Chapter 7 - Concession for widely offered share purchase schemes
7.1 The Income Tax Act 2007 currently provides a concessionary regime to encourage employers to offer shares to employees under certain widely-offered employee share schemes.
Tax benefits provided by the concessionary regime
7.2 There are two main benefits available under the concessionary regime:
- Exemption for employee: The value of a benefit received by an employee under a concessionary scheme is not taxable to the employee.
- Deemed interest deduction for employer: The employer company 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.
7.3 Another benefit under the concessionary regime is that interest-free loans made under a qualifying employee share scheme are automatically exempt from fringe benefit tax (FBT).
Requirements of the concessionary regime
7.4 The main requirements of the concessionary regime are:
- 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; and
- a trustee must hold the shares on trust for the employee for a period of restriction (generally at least three years).
7.5 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 percent or more of the issued capital of the company.
Period of restriction
7.6 The period of restriction is the period that employees are prohibited from charging or disposing of their rights or interests in the shares. There are a number of different time periods specified in the concessionary regime provisions.
After period of restriction
7.7 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). These options incentivise the employee to hold onto the shares and not sell them back to the trustee, because the maximum amount they can obtain from selling them back is the amount they paid for them. If they hold onto the shares, they continue to have a shared interest in the success of the company.
Issues with current law
7.8 There are various issues with the current concessionary regime:
- the concessionary nature of the regime appears to undermine fairness, tax neutrality and economic efficiency;
- the reasons for introduction of the regime may no longer be valid;
- the regime is complex and inflexible;
- the tax benefits of the regime are uncertain and poorly targeted;
- the regime does not limit the amount of tax-free benefit that can be conferred;
- there are some 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.
The reasons for introducing the regime may no longer be valid
7.9 The current concessionary regime was introduced in 1973. It was enacted in the context of a heavily-regulated labour market which meant there was limited ability to directly relate an employee’s salary to the performance of the employer. There was also a high level of industrial unrest at the time of enactment. The purpose of the concessionary regime was to encourage companies to give employees a stake in their industry by issuing shares to them. The Government wanted to encourage a greater identity of interest between the employer and the employee. As noted in the discussion of tax incentives, these benefits are probably captured by the parties themselves and so do not provide a convincing rationale for an incentive.
The regime is complex and inflexible
7.10 The complexity in the regime comes from the various requirements that need to be satisfied in order for an employee share scheme to qualify for concessionary treatment. Specifically, there are various thresholds and timing requirements that must be satisfied (see above). Further, because the regime has various thresholds, and because it needs to apply to all employees equally, the schemes tend to be inflexible. For example, the concessionary regime cannot factor in the remuneration or time worked in determining the number of shares allocated to an employee. Further, when a loan is provided, the repayment instalment periods cannot exceed one month. Likewise, the period of the restriction on the shares is specified in the legislation so it may not reflect an individual employment situation.
The tax benefits provided by the regime are arbitrary
7.11 The deemed 10 percent interest deduction seems anomalous. Why should a company offering interest-free loans under an approved scheme be entitled to a deduction equal to 10 percent of the loans each year? Clearly this is an incentive, but the amount and basis for this particular incentive are not obvious.
7.12 The FBT-exempt status of the loans will also often be of little 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 benefit of the concessionary regime is that the interest-free loan can be FBT-exempt regardless of the company’s dividend paying policy.
No limit on tax-free benefit
7.13 As noted above, there is an upper limit on the amount of consideration that an employee can pay for the shares in a three year period. However, there is no explicit minimum amount of consideration an employee must pay to be entitled to the shares, nor is there any limit on the value of the shares that may be provided. In the case of a company with a large number of employees, or with employees on quite different remuneration levels, there is a natural limit on the value of the shares that can be provided under a concessionary scheme. However, in the case of a company with a smaller number of broadly equal employees, there may be an opportunity to take advantage of the concessionary nature of the regime. In other words, it may allow very large amounts of employment income to be received tax-free.
Options for reform
7.14 There are three broad options:
- Repeal the current concessionary regime and retain only the non-concessionary provisions in subpart CE and section CX 35: This option is consistent with the overall framework set out in Chapter 2.
- Retain the current concessionary regime: This option is inconsistent with the overall tax framework set out above. It also results in the continuation of the current technical issues, but these could obviously be addressed by remedial amendments to the Income Tax Act 2007. Furthermore, there are various specific aspects of the regime (such as the amount of the notional interest deduction) that may have been appropriate when the scheme was first introduced, that now seem inappropriate. As a result, there would need to be good reasons for retaining the current concessionary regime. If it were retained under the proposal set out in Chapter 3, no deductions for the costs of providing the shares should be allowed for the employer (because no income is included for the employee).
- Modernise the current regime: This option is inconsistent with the overall tax framework set out above. Amendments could include:
- the current limit on the amounts employees can pay for their shares could be significantly increased;
- a minimum level of contribution could be required;
- schemes could be allowed to be somewhat more flexible in terms of discriminating between full-time and part-time employees, without losing the requirement for schemes to offer benefits which are practically accessible by all employees;
- an upper limit could be placed on the exempt benefit to employees;
- the deemed interest deduction could be removed; and
- ;the legislation could clearly state whether a loan facility for the full cost of the shares is mandatory.
We are interested to hear from readers:
- whether there are good reasons for retaining the current concessionary regime or replacing it with another concessionary regime; and
- if so, whether there are any particular features of the current concessionary regime that should be retained or removed.