Employee share schemes
SIMPLIFYING THE COLLECTION OF TAX ON EMPLOYEE SHARE SCHEMES
(Clauses 2(3), 52 to 54, 109, 204 and 222)
Summary of proposed amendments
Changes are proposed to the general PAYE collection rules in the Income Tax Act 2007 to improve the collection of tax on benefits received as employment income under a share purchase agreement. Share purchase agreements in this context are often referred to as “employee share schemes”.
The proposed changes:
- allow the employer to choose to withhold tax on any employment income an employee receives under a share purchase agreement using the PAYE system; and
- require employers to disclose the value of any benefits an employee receives under a share purchase agreement via the employer monthly schedule (EMS).
Application date
The changes apply on and after 1 April 2017 to employment income received after that date.
Key features
Amendments are proposed to the rules governing the collection of tax on employment income for employees who receive a benefit under a share purchase agreement. The new rules will give employers the choice to pay and return tax on employees’ behalf on employment income arising from a share purchase agreement.
The amendments set out:
- how the employer exercises their choice to withhold tax on such benefits; and
- when benefits an employee receives from a share purchase agreement under section CE 2 are to be disclosed by the employer to Inland Revenue.
The definition of “extra pay” in section RD 7 will be amended by adding to the list of payments in that section a benefit an employee receives as employment income under a share purchase agreement to the extent that new section RD 7B applies to the amount of the benefit.
New section RD 7B sets out the conditions when employers exercise the choice as to whether to withhold and pay an amount of tax on a benefit under a share purchase agreement that is treated as an “extra pay” under section RD 7. The employer’s choice applies to all members of the share purchase agreement. The choice is irrevocable for that agreement.
Employees of an employer who has not chosen to withhold tax on employment income received under a share purchase agreement continue to be treated as filing taxpayers and include such income in their individual tax return.
The timing and disclosure of amounts an employee receives as employment income is set out in section RD 6 and requires employers to disclose such amounts to Inland Revenue at the end of the pay period in which the employment income is treated as received by the employee.
Changes are also being made to section 46 of the Tax Administration Act 1994 for when an employer chooses not to withhold tax on benefits an employee receives from a share purchase scheme. It is proposed that the employer must disclose details of the amount of the benefit received along with other pertinent details relating to the employee. The definition of “employee” in section 46 is amended to include former employees who receive a benefit under section CE 2 to which section RD 7B does not apply.
Consequential changes are also made to the Accident Compensation Act 2001 and the KiwiSaver Act 2006.
Background
Benefits provided to an employee under a share purchase agreement are “employment income”.
Unlike most employment income or benefits (such as salary and wages or a use of a company car), such benefits are not currently subject to tax at source under either the PAYE or FBT rules. This means that employee recipients of a benefit under a share purchase agreement must currently file an individual tax return including the benefit as income and pay the tax on those benefits themselves.
For employees unused to filing returns and paying tax directly to Inland Revenue, the current collection mechanism may not be well understood and impose unnecessary compliance costs. These compliance costs can affect voluntary compliance and perceptions about the integrity of the tax system.
From Inland Revenue’s perspective, the current rules impose a number of administrative costs. If an individual employee does not return the income from an employee share scheme, the Commissioner has to expend resources to collect a potentially small amount of tax from an individual.
In April 2015, officials released an issues paper Simplifying the collection of tax on employee share schemes which discussed the problems with the current collection of tax on benefits received under an employee share scheme. The issues paper discussed changing the collection of tax on employment income received under a share purchase agreement using the PAYE system, the FBT rules or a separate withholding tax. Changing the method of tax collection would shift the tax compliance obligation to file and pay from employees to employers.
Submitters were broadly supportive of the idea of shifting the point of taxation to source, provided the employer could choose whether to withhold tax. The PAYE system was the generally preferred method of tax collection.
Submitters argued that an elective approach would allow employers to balance the cost of compliance they would incur relative to the benefits their employees would receive when making a decision whether or not to collect and pay tax on their employees’ behalf.
Submitters also generally recognised that any elective use of the rules would need to be accompanied by suitable disclosure requirement to allow Inland Revenue to know which employees had received a benefit under an employee share scheme.
Inland Revenue does not hold comprehensive information about employee entitlements under share purchase schemes. The issues paper Simplifying the collection of tax on employee share schemes noted that if collection of tax on employment income under a share purchase agreement was elective, Inland Revenue would need information about the names and tax file numbers of participating employees and the value of benefits received under the agreement. As set out in the Regulatory Impact Statement to this bill, Inland Revenue considered a number of ways this information could be collected and concluded that the employer monthly schedule (EMS) was the best option as the necessary information is provided in a timely and administratively efficient manner.
The proposed changes in this bill take into account submitters’ views.
The objective of changing the tax collection rules on employment income received under a share purchase agreement is to improve the efficiency of the tax system from the perspective of encouraging taxpayer compliance and improving the integrity of the tax system.
The change should also, where appropriate, reduce compliance costs on employees.
Further analysis of the reasons for the proposed changes to the collection of tax on employee share schemes may be found in the regulatory impact statement to this bill, published on Inland Revenue’s tax policy website, www.taxpolicy.govt.nz.
Detailed analysis
Shifting the tax collection point on employment income under a share purchase agreement to its source – the employer
If the employer so elects, benefits received from a share purchase agreement under section CE 2 of the Income Tax Act will be treated as an “extra pay” for the purposes of section RD 7 of the PAYE rules. Such benefits will consequently be treated as a “PAYE income payment” under section RD 3. This ensures that the obligation to pay tax is transferred from the employee to the employer under the PAYE rules. The applicable rate of tax on the benefit will be determined by section RD 10 and schedule 2. It also ensures, for the purposes of section 33A of the Tax Administration Act, the employee is treated as a non-filing taxpayer because the employer returns and pays tax on the employee’s behalf.
Employers have the choice under section RD 7B whether to withhold tax on the extra pay. The choice is exercised for a share purchase agreement. The choice, once made for that agreement as it applies to a class of employees, is irrevocable.
The timing for when disclosure is required (new section RD 6(1)(d)) is the pay period when the employee is treated as receiving the benefit under section CE 2 and should be provided in an employer monthly schedule for that pay period (sections RD 22 and RD 4 refer).
Consequences if employer does not withhold tax on employment income under a share purchase agreement
If the employer chooses not to withhold tax on employment income an employee receives under a share purchase agreement, the obligation to file and pay tax remains with the employee. The employer, however, will have an obligation under the Tax Administration Act to provide Inland Revenue with details about the employer and the amount of any benefits an employee (including a former employee) receives under a share purchase agreement.
Proposed amendments to section 46 of the Tax Administration Act define the term “emoluments” as including a benefit an employee receives under section CE 2 in situations when the employer does not make an election under new section RD 7B to withhold an amount of income tax. Section 46 is further amended by changing the definition of “employee” to include former employees who are party to a share purchase agreement to which section CE 2 applies.
Including the value of these benefits in the EMS does not automatically create an obligation to withhold tax because if the employer chooses not to withhold and pay tax, the benefits received by an employee under a share purchase agreement are not treated as “PAYE income payments”.
For the immediate future, disclosures made using the electronic EMS may generate reconciliation errors on the schedule. It is expected that such reconciliation errors would be eliminated in the future as part of the redesign of Inland Revenue technology platforms under Inland Revenue’s Business Transformation programme. Inland Revenue is preparing appropriate materials for employers to explain the changes and implications for completing electronic EMS.
Interaction with social policy programmes administered by Inland Revenue
The officials’ issues paper noted that changing the method of collecting tax on share purchase agreement benefits should not impact employees’ current entitlements or obligations for any of the social policy programmes by Inland Revenue. To this end, employment income received under a share purchase agreement will continue to count for the purposes of child support, student loans and entitlements to Working for Families tax credits. It is expected that the requirement for the employer to disclose this income via the EMS will improve the overall integrity of these programmes.
Also consistent with this objective, consequential changes are necessary to the Accident Compensation Act 2001 and the KiwiSaver Act 2006 to ensure that any amounts disclosed to Inland Revenue via the EMS as a result of the recommended proposal are not taken into account.
Changes are being made to the definition of “salary and wages” in section 4 of the KiwiSaver Act 2006 to exclude benefits an employee receives from a share purchase scheme under section CE 2 of the Income Tax Act.
A similar change is made to section 11(1) of the Accident Compensation Act 2001 to ensure that benefits under a share purchase agreement, proposed to be part of the PAYE rules, will not be counted for the purposes of assessing the ACC levy on employee earnings.