Chapter 1 - Background
1.1 This consultation document expands on a proposal raised in an officials’ issues paper released for public feedback in May 2016.[1] It examines in closer detail a proposal for the taxation of employee share schemes (ESS) offered by start-up companies. The proposal would provide the ability to defer the taxation point for employees of start-up companies (with a corresponding deferral of the company’s deduction).
1.2 ESS are an important way of incentivising and remunerating employees in New Zealand and internationally. It is important that their treatment under New Zealand tax law does not advantage or disadvantage their use compared to other forms of remuneration. The thrust of the proposals in the May 2016 issues paper was to ensure that the taxation of ESS benefits is consistent with the taxation of cash remuneration. Officials released a further consultation document in September 2016[2] seeking submissions on the updated proposal. The policy recommendations resulting from this second round of consultation are contained in the recently introduced Taxation (Annual Rates for 2017–18, Investment and Employment Income, and Remedial Matters) Bill.
1.3 Chapter 6 of that issues paper discussed and sought submissions on the possibility of a deferral regime for start-up companies. This deferral regime would delay the point that the employee was required to pay tax on the benefit from ESS (with a corresponding deferral of the company’s deduction). The proposal was also discussed with stakeholders who were open to the possibility of an elective regime for start-up companies.
1.4 The purpose of this paper is to provide more detail on a possible deferral regime, and determine through consultation whether a fair deferral regime can be developed.
1.5 The approach taken in this paper is not intended to provide a tax concession. The “cost” of deferring the taxing point is that employees will, in effect, be taxable on any gains on the shares until the deferral taxing point occurs. Of course, where the shares decline in value, this will result in less tax for the employee.
Taxation of employee share scheme income as proposed in the Bill
1.6 The proposals in the Bill[3] were designed to ensure that employees will be taxable on shares received in connection with an ESS once the shares are earned by the employee, and they become the “economic owner” of the shares. Broadly speaking, an employee is the “economic owner” of the shares when all conditions and contingencies relating to their ownership or retention of the shares have fallen away, so that they hold them on substantially the same basis as non-employee shareholders. This is defined in the Bill as the “share scheme taxing date”. The amount of income is the value of the shares at the share scheme taxing date, less any amount the employee pays for the shares.
1.7 Conditions and contingencies can include:
- The possibility of loss of the shares if the person does not remain employed for a future period, or if the company’s performance does not meet certain benchmarks.
- Where the employer sells shares to the employee and provides a limited-recourse loan to finance the purchase price.
Proposals
Tax deferral schemes for start-up companies
1.8 This issues paper considers the feedback received on the May 2016 issues paper in relation to start-ups. It then uses those as a starting point for discussing revised proposals.
1.9 For unconditional share schemes, that is, where ordinary shares are provided to an employee with no conditions attached to them, the tax treatment will not change under the proposals in the Bill. These shares will give rise to employment income when the shares are acquired. In the case of employee share options, employees are generally taxed when the options are exercised.
1.10 The proposals in the Bill generally would have the effect of taxing ESS benefits at the same time or later than they are currently taxed. Nevertheless, some submitters commented that taxing share benefits is problematic where the employee cannot sell the shares at the taxing point. This is for two reasons. First, it might be difficult to find the cash to pay the tax. Second, valuation might be problematic. Both of these issues are likely to be at their most pressing for early stage or start-up companies. That is the basis for the deferral proposal for start-up companies in this issues paper, which is discussed in Chapters 2 to 8.
1.11 This paper seeks further submissions on details regarding the design of a deferral scheme. This includes a discussion on:
- the scope of the deferral measure;
- the nature and timing of the election;
- when the tax impost should arise under the deferral scheme;
- timing of deductions for the employer; and
- matters of administration and compliance.
Ensuring the R&D loss cash-out can apply to ESS benefits
1.12 In Chapter 9 we discuss the interaction of the ESS start-up proposals and the existing R&D loss cash-out regime and propose to ensure that ESS costs to the employer are appropriately dealt with under that regime.
1.13 Feedback on this issues paper will be used to help shape recommendations to Government for its consideration and inclusion in a future tax bill.
How to make a submission
1.14 Officials invite submissions on the suggested changes and points raised in this issues paper. Send submissions to [email protected] with “Taxation of employee share schemes: start-up companies” in the subject line.
1.15 Alternatively, submissions can be addressed to:
Taxation of employee share schemes: start-up companies
C/- Deputy Commissioner, Policy and Strategy
Inland Revenue Department
PO Box 2198
Wellington 6140
1.16 The closing date for submissions is 12 July 2017.
1.17 Submissions should include a brief summary of major points and recommendations. They should also indicate whether it would be acceptable for Inland Revenue and Treasury officials to contact those making the submission to discuss the points raised, if required.
1.18 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their release. The withholding of particular submissions, or parts thereof, on the grounds of privacy, or commercial sensitivity, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider that there is any part of it that should properly be withheld under the Act should clearly indicate this.
1 Taxation of employee share schemes: An officials’ issues paper, Inland Revenue (May 2016).
2 Tax treatment of employee share schemes – further consultation, Inland Revenue (September 2016).
3 Taxation (Annual Rates for 2017–18, Investment and Employment Income, and Remedial Matters) Bill.