example, shares are acquired for market value but must be forfeited for no consideration if the employee leaves employment within 3 years.
  • Under the new rules, where shares are provided to an employee subject to future conditions, the difference between the price the employee pays and the market value will be measured and taxed at the time when the employee holds the shares in the same way as any other shareholder. For example, when shares are issued to an employee but held by a trustee for a period of time pending satisfaction of certain vesting criteria, the value of the shares at the time the vesting criteria are satisfied will determine the tax benefit under the ESS. This aligns the treatment of ESS with option schemes.
  • An exclusion from taxable income has been introduced for ESS benefits accruing from service outside NZ, provided the employee is not an NZ resident and not deriving NZ sourced income.
  • An employer will be entitled to a corresponding deduction for the amount that is taxable to the employee (being the difference between the market value of the shares and the price paid for them).
  • The widely offered share scheme concession in section DC 12 is being retained, but with a number of amendments mostly intended to make the current rules more workable. These include increasing the value of shares that can be issued to employees from $2,340 over a three year period to $5,000 a year and removing the deemed tax deduction now available for employers (with effect from 6 April 2017).

Transitional period

The Bill proposes transitional relief for:

  • benefits provided under an ESS where the shares were granted or acquired before 12 May 2016 (being the date the IRD issues paper first proposing the changes was released), and
  • benefits arising from shares granted within 6 months of the enactment of the new rules where the taxing point under the new rules would arise before 1 April 2022, provided that the shares were not granted with a purpose of avoiding the application of the new law.

Previous changes to disclosure and payment of tax

In separate changes already enacted, from 1 April 2017 employers are required to report to Inland Revenue on ESS benefits provided. Employers may also elect to pay their employees' tax on ESS benefits through the PAYE system.

The PAYE changes apply retrospectively to ESS benefits from 1 April 2008 to validate the position taken by companies who were already withholding PAYE on employee share scheme benefits.

Chapman Tripp comments

The proposed new rules make significant changes to the taxation of ESS, particularly conditional share schemes. They will align the tax treatment of ESS with option schemes and, broadly, with other forms of remuneration.

The tax payable in some cases will increase but the new rules will be simpler and more easily understood. The increased annual threshold for widely offered ESS and other changes should also increase the appeal of such schemes.

For those looking to implement new share schemes, it will obviously be important to take these new rules into account in the design of your scheme. As we note above, it is likely that scheme design can be simplified going forward.

Chapman Tripp would be happy to assist you to prepare submissions.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

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