Inland Revenue - Tax policy Tax Policy

News and information about the Government's tax policy work programme, including:
- proposed changes to the laws that Inland Revenue is responsible for
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Employee share schemes


OVERVIEW


Employee share schemes – arrangements for companies to provide shares and share options to their employees – are an important form of employee remuneration in New Zealand and internationally. Although the design and the accounting treatment of these plans have evolved considerably over recent decades, the tax rules applying to them in New Zealand have not been comprehensively reviewed during that period and are now out of date.

Employee share schemes can have beneficial economic effects and it is important that the tax rules do not raise unintended barriers to their use. In some circumstances, the current rules can result in over-taxation; in others they result in under-taxation.

The current system impedes the use of employee share schemes in a number of ways.

  • There is considerable uncertainty about how the current rules apply to taxation of employees and employers, which may deter firms from offering these schemes.
  • The cost to an employer of providing shares directly to an employee is not explicitly deductible. Non-deductibility creates over-taxation, which is a disincentive to using employee share schemes. Arrangements which currently do allow employers to take deductions for shares provided directly, or indirectly by other companies, produce deductions which do not reflect the amount or timing of the income recognised by the employee.

The current treatment of some sophisticated employee share schemes can result in employment income being treated as tax-free capital gains and so escaping taxation. This undermines the fairness of the tax system.

The Bill proposes new core rules for determining the amount and time of derivation of income and incurring of expenditure under an employee share scheme. The objective of the proposals is neutral tax treatment of employee share scheme benefits. That is, to the extent possible, the tax position of both the employer and the employee should be the same whether remuneration for labour is paid in cash or shares. Generally these rules will apply to benefits where the taxing point under current law has not occurred before the day 6 months after the enactment of the Bill.

The Act also currently provides a concessionary regime to encourage employers to offer shares to employees under certain widely-offered employee share schemes (commonly referred to as “exempt schemes”). Income derived by employees under these schemes is exempt from tax and there is a deemed 10% notional interest deduction allowed to employers who provide loans as part of such schemes. The law governing these schemes is out of date, complex and no longer fit for purpose. In addition, it not consistent with our broad-base, low-rate (BBLR) income tax system.

Accordingly, the Bill also proposes a simplified set of rules for these exempt schemes, with a greater level of exempt benefit able to be provided and more flexibility in the design of these schemes. The Bill aims to clarify that employers offering exempt benefits will not be entitled to a deduction for the cost of providing those benefits. The retention of the tax exemption for exempt schemes is an exception to the neutrality principle, but is justified on compliance cost grounds.

The Bill also proposes a number of consequential and miscellaneous changes, and provides transitional arrangements for existing schemes.

The proposed new rules for employee share schemes have been developed through a public consultation process beginning with the release of the officials’ issues paper Taxation of employee share schemes in May 2016 and further consultation in September 2016.


SCOPE OF THE NEW RULES


(Clauses 11, 12, 14 and 41)

Summary of proposed amendment

The proposed new income and deduction rules will apply to arrangements where employees receive shares as part of their remuneration package. There are a number of qualifications and carve outs to the definition of “employee share scheme” to ensure the rules are appropriately targeted.

Application date

The new rules will generally apply to benefits provided under employee share schemes which are not taxed under the existing rules within 6 months of enactment of the Bill. There is further detail of the transitional arrangements below.

Key features

The proposed new rules will apply to benefits provided under arrangements that involve issuing or transferring shares to past, present and future employees[5] or shareholder-employees (or their associates) of the issuing company (or a group company).

However, they will not apply to arrangements that require employees to:

(a) pay market value for the shares on the “share scheme taxing date” (described in more detail below, but generally the date on which the employee holds the shares like any other shareholder);

(b) put at risk shares they acquired for market value, where the scheme provides no protection to the person against a fall in the value of the shares.

They will also not apply to exempt schemes (which have their own specific rules, discussed below).

Background

The definition of “employee share scheme” is a key component of the rules.

The core employee share scheme rules in the Income Tax Act 2007 currently apply to “share purchase agreements”. These are agreements to dispose of or issue shares to an employee, entered into in connection with the employee’s employment or service, whether or not an employment relationship exists when the employee receives a benefit under the agreement.

Under current rules there is some uncertainty as to whether this definition encompasses arrangements entered into before a person commences a formal employment relationship and has received a PAYE income payment.

This definition also excludes shareholder-employees to the extent to which they choose not to deduct PAYE.

There is no policy rationale for excluding these classes of recipients of employee share scheme benefits.

Detailed analysis

Clauses 11, 12 and 14 propose that under sections CE 1(1)(d), CE 2, and CE 6 – 7D, a benefit received under an employee share scheme is income of a person. Similarly, clause 41 proposes a new section DV 27 that governs what deductions are available when a person is party to an employee share scheme.

Clause 14 proposes a definition of “employee share scheme” in new section CE 7. The definition is initially fairly wide.

It is an arrangement with a purpose or effect of issuing or transferring shares in a company to a person who will be, is, or has been an employee (or shareholder-employee) of that company or of another company in the same group. It also includes the provision of shares to an associate of the employee or shareholder-employee, if the arrangement is connected with that person’s employment or service.

The use of the term “arrangement” covers all aspects of a scheme, for example, direct transfers of shares, loans to buy shares, bonuses, put and call options and transfers to trusts etc. The definition also covers past, present and future employees, and includes shareholder-employees.

However, an employee share scheme does not include an arrangement that requires an employee, shareholder-employee or associate to:

(a) pay market value for the shares on the “share scheme taxing date” (described in more detail below, but generally the date on which the employee holds the shares like any other shareholder); or

(b) put at risk shares they acquired for market value, where the scheme provides no protection to the person against a fall in the value of the shares.

Example 1

Jim is employed by ABC Co, a closely-held company. As part of his employment agreement, after he has worked for the company for 3 years, if the company’s other shareholders are happy with his performance, they will let him buy 25% of the company’s shares for their current market value.

While this is an arrangement with a purpose or effect of issuing or transferring shares in a company to a person who will be, is, or has been an employee (or shareholder-employee), market value will be paid for the shares on the share scheme taxing date. Accordingly, this arrangement is not an employee share scheme for the purposes of the proposed new definition.

Example 2

Casey, Hamish and Steve get together and incorporate a company to develop some technology intellectual property (IP). They are each employed by the company in different roles. When the shares are issued they are worth virtually nothing (on a balance sheet basis) and a nominal subscription price of $0.01 is paid by each shareholder-employee. The shareholders’ agreement states that to ensure they commit to developing the IP over three years, if they leave within 3 years they lose their shares. After this point they keep their shares no matter what.

While this is an arrangement with a purpose or effect of issuing or transferring shares in a company to a person who will be, is, or has been an employee (or shareholder-employee), market value was paid for the shares and the employees have then chosen to put the shares at risk. Accordingly, this arrangement is not an employee share scheme for the purposes of the proposed new definition.

Example 3

Melissa is hired as CEO by X Co, a closely-held company with exciting but uncertain prospects. She is paid a $120,000 salary. Because she is an employee, she is also able to buy $50,000 worth of shares (which is the current market value – established by an independent valuation). If Melissa leaves employment within 3 years, X Co has the right to buy her shares back for the lesser of $50,000 and market value. After that date, it has to buy the shares back for full market value.

This is because if she leaves, X Co does not want Melissa to hold its shares if she is not part of their team, but after 3 years they are prepared for Melissa to receive the upside in the shares. Before, then, she bears the risk of loss but no chance of gain. If the shares fall to $10,000 and Melissa leaves X Co within three years, the company will buy her shares back for $10,000 and she will lose $40,000 of her $50,000 investment.

If Melissa leaves the company and the shares are worth $1m, then the company will buy them back and Melissa will be denied the upside.

As above, this arrangement is not an employee share scheme as defined as Melissa has paid market value for her shares and has then effectively put them at risk for 3 years.

The definition of employee share scheme also excludes exempt schemes (which have their own specific rules, discussed below).


TIMING AND AMOUNT OF EMPLOYEES’ INCOME


(Clauses 11, 12, 14 and 41)

Summary of proposed amendment

The proposed amendments ensure the timing and amount of employees’ income from employee share schemes is consistent with other forms of employment income.

Application date

The new rules will generally apply to benefits provided under employee share schemes which are not taxed under the existing rules within 6 months of enactment of the Bill. There is further detail on the transitional arrangements below.

Key features

Clauses 11, 12 and 14 provide that benefits provided under an employee share scheme (usually in the form of shares) are assessable income for an employee at the earlier of the date when:

  • the benefits are either transferred or cancelled for consideration; or
  • the employee share scheme beneficiary owns the shares in the same way as any other shareholder. They will not own the shares in the same way as any other shareholder if (for example) the employee is required to forfeit the shares if they choose to leave the company, or the employee is entitled to be compensated for a decline in the value of the shares.

This is referred to as the “share scheme taxing date”. No change is proposed to the tax treatment of straight-forward employee share options, which already reflects this principle, in that the employee is not taxed until the option is exercised.

The amount of the benefit should be the amount received for the transfer or cancellation, or the value of the shares at the share scheme taxing date. It should be reduced by the amount paid (if any) for the benefit.

The proposed rules require matching between the employee’s income and the employer’s deduction, so the rules outlined above also determine the amount and time of the deduction to the employer (the employer’s deduction is discussed further below).

Background

Any reward for services is generally taxable as income, under the ordinary definition. However, the application of the common law of income tax to the provision of rewards in the form of property, for example shares or options, has sometimes been problematic.

For that reason, since 1968, New Zealand tax law has contained special provisions relating to the taxation of employee share scheme benefits. Currently these are contained in sections CE 1 – CE 4, CE 6 and CE 7.

Under current law, shares provided under an employee share scheme are taxable when the employee acquires the shares. Section CE 6(2) provides that:

  • shares acquired pursuant to an option are treated as acquired when the option is exercised. This means that an employee is not taxed on the grant or vesting of an option, but on its exercise; and
  • shares acquired by a trustee for the benefit of an employee (that is, a specific employee) are treated as acquired by the employee, even if the employee may be required to forfeit the shares.

The second of these rules leads to outcomes that are neither tax-neutral nor consistent with the taxation of employee share options.

Example 1

Jim has a tax rate of 33%. If his employer offers him a $1,000 bonus if he is still working for the employer in a year’s time, he will receive (if he satisfies the condition) $1,000 of taxable income.

If instead his employer decides to pay Jim the same bonus in shares, the tax neutral outcome would be for the employer to provide $1,000 of shares, and for Jim to pay $330 tax.

In both cases Jim receives $1,000 of before-tax income and has paid $330 of tax. Tax will not be a factor in how Jim wants to be paid.

Example 2

Suppose that Jim’s employer offers him a cash bonus on the same terms as in example 1, except that the amount of the bonus is the value of 1,000 shares in one year’s time. Suppose that 1,000 shares are worth $1,000 at the start of the year, when the offer is made, and $1,500 at the end of the year. Jim will not be taxed on $1,000. He will be taxed on $1,500 when he receives the cash bonus.

Instead of offering a cash bonus dependent on the value of the shares, suppose Jim’s employer transfers 1,000 shares to a trustee, on the basis that the trustee will transfer them to Jim at the end of the year if he is still with the company, and not otherwise. The economic benefit to Jim is the same as in the first variation of this example. However, under current law, Jim has income of $1,000 when the shares are transferred to the trustee. This is not consistent with the treatment of equivalent cash remuneration (i.e. the first variation of this example), and therefore is not a neutral tax treatment.

Example 3

Jane’s employer decides to provide her with options to buy 1,000 shares in the company. The shares are currently worth $1, and the options have a strike price of $1 (that is, they are issued “at the money”). The options can be exercised only if Jane is still employed in a year. Suppose there is an equal chance that the shares will be worth $600 or $1,600 in a year’s time. If they are worth $1,600, Jane exercises the options, and has $600 of taxable income. If they are worth $600, she does not exercise the options, and gets nothing.

Example 4

Instead of providing options, suppose Jane’s employer sells her 1,000 shares for $1,000, and provides her with an interest-free loan to fund the purchase. The loan must be repaid after one year. The employer specifies that if the shares have fallen in value at the repayment date, Jane must sell the shares back to the employer for $1,000. Suppose the same share values and probabilities as in example 3. If the shares are worth $1,600 in one year, Jane will keep the shares and pay off the loan. If they are worth $600, she will sell them to the employer for $1,000 and use that money to pay off the loan.

Under current law, Jane has no taxable income from this arrangement, even though it produces outcomes identical with the option arrangement, under which Jane has $600 of income if she acquires the shares.

The proposed new rules prevent these inconsistent outcomes by deferring the time at which an employee recognises income from an employee share scheme in certain situations. In examples 2 and 4 above, under the new rules, both Jim and Jane would be taxed on the value of the shares once the employment condition is satisfied (in Jim’s case) or the employer’s right to acquire the shares for $1,000 no longer exists (in Jane’s case).

Detailed analysis

Timing of income

The time when the employee is taxable is defined as the “share scheme taxing date”, and is defined in proposed section CE 7B (clause 14 of the Bill).

Unless an employee first transfers its share scheme benefits to a non-associate, or the company cancels them, the share scheme taxing date is when:

  • there is no real risk that beneficial ownership of the shares will change, or that the shares will be required to be transferred or cancelled;
  • the employee is not compensated for a fall in the value of the shares; and
  • there is no real risk that there will be a change in the terms of the shares affecting their value.

If the benefits are cancelled or transferred to a non-associate before these events occur, then the share scheme taxing date is at the time of the cancellation or transfer.

In determining whether there is a risk of a change of ownership, transfer or cancellation, certain rights and requirements do not affect the employee’s status as the economic owner of the shares under the scheme (proposed section CE 7B(2)) and are ignored. They are rights or requirements:

  • for transfer for market value;
  • not contemplated by the employee share scheme;
  • that have no real risk of occurring;
  • that are of no real commercial significance; or
  • that also apply to shares not subject to the employee share scheme.

The following series of examples illustrate how these proposed rules will work in practice for common types of employee share schemes.

Example 1 – Simple vesting period

Facts

A Co transfers shares worth $10,000 to a trustee on trust for an employee. If the employee leaves the company for any reason during the next three years, the shares are forfeited for no consideration. After three years, the shares are transferred to the employee.

Result

The share scheme taxing date is when the three years is up and the employee is still employed.

Analysis

The risk of loss of the shares for the first three years means there is a real risk that the beneficial ownership of the share will change. None of the exceptions applies.

Example 2 – Vesting period with good leaver exception

Facts

As for Example 1, except that if the employee ceases employment because of death, illness, disability, redundancy or retirement within the three-year period they are entitled to the shares.

Result

The share scheme taxing date will be the end of the vesting period, or when the person leaves for any of the above reasons.

Analysis

There is a real risk that the employee will leave employment for some other reason than those listed (for example, a better opportunity presents itself) and therefore the share scheme taxing date does not occur so long as that risk exists.

Example 3 – Vesting subject to misconduct

Facts

As for Example 1, except that if the employee ceases employment for any reason other than being subject to disciplinary action or committing some form of employment-related misconduct during the three-year period (i.e. being a “bad leaver”) the employee is entitled to the shares.

Result

The share scheme taxing date is when the shares are initially transferred to the trust, and the income will be their value at that time.

Analysis

The risk of the employee losing their job for these “bad” reasons during the three year period is not sufficiently real to require deferral.

Example 3A – Vesting subject to misconduct with accrual

Facts

As for Example 3, except that if the employee ceases employment for any reason other than being a bad leaver, they are entitled to only a pro rata portion of the shares based on completed years’ service (for example, nothing for the first year, one third of the shares if the employee leaves between one and two years, etc.).

Result

There will be three share scheme taxing dates – at the end of years 1, 2 and 3 respectively. The employee will be taxed at the end of each year on the value at that time of one third of the shares.

Analysis

Until the end of the first year, if the employee leaves for another job, they will not be entitled to any shares. Once the first year is completed, they will be entitled to one third of the shares, provided they are not a bad leaver during the next two years. The risk that the employee will leave for another job is sufficiently real that it defers the share scheme taxing date. The risk that the employee will leave as a bad leaver is sufficiently unlikely that it does not defer the share scheme taxing date. The fact that the shares are held by the trustee until the end of year three does not of itself defer the share scheme taxing date.

Example 3B – Performance hurdles

Facts

As for Example 3A, except that the employee is not entitled to the shares at all unless a total shareholder return[6] hurdle (measured as an annual percentage) is also met. If the hurdle is met in year 1, one third of the shares vest. If it is met in year 2, a further one third of the shares vest. Also, if it was not met in year 1, but is met on a combined basis over years 1 and 2, a further one-third of the shares will vest. The same approach applies in year 3.

Result

There will be three possible share scheme taxing dates – at the end of years 1, 2 and 3 respectively. The employee will be taxed at the end of each year on the value of the shares that vest at that time.

Analysis

Until the end of the first year, if the employee leaves for another job, they will not be entitled to any shares. Once the first year is completed, they will be entitled to retain one third of the shares, provided they are not a bad leaver during the next two years, and provided the year 1 performance hurdle is met. The risk that the employee will be a bad leaver is sufficiently unlikely that it does not defer the share scheme taxing date. The fact that the shares are held by the trustee until the end of year 3 does not of itself defer the share scheme taxing date.

Example 4 – Vesting period, with compulsory sale for market value thereafter

Facts

As for Example 1, except that even after the three-year period ends, the trustee retains legal ownership of the shares, and the employee must transfer their rights back to the trustee or A Co when the employee leaves. However, once the three-year period is up, the employee will receive the market value of the shares when their beneficial ownership is transferred.

Result

As for Example 1.

Analysis

Once the three-year period has expired, the employer’s or trustee’s right to acquire the beneficial interest in the shares is for market value, and therefore is not taken into account in determining the share scheme taxing date.

Example 5 – Insubstantial put option

Facts

As for Example 4, except that the employee has the right at all times to sell the shares back to the trustee for a total price of $1.

Result

The share scheme taxing date would be the same as in Example 4.

Analysis

The employee’s right to sell the shares for $1 is not, at the time it is granted, a right which has a real risk of being exercised, given that there is no liability attached to the shares and that they are then worth $10,000. This right would therefore not defer the share scheme taxing date.

Example 6 – Loan funded scheme A

Facts

B Co provides an employee with an interest-free full recourse loan of $10,000 to acquire shares in B Co for market value, on the basis that:

  • the shares are held by a trustee for three years;
  • dividends are paid to the employee from the time the shares are acquired;
  • if the employee leaves within three years, the shares must be sold back to the trustee for $10,000, which must be used to repay the loan;
  • if the employee is still employed by B Co after three years, the employee can either sell the shares to the trustee for the loan amount, or choose to continue in the scheme; and
  • if the employee chooses to continue, the loan is only repayable when the shares are sold.

Result

The share scheme taxing date will be the earlier of when the employee leaves employment, or the expiry of the three years.

Analysis

Until the three years are up, if the employee leaves B Co for whatever reason, they lose their beneficial ownership of the shares for an amount that is not their market value. So the share scheme taxing date will on the face of it be the end of that three-year period. If the employee leaves within that period and is therefore required to transfer their rights, the sale price will be taxed, but since the sale price is the same as the amount contributed, there will be no gain or loss. Once the three-year period is up, the employee will either have no income (if they sell the shares back to the trustee for $10,000) or will pay tax on the difference between the value of the shares at that time and their $10,000 price (if they choose to keep the shares).

Example 7 – Loan funded scheme B

Facts

As for Example 6, except that:

  • the loan is limited recourse for the first three years (i.e., during that period, the amount repayable is limited to the value of the shares at the time of repayment); and
  • if the employee leaves within three years, or chooses at the end of the three years to sell the shares to the trustee, they must be sold back to the trustee for market value.

Result

As for Example 6.

Analysis

The limited recourse loan provides a benefit to the employee which compensates the employee for a fall in the value of the shares. Accordingly the share scheme taxing date is the same as for Example 6 – that is, the end of three years (when the loan ceases to be limited recourse) or when the shares are sold to the trustee. If the employee sells the shares for less than $10,000 (because that is their market value), the employee will have a deductible loss from the scheme under the employee share scheme rules. They will have debt forgiveness income of an equal amount.

Example 8 – Loan funded scheme C

Facts

As for Example 6, except that:

  • as in Example 7, the sale back to the trustee must be for market value, whenever it occurs;
  • at the time of such a sale, the employer must pay the employee the amount of any decline in the value of the shares since the grant date.

Result

As for Example 6.

Analysis

The employer’s promise to pay a bonus equal to the decline in the value of the shares is a benefit which compensates the employee for a decline in the value of the shares. If the employee sells the shares for less than $10,000 they will have a deductible loss from the scheme, which will be equal to the income they will recognise due to the payment from the employer.

Example 9 – Loan funded scheme D

Facts

As for Example 8, except that there is no arrangement for the employer to pay the employee the amount of any decline in value of the shares.

Result

The share scheme taxing date is when the agreement is entered into.

Analysis

From the time the agreement is entered into, the employee has the full risk and reward of share ownership.

Example 10 – Vesting only in the event of a sale or IPO

Facts

C Co transfers 1,000 shares to a trustee for an employee. The shares remain held on trust until the employee leaves, more than 50% of C Co is sold, or C Co is listed (whichever happens first). If the employee leaves first, the shares are forfeited. If more than 50% of C Co is sold, the employee’s shares must also be sold and the employee will receive the proceeds. If C Co is listed, the shares are released to the employee.

Result

The share scheme taxing date is when the employee leaves, or C Co is sold or listed.

Analysis

Because the employee forfeits the shares for no consideration if they leave, the share scheme taxing date will be deferred until the employee leaves (in which case there will be no income), the shares are sold (in which case the sale price will be taxable), or the shares are released to the employee (the market value of the shares will be taxable).

Amount of income

The amount of income to the employee will be the value of the shares at the share scheme taxing date (or the transfer price if transferred to a non-associate, or the amount paid for cancellation, if cancelled by the employer) less the amount paid for them. Even where benefits are conferred on or transferred to an associate of an employee, it is always the employee who is taxed on the income. If the amount paid exceeds the value of the shares, the difference is deductible to the employee (proposed new section CE 2(3) in clause 12 and proposed new section DV 27(3) in clause 41).

Apportionment for overseas service

The proposed new rules contain an expanded income apportionment formula (proposed section CE 2(5) and (6) in clause 12). The expanded formula applies to all employees (rather than only transitional residents as in current section CE 2(9)). It excludes from taxable income employee share scheme benefits which accrue while a person is neither New Zealand resident nor deriving New Zealand source income. The extent of such accrual is determined by first establishing the entire period over which the benefit accrues, and then determining the proportion of that period during which the person is non-resident and not deriving New Zealand source income from their employment. The period of accrual ends once the rights vest, rather than when the income arises. So, for example, in the case of an option, the period of accrual ends once the options are exercisable rather than when they are actually exercised.

The employee share scheme income is treated as non-residents’ foreign source income (which is not taxable income) to the extent of this proportion.

Transfers to associates

No change is proposed for the treatment of transfers to associates. Such transfers are ignored for purposes of calculating the employee’s share scheme income.

Rollover relief for transfer to new scheme

If a person’s employee share scheme rights are cancelled and replaced with rights in a different scheme, the value of the replacement rights is not included in the person’s income arising due to the cancellation of the original scheme (proposed sections CE 2(2)(c) in clause 12 and CE 7D in clause 14).

The benefit provided by the replacement scheme will be taxed appropriately by applying the proposed new rules to that scheme


TIMING AND AMOUNT OF EMPLOYERS’ DEDUCTION


(Clauses 23 and 41)

Summary of proposed amendment

The Bill proposes to provide a deduction to employers providing employee share benefits which matches the income to employees in timing and quantity. Deductions currently available for other payments need to be disallowed where those payments would otherwise lead to a double deduction.

Application date

The proposed changes will have the same application date as for the provisions applying to the taxation of employees – that is, they generally apply to benefits provided under employee share schemes which are not taxed under the existing rules within six months of enactment of the Bill.

Key features

The proposals will allow a deduction to employers equal in amount and timing to the income derived by an employee under the new rules. It would explicitly preserve deductions for the costs of running an employee share scheme, and for the cost of any bonus associated with a share scheme paid to an employee. No other deductions will be allowed.

Background

The principle of neutral tax treatment of employee share scheme benefits supports employers being entitled to a deduction for the value of the benefit provided. The fact that the issue of shares by a company does not involve an explicit cash cost does not affect this principle. That is, there is a transfer of value to the employee from the other shareholders, which arises whether that value is transferred as cash or as shares in the company.

Under the corporate tax system, where company expenses are deducted by the company as a separate taxpayer from its shareholders, this cost must be recognised in the calculation of income by the company rather than the shareholders on whose behalf it is earned.

Ways to create a deduction do exist. For example, payment of a bonus to the employee which is used to fund a full value share acquisition, contributions to an employee share trust or reimbursement to a parent company. However, the tax treatment of these transactions can be uncertain, and structuring to achieve these should not be necessary (they just incur unnecessary transaction costs).

There is also the potential for the amount and timing of the deduction created by these transactions to not correctly reflect the economic cost to the company of providing the employee share scheme benefits.

Detailed analysis

An employer is denied a deduction for provision of employee share scheme benefits (proposed section DV 27 in clause 41), except for:

  • costs incurred in administering or managing the scheme (proposed section DV 27(4)). These costs include legal and accounting fees incurred in setting up the scheme, as well as on-going management fees. Deductibility of these costs will be left to the usual tests, e.g. the capital/revenue test. Costs incurred by an employee share scheme trust will be treated as incurred by the employer or issuing company, as a result of the new provision treating an employee share scheme trust as a nominee;
  • the amount of the employee’s income, which is treated as a cost incurred at the same time as the employee recognises the income (proposed section DV 27(6)-(8)). Deductibility of this cost will depend on meeting the usual tests; and
  • amounts which are taxable to the employee as employment income other than as employee share scheme benefits (proposed section DV 27(5)). This is intended to preserve a deduction for the cost of paying a bonus where the payment of the bonus is part of the terms of an employee share scheme.

Accordingly:

  • payments to fund an employee share scheme trust to acquire shares, or to reimburse a parent for providing shares, will not be deductible; and
  • as a practical matter, employers will need to either prohibit employees from transferring their rights to a non-associate before the share scheme taxing date, or place a requirement on employees to inform them of the time and amount paid in such a transfer, in order to correctly calculate their deduction.

In order to prevent double deductions, when shares are provided to an employee and a deduction has been taken for that provision other than in accordance with to the new section, the deduction under the new section is reduced by the earlier deduction (proposed section DV 27(8)(b)).


EFFECT OF DEDUCTION AND PAYMENTS ON AVAILABLE SUBSCRIBED CAPITAL


(Clauses 7 and 10)

Summary of proposed amendment

The new rules seek to tax any benefit conferred on an employee by the issue of shares in an employee share scheme in the same way as an equivalent cash payment followed by an acquisition of shares in the issuing company. Consistent with this principle, the proposed rules provide for an increase in the employer’s available subscribed capital (ASC) by the amount deemed to be paid (plus actually paid) for the shares. The proposed rules also cater for the situation where the employer is not the company issuing the shares.

This is a taxpayer-friendly measure to ensure employee share schemes are not disadvantaged as a form of remuneration compared with an equivalent cash transaction, which would generally give rise to an ASC increase.

Application date

The ASC rules will apply to the provision of shares which are taxed under the new rules.

Key features

The ASC proposals deal with the effect of employee share scheme transactions on the employer and (if different) the company issuing the shares.

The amount of the deduction to the employer will give rise to additional ASC for both the employer and, if the shares issued are in the parent of the employer, the parent. In the latter case, any reimbursement paid to the parent will reduce the subsidiary’s ASC but will not increase the parent’s ASC. If the employer has income from the issue of the shares, that will reduce its ASC.

The proposals also ensure that the acquisition of shares as part of an employee share scheme can be treated as an acquisition of treasury stock, regardless of whether the shares are acquired by the company itself and not cancelled, or are acquired by a trustee who is treated as a nominee of the company.

Background

To ensure neutrality between provision of benefits under an employee share scheme and an equivalent cash transaction, as well as providing for the income and deduction consequences, the new rules must provide for changes to a company’s ASC.

To do this, the proposed rules provide for an increase in the employer’s ASC by the amount deemed to be paid (plus actually paid) for the shares. The proposed rules also cater for the situation where the employer is not the company issuing the shares (this is common where the employer company is a subsidiary and the employee receives shares in the parent company).

Additionally, in order to cater for the common practice of acquiring employee share scheme shares from other shareholders rather than by a fresh issue of shares, it is also necessary to ensure that the treasury stock regime can apply sensibly to employee share schemes.

Detailed analysis

Under clause 10, if the employer is also the company whose shares are provided, then the employer’s ASC will be:

  • increased by:
    • the amount received for the provision of the shares (under existing section CD 43(2)(b)); and
    • the amount of its deduction for the provision of the shares (under proposed section CD 43(6E)(a));
  • decreased by the amount of any income arising if it has income because the value of the shares provided is less than the amount received from the employee (under proposed section CD 43(29)).

Example 1

Facts

Employer Co issues 700 shares worth $3 each to an employee for $2 per share (that is, at a $1 per share discount). The scheme taxing date is the date of issue. The employee has $700 income and Employer Co has $700 deduction.

ASC Result

Employer Co’s ASC increases by $2,100, being the total of the $1,400 received and its $700 expenditure.

Example 2

Facts

Employer Co issues 700 shares worth $3 each to an employee for $2 per share, funded by a loan from the employer. If the employee is still employed by the company after one year, the employee will receive a $1,400 bonus, which must be used to repay the loan. Otherwise, the employee must return the shares to the employee in full repayment of the loan at the time she leaves employment. After one year, the shares are worth $4 each.

ASC result

Issuing the shares gives rise to ASC of $1,400. If the shares are repurchased because the employee does not remain employed, that will usually give rise to an ASC reduction of $1,400. Otherwise, at the share scheme taxing date, Employer Co’s ASC will increase by $1,400, the amount which is both taxable to the employee and expenditure for Employer Co (making for a total increase in ASC as a result of the employee share scheme of $2,800).

Example 3

Facts

As for example 2, except that after one year the shares are worth $1 each.

ASC result

As for example 2, except that if the employee remains employed, Employer Co’s ASC will decrease by $700, the same amount that is both deductible to the employee and taxable to Employer Co.

If the employer is not the company whose shares are provided, then its ASC will be:

  • increased by the amount of its deduction for providing the shares (proposed section CD 43(6E)(a));
  • decreased by the amount of any income arising if it has income because the value of the shares is less than the amount received from the employee (proposed section CD 43(29));
  • decreased by the amount of any reimbursement paid to the share provider (proposed section CD 43(6H)).

The adjustment should be made to the employer’s share class most similar to the shares provided under the scheme. If the decrease due to reimbursement exceeds the increase arising due to a deduction, and the excess is greater than the ASC of the relevant share class, the reimbursement amount is to that extent taxed as a dividend (proposed section CD 43(6I)).

Example 4

Facts

Parent Co, the 100% owner of Employer Co, issues 700 shares worth $3 each to an employee of Employer Co for $2 per share. The scheme taxing date is the date of issue. The employee has $700 income and Employer Co has $700 deduction.

ASC result for Employer Co

Employer Co’s ASC increases by the amount of its $700 expenditure.

Example 5

Facts

Parent Co issues 700 shares worth $3 each to an employee of Employer Co for $2 per share, funded by a loan from Parent Co. If the employee is still employed by the Employer Co after one year, the employee will receive a $1,400 bonus from Employer Co, which must be used to repay the loan. Otherwise, the employee must return the shares to the employer in full repayment of the loan at the time she leaves employment. After one year, the shares are worth $4 each.

ASC result for Employer Co

If the employee stays employed for the year, at the share scheme taxing date, Employer Co’s ASC will increase by $1,400, the amount which is both taxable to the employee and expenditure for Employer Co under the employee share scheme rules.

Example 6

Facts

As for example 5, except that if the shares are not forfeited, Employer Co pays Parent Co $1 per share reimbursement.

ASC result for Employer Co

Employer Co’s ASC will increase by $700 if the employee remains employed, which is the difference between its $1,400 deduction and its $700 reimbursement to Parent Co.

If the shares are provided by the ultimate parent of the employer, the ASC of the parent company will be:

  • increased by:
    • the amount paid by the employee for the shares (under existing section CD 43(2)(b)); and
    • the amount of the employer’s deduction for the provision of the shares (proposed section CD 43(6E)(b));
  • decreased by the amount of any income arising to the employer if it has income because the value of the shares provided is less than the amount received from the employee (proposed section CD 43(29)); and
  • unaffected by any amount paid to it by the employer (proposed section CD 43(20B)).

Example 7

Facts

As for example 4 above.

ASC result for Parent Co

Parent Co’s ASC increases by the $1,400 received for the issue of its shares plus the $700 deductible to Employer Co (for a total ASC increase of $2,100).

Example 8

Facts

As for example 5.

ASC result for Parent Co

The issue of the shares gives rise to ASC of $1,400. If the shares are repurchased by Parent Co because the employee does not remain employed, that will usually give rise to an ASC reduction of $1,400. Otherwise, at the share scheme taxing date, Parent Co’s ASC will increase by $1,400, the amount which is both taxable to the employee and expenditure for Employer Co.

ASC Example 9

Facts

As for example 6, except that the shares are worth $1 each after one year.

ASC result

Parent Co’s ASC will increase by $1,400 when the shares are issued. If the employee remains employed, (a) the reimbursement of $1 per share does not affect Parent Co’s ASC (b) Parent Co’s ASC decreases by $700 – the amount of the income arising to Employer Co as a result of the amount payable by the employee for the shares ($1,400) being in excess of the value of the shares at the share scheme taxing date ($700).

Treasury stock

If an employee share scheme trustee acquires shares for the purposes of the scheme, it is proposed that those shares will be treated as acquired by the share issuer (proposed section CE 6). The amount paid to the selling shareholder for their acquisition will be a dividend, unless one of the exceptions to dividend treatment applies.

If the shares are held by the trustee, the treasury stock rules will apply to them. Amendments are proposed to the treasury stock rules so that they apply more clearly in such a case.

Proposed measures in clause 7 make it explicit that the treasury stock regime can apply to an acquisition by an employee share scheme trust, just as if the shares were acquired by the company and not cancelled (amendments proposed to section CD 25(1)(a)).

It is proposed that the shares are allocated to an employee within one year of their acquisition, their acquisition and re-issue will be ignored by the share issuer (but not an employer who is not the share issuer) for ASC purposes (amendments proposed to section CD 25(2)(b)). Note that the shares would only have to be allocated to the employee under the scheme to qualify for treasury stock treatment, they do not have to be transferred to the employee.

It is proposed that shares which are allocated to an employee within a year and then forfeited are treated as acquired by the company at that time for the amount the trustee paid for them when originally acquired (proposed section CD 25(7)).

It is proposed that shares which are not allocated within one year be treated as having been acquired on market and cancelled (also amendments proposed to section CD 25(2)(b)).

Example 10

Facts

As for example 6 except that the shares are sold to the employee at the start of the period by an employee share scheme trust which acquired them on market for $2.50 per share six months before the allocation. The $1,400 loan is also provided by the trust. The trustee will hold the shares until the 12 months is up, and then either retain them in satisfaction of the loan, or transfer them to the employee.

ASC result for Parent Co

The trustee’s acquisition of the shares is treated as an on-market acquisition of treasury stock by Parent Co. Therefore both the acquisition and provision of shares to the employee have no effect on Parent Co’s ASC. There is no increase in Parent Co’s ASC as a result of Employer Co’s $1,400 deduction. If the employee does not stay for 12 months, Parent Co will be treated as acquiring the shares for $2.50 per share, the amount for which they were initially acquired on market. This acquisition will not affect Parent Co’s ASC if the shares are allocated to another employee within 12 months.

ASC result for Employer Co

If the employee stays for 12 months, Employer Co will have additional ASC of $700, being the excess of its $1,400 deduction over the $700 reimbursement paid to Parent Co.


EXEMPT SCHEMES


(Clauses 25, 31, 42 and 248)

Summary of proposed amendment

The Income Tax Act 2007 currently provides a concessionary regime to encourage employers to offer shares to employees under certain widely-offered “share purchase schemes” (commonly known as “exempt schemes”).

The current rules are out of date, complex and no longer fit for purpose. They also do not fit within New Zealand’s broad base, low rate framework. The proposed amendments:

  • modernise and simplify the criteria for these schemes, including removing employers’ 10% notional interest deduction;
  • increase the monetary threshold for the schemes (which has not been increased since 1980); and
  • address the current ability for employers to claim unintended deductions for the cost of providing the exempt share benefit to employees.

Application date

It is proposed that the amendments will generally apply from the date of enactment. However, clause 42 (new section DV 28), which denies employers a deduction for the cost of acquiring shares provided under an exempt scheme, applies from the date of the Bill’s introduction.

Key features

The proposed amendments, seek to simplify and clarify the legislation relating to exempt schemes, while retaining many of the key features of the original schemes and their tax treatment. In many cases, the requirements will be relaxed. Where the original policy is no longer appropriate or unintended consequences have arisen, the proposed amendments address this.

Under the proposed amendments, shares provided to employees under schemes that meet certain criteria (described below in the detailed analysis) will be exempt income to the employees. Benefits provided under schemes that qualify for the current tax-exempt treatment will simply continue to qualify under the new legislation, but such schemes will be entitled to provide the same level of exempt benefit as new schemes.

For all exempt schemes, from the date of introduction of the Bill, employers will be explicitly denied a deduction for the cost of providing the shares (other than scheme management and administration costs) and the 10% notional interest deduction will be repealed from the date of enactment.

The automatic exemption from fringe benefit tax (FBT) for loans provided under exempt schemes in section CX 10(2) will continue.

Background

Since the 1970s, the Income Tax Act has contained a concessionary regime to encourage employers to offer shares to employees under certain widely-offered employee share schemes. The concession is on the basis that the schemes are designed to increase employee engagement at all levels of the company and align employee and shareholder incentives. They may also assist employees to develop and improve financial literacy skills.

There are currently two main tax benefits available under the regime.

  1. Exemption for employee: The value of a benefit received by an employee under a concessionary scheme is not taxable to the employee.
  2. Deemed interest deduction for employer: The employer is given a deemed deduction of 10% notional interest on loans made to employees to buy shares. This is additional to any deduction for actual interest incurred on money borrowed to finance the scheme.

Another benefit under the regime is that interest-free loans made under an exempt scheme are automatically exempt from FBT. The FBT-exempt status of the loans is a limited benefit. In most cases such loans would be FBT-exempt in any event, as “employee share loans” (that is, any loan provided by an employer to an employee to purchase its shares under an employee share scheme). The only real benefit of the specific FBT exemption is that the interest-free loan can be FBT-exempt regardless of the company’s dividend paying policy.

To qualify as an exempt scheme, currently the scheme must meet all the following criteria.

  • The cost to employees of shares made available for purchase must not exceed their market value at the date of purchase (but may be less).
  • The amount that an employee spends on buying shares under the scheme (or a similar scheme) must not exceed $2,340 within a three-year period.
  • Every full-time permanent employee must be eligible to participate in the scheme on an equal basis with every other full-time permanent employee. If the scheme applies to part-time employees or to seasonal employees, they must also be eligible to participate on an equal basis with every other part-time employee or every seasonal employee.
  • Any minimum period of service which may be required before a full-time permanent employee becomes eligible to participate must not exceed three years (or the equivalent of three years full-time service).
  • Loans to employees for the purchase of shares must be free of all interest and other charges.
  • The repayment of loans by employees is to be by regular equal instalments at intervals of not more than one month over a period between three and five years from the date of the loan.
  • A trustee must hold the shares on trust for the employee for a period of restriction (generally at least three years).

The benefits of the regime do not apply to shares given to directors of the company or a person who (with any associated person) holds 10% or more of the issued capital of the company.

On the expiry of the restrictive period, the employee has two options. First, the employee can opt to have the shares transferred from the trust to them. Secondly, the employee can opt for the trust to buy the shares back at the market value (but not more than the price paid by the employee).

Problems with the current law

There are various issues with the current regime:

  • the regime is complex and inflexible;
  • the tax benefits of the regime are uncertain and poorly targeted;
  • the regime does not explicitly limit the amount of tax-free benefit that can be conferred;
  • there are some minor drafting issues with the legislation; and
  • the maximum amount an employee can pay for shares ($2,340 over a three-year period) has not been adjusted since 1980, and this means as a practical matter that the benefits available under the regime are very limited. Adjusted for wage inflation, the figure would now be around $13,000.

Detailed analysis

Income tax exemption for shares provided under exempt schemes

Clause 25 (new section CW 26B) provides that amounts derived from exempt schemes are exempt income.

While a tax exemption for employment income does not fit generally within New Zealand’s broad-base, low-rate (BBLR) tax framework, given there is a limit on the amount of benefit that can be provided under the scheme ($2,000 per employee per annum) and the scheme has to be offered to almost all employees, it is appropriate to retain the tax exemption to minimise compliance costs.

The amendments propose retaining the exemption, but with a limit on the tax-free benefit that can be provided.

The existing law achieves the tax exemption by deeming the benefit derived under an exempt scheme to be zero (section CE 2(7)). The proposed amendments locate the exemption in subpart CW, which is a more appropriate part of the Income Tax Act for an exemption.

Employer deduction for shares provided under exempt schemes

There are currently several potential deductions associated with exempt schemes:

  1. the 10% notional interest deduction with respect to employee share loans;
  2. costs associated with setting up and running the scheme; and
  3. in some cases, the direct or indirect costs of acquiring shares for the scheme.

Clause 31 repeals the 10% notional interest deduction in 1 above. The original policy rationale for this benefit is unclear and it is inconsistent with our BBLR tax framework.

Clause 42 proposes a new section DV 28 which denies a deduction for any costs associated with exempt schemes, other than administrative and management fees associated with setting up and running the scheme. This ensures that the unintended deductions identified in item 3 above are no longer available, but the deductions identified in item 2 are still available, subject to the usual limitations. This is consistent with the general deductibility provision for employee share scheme benefits in proposed new section DV 27 that only allows a deduction for administrative and management fees and for the provision of employee share scheme benefits to the extent that the benefit is assessable income to the employee.

Meaning of exempt scheme and criteria for qualifying for exemption

The proposed amendments have been designed to ensure existing schemes that meet the criteria described below can continue to operate without unnecessary disruption. Therefore, to the extent possible the existing rules have been retained and simply clarified.

It is proposed that existing exempt schemes approved by the Commissioner under previous legislation (for example, section DC 12 of the Income Tax Act 2007), would continue to be “exempt schemes” and be eligible for the tax exemption, provided they continue to meet the existing criteria as modified by the increase in the benefit level in proposed section CW 26C(2).

See proposed section CW 26C(1)(a).

The underlying policy of the criteria is to ensure:

  1. the scheme is genuinely offered to the vast majority of employees on equal terms – for example, it cannot just be targeted towards executives;
  2. related to 1, all employees have to be able to afford to participate in the scheme, not just the more highly paid employees – this is achieved by limiting the cost of the shares that can be offered, requiring employers to provide financing for any cost or because the employee does not have to pay anything for the shares;
  3. there is a limit on the benefit that can be provided tax-free; and
  4. the scheme is genuinely a share scheme and not just a mechanism to provide tax-free cash to employees (this is why there is a restriction period).
Criteria

To achieve this policy, all the following proposed criteria must be met in order for a scheme to be exempt.

  • The cost to employees of shares made available for purchase must not exceed their market value at the date of purchase but may be less (proposed section CW 26C(2)(a)).
  • The maximum value of shares provided under an exempt scheme is $5,000 per annum (proposed section CW 26C(2)(b)).
  • The maximum discount an employer can provide to an employee is $2,000 per annum (proposed section CW 26C(2)(c)). This means that the most an employee can spend buying shares per annum is $3,000 ($3,000 plus the $2,000 discount means a maximum value of $5,000 worth of shares). This equates to a maximum cost of $9,000 over three years.
  • 90% or more of full-time permanent employees who are not subject to securities law of other jurisdictions must be eligible to participate in the scheme. If the scheme applies to part-time employees or to seasonal employees, the same threshold applies (proposed section CW 26C(3)(a)-(c)). Currently, all full time employees must be eligible to participate.
  • If the scheme has a minimum spend requirement, the amount can be no more than $1,000 per annum (proposed section CW 26C(3)(d)). This is the updated equivalent of section DC 13(4) and increases the $624 per three year figure.
  • Any minimum period of service which may be required before an employee becomes eligible to participate must not exceed three years (or the equivalent of three years full-time service) (proposed section CW 26C(3)(e)).
  • If the employee is required to pay any amount for the shares, then the employer must provide a loan for that amount or allow the employee to pay for the shares in instalments (proposed section CW 26C(4)(a)).
  • Loans to employees for the purchase of shares must be free of all interest and other charges (proposed section CW 26C(4)(b)).
  • Employees will repay loans by regular equal instalments at intervals of not more than one month over a period between three and five years from the date of the loan (proposed section CW 26C(4)(c)).
  • Generally speaking, the shares have to be held for three years (either by the employee or by a trustee of a trust on behalf of the employee) – this is to ensure that the scheme is really a share purchase scheme, and not a mechanism for providing cash remuneration. If the employee has paid full market value for the shares, then they only have to hold them until they have fully repaid the loan – at this point they are like any other shareholder and should not have extra restrictions placed on them (proposed section CW 26C(7)).
  • The employee can choose to withdraw from the scheme by giving the employer 1 month’s notice and have their shares purchased back for the lesser of market value and cost (proposed section 26C(5)).
  • If participation in the scheme is causing serious hardship for the employee, the terms of payment can be varied or employees can be allowed to withdraw from the scheme and receive the market value of their shares (proposed section CW 26C(6)).
  • If the employee leaves employment before the three years is up, then:
    • if they leave because of death, accident, sickness, redundancy or retirement at normal retiring age they can keep the shares (subject to repayment of the loan) or have the shares bought back for the lesser of market value and cost; and
    • if they leave for any other reason, the shares are bought back at the lesser of cost and market value. (see proposed section CW 26C(6) and (9)).
  • The exempt scheme is not required to be approved by the Commissioner of Inland Revenue, however, the Commissioner must be notified of the scheme’s existence and the employer must advise the Commissioner when grants are made under the scheme (see clause 248 which contains proposed section 63B of the Tax Administration Act 1994 and clause 31 which repeals section DC 12 – DC 15).
  • There is no requirement for a scheme to have a trust – many schemes have trusts as a matter of convenience. Removing this requirement provides greater flexibility (especially for small employers who may not want the administrative expense of operating a trust for a fairly small scheme).

TECHNICAL, CONSEQUENTIAL AND TRANSITIONAL MATTERS


(Clauses 12, 14, 28, 60, 70, 74 and 187(26))

Summary of proposed amendments

A number of transitional and consequential provisions are needed to support the core amendments. These provisions:

  • specify a cost base for shares acquired under an employee share scheme (proposed section CE 2(4));
  • provide for the treatment of employee share scheme shares subject to the foreign investment fund (FIF) rules (amended section EX 38);
  • specify the treatment of employee share scheme trusts (proposed section CE 6 and repeal of existing section HC 27(3B));
  • introduce a specific anti-avoidance rule to counteract tax avoidance transactions with respect to employee share schemes (proposed section GB 49B);
  • make a minor amendment to the penalties applying to employers who do not take reasonable care in reporting employee share scheme benefits (proposed amendments to the definition of “tax shortfall” in section 3(1) of the Tax Administration Act 1994);
  • provide transitional rules for existing schemes to ensure taxpayers have sufficient time to amend schemes (if necessary) to take account of the new law following enactment of the Bill (proposed new section CZ 1); and
  • replaces the former terminology – share purchase agreement – with the new term – employee share scheme – throughout the Income Tax Act 2007 and Tax Administration Act 1994.

Application date

There are various application dates for each of the amendments, as specified below.

Detailed analysis

Cost base

It is proposed that income from an employee share scheme benefit, be added to the cost of the shares for tax purposes (clause 12, proposed new section CE 2(4)). Similarly a deduction reduces the cost base.

This provision applies from the date six months after the date of enactment.

FIF regime

The Bill effectively excludes from the FIF regime employee share scheme shares which are treated as owned by the employee for tax purposes but for which the share scheme taxing date has not arisen. Before that time, it is appropriate to tax the dividends on the shares, but not appropriate to tax any change in value, since that will be taxed when the shares give rise to income under section CE 2. See clause 60, proposed amendments to section EX 38.

This provision applies from the date six months after the date of enactment.

Trusts

As referred to above, an employee share scheme trustee will be treated as the nominee of the employer and (if different) the share issuing company (see clause 14, proposed section CE 6). This means that the activities of the trustee on behalf of those companies will be treated as undertaken directly by the companies themselves. They will therefore have no effect on the trustee’s taxable income.

Section HC 27(3B), which deals with the situation where an employer has claimed a deduction for a settlement on an employee share scheme trustee, is proposed to be repealed, as such settlements will no longer be deductible. See clause 74.

These provisions apply from the date six months after the date of enactment.

Specific anti-avoidance provision

Clause 70 of the Bill contains a specific anti-avoidance provision, in proposed section GB 49B. This allows the Commissioner to counteract any tax advantage gained from an arrangement which attempts to circumvent the intent and application of the share scheme taxing date, by seeking to have shares taxed either earlier or later than is consistent with that intent.

This provision applies from the date six months after the date of enactment.

Penalties

Clause 187(26) of the Bill amends the definition of a “tax shortfall”, so that an employer who is required to report the amount of an employee’s share scheme income in a tax return, and who fails to take reasonable care in determining the amount of that income, is liable for the same shortfall penalty whether or not the employer has elected to pay PAYE on the benefit. There is no basis for differentiating in this respect between employers who do and those who do not withhold PAYE.

This provision applies from the date of enactment.

Transitional rules

Employee share schemes are often long-term arrangements, lasting three or more years. Additionally, new share schemes are set up fairly regularly by companies and it is important for companies and employee participants to have clarity around the tax laws when they enter into these arrangements.
Accordingly, it is important to provide sufficient transitional measures for existing and contemplated employee share schemes. It is not desirable to put employers and employees in a position where employees are being granted employee share scheme benefits without certainty as to their tax treatment. However, it would also not be appropriate for employers and employees to be able to unduly extend the application of the existing rules by artificially qualifying for grandparenting grants of employee share scheme benefits which are not, in substance, intended to be conferred until a much later time.

To balance these competing objectives, a 6 month period after enactment is proposed when benefits can continue to be taxed under the old law in specific circumstances. Clause 28 proposes section CZ 1 which provides that the new employee share scheme rules do not apply to shares granted or acquired before the publication of the officials’ issues paper on 12 May 2016. The new rules would also not apply to a particular share if:

(i) that share was granted or acquired before the date that is six months after the date of enactment;

(ii) the shares were not granted with a purpose of avoiding the application of the new law; and

(iii) the share scheme taxing date under the new law is before 1 April 2022.

If shares benefits are taxed under both the existing and proposed new rules, the new rules provide the employee with a credit for income recognised under the old rules.

This transitional provision applies from the date six months after the date of enactment.

 

5 Which includes any person receiving a PAYE income payment (for example, certain directors).

6 Annual “total shareholder return” is a combination of dividends paid and appreciation in share price during a year.