Sherry amends employee share scheme

The federal government has backed down on its proposed crackdown on employee share schemes, tripling the income cap on the tax break to $180,000.

Assistant Treasurer Nick Sherry today announced amendments to the government's consultation paper on the scheme, which caused an uproar from businesses and workers when it was first released.

The government had proposed to cap income at $60,000 for eligibility for the scheme, however Senator Sherry today announced it will be increased from the current $150,000 to $180,000, to align it with the top marginal tax rate threshold.

Other changes to the scheme include providing further clarity on the "real risk of forfeiture", moving the deferred taxing level to a point where the taxpayer will not risk losing shares and allowing the deferral of tax in relation to up to $5,000 worth of shares.

The changes follows a consultation period with industry and business.

Senator Sherry told ABC radio the government expects to add $135 million to the budget going forward, down from the originally flagged $200 million.

"what we've ensured is a significant improvement in both integrity and fairness," he said.

"And, as a consequence of the world financial economic crisis, $135 million and improved integrity, better targeting and fairness is very, very important."

The Institute of Chartered Accountants has welcomed the amendments, adding it was pleased that a number of key recommendations it put forward were adopted.

"What has been announced by the government today is very close in substance to the existing tax rules, which is what businesses and tax experts have been calling for," the institute's tax counsel Yasser El-Ansary said.

"I am pleased that the government has taken on board the Institute's advice around implementing better reporting obligations for business."

Senator Nick Sherry's announcement is below:

The Assistant Treasurer, Senator Nick Sherry, today released a Policy Statement setting out the final taxation treatment of shares and rights acquired under employee share schemes, effective from today. The final policy provides further certainty to allow companies to continue to provide share schemes into the future.

"The Government strongly supports employee share schemes. We also support the role of the tax system in encouraging employees to be involved in share schemes - we made that clear in the Budget and we've been consistent in that support."

"As with all tax policies, however, the overall integrity of the tax system is a critical concern. The Government must balance its obligations to ensure ongoing system integrity and the need to be sure that our tax system applies fairly and equitably to all Australians."

"These are the motivations for the Government's reforms to the taxation of employee share schemes," said the Assistant Treasurer.

Under the arrangements outlined on Budget night, all discounts on shares and rights provided under an employee share scheme would be assessed in the income year in which the shares and rights are acquired.

The Government issued a public consultation paper on a new regime, which sought to balance industry concerns with the need to address the acknowledged problems of tax evasion and tax avoidance.

"As part of that consultation process, the Government has taken on board the concerns raised and examined the most efficient way of protecting the tax base and cutting down on potential avoidance and confusion at the higher end while maintaining the current support for employee share ownership schemes, particularly for low and middle income workers."

"The Government is announcing today that it has adopted the changes that were proposed in the consultation paper with several final modifications to address some of the concerns raised during the consultation," said the Assistant Treasurer.

Modifications from the position announced in the consultation paper are:

- increasing the income tax threshold for eligibility for the upfront tax concessions from $150,000 to $180,000, to align it with the top marginal tax rate threshold;

- providing further clarity on the meaning of "real risk of forfeiture" via the use of explanatory materials and Tax Office materials, including through the use of a range of example cameos to assist industry;

- Employees receiving benefits under these schemes will not be able to pay tax upfront and the scheme's governing rules must clearly distinguish these schemes from those eligible for the upfront tax exemption.

- moving the deferred taxing point from a point at which the taxpayer will no longer have a real risk of losing the share or right to a point at which:

- in the case of shares, there is both no longer a real risk of the taxpayer losing the share and no restriction (present at acquisition) preventing the taxpayer from disposing of the share; and

- in the case of rights to shares (options), there is both no longer a real risk of the taxpayer losing the right and no restriction (present at acquisition) preventing the taxpayer from either disposing or exercising of the right, however, if after exercising the right, the underlying share is subject to forfeiture and restrictions preventing the taxpayer from disposing of the underlying share, it is the point at which there is both no longer a real risk of the taxpayer losing the share and no restriction (present at acquisition) preventing the taxpayer from disposing of the share.

- allowing the deferral of tax in relation to up to $5,000 worth of shares under particular salary sacrifice based employee share schemes, where there is no real risk of forfeiture.

- removing the reporting requirement for employers to report the market value of employee share scheme benefits in the year of grant, if this is not the year in which the employee is taxed; and

- establishing a three part forward plan of consultation with industry by:

- asking the Board of Taxation to examine two remaining issues (a) how best to determine the market value of employee share scheme benefits; and, (b) whether shares and rights under an employee share scheme that are provided by start-up, research and development and speculative-type companies should be subject to a tax deferral arrangement, despite not being subject to a real risk of forfeiture;

- commit to an Exposure Draft process of the Bill to ensure the policy is accurately reflected in the application of the law, including consultation on a range of technical issues raised in submissions that will be contained in the Exposure Draft Bill; and

- supplementing this process by asking the Board of Taxation to consult with stakeholders ,in particular interested members of the previous Consultative Group, to examine technical matters associated with the implementation of these reforms, and to report to Government in time to allow the Board's views to be taken into account in the draft legislation.

"This final framework will boost integrity through reporting, better target support through the income threshold applying to the upfront concession,and greatly improve corporate governance outcomes by requiring most schemes to feature a real risk of forfeiture to gain access to the deferral tax concession."

"Salary sacrifice based schemes will also benefit through a targeted cap that will facilitate limited deferral for most members."

"I would like to thank industry and the various stakeholders for working with the Government during the last few weeks," said the Assistant Treasurer.

Under the final framework for employee share schemes, the taxation of discounts on shares and rights acquired under an employee share scheme will remain the starting principle of the regime, with concessional treatment available for particular schemes.

The upfront tax exemption will be means tested and tax deferral will only be accessible where there is a real risk that the shares or rights may be forfeited, such as due to performance hurdles or employment conditions. The pre-Budget use of cessation of employment as a taxing point will be retained and the maximum 10 year deferral period will be reduced to seven years.

A full reporting regime will also be introduced to significantly boost the integrity of the taxation of share schemes.

The combination of these final reforms and the measures out in the 5 June, 2009 consultation paper are set out in the attached Policy Statement.

As previously announced, the existing law will apply to all shares and rights acquired before 1 July 2009. The Government will introduce the legislation during the Spring Sittings of Parliament.

POLICY STATEMENT

FINAL FRAMEWORK FOR THE Taxation of employee share schemes

Key features of the final framework for the taxation of employee share schemes include the following.

- Tax on the discount for shares and rights acquired under an employee share scheme will be paid upfront except where there is a "real risk of forfeiture" or where it comes from a capped salary sacrifice based scheme, and the scheme satisfies the existing conditions for a qualifying employee share scheme.

- Explanatory materials and Tax Office materials are being developed to assist taxpayers with applying the principle of real risk of forfeiture to their particular facts and circumstances.

- Further examples to assist in the interim are contained below.

- A new annual reporting requirement will be introduced for employers offering employee share schemes.

- In the consultation paper, it was proposed that employers be required to report on the number of shares and rights provided at grant and the market value of those shares and rights both at grant and at the taxing point (if different). To minimise compliance costs, employers will only be required to provide the market value of shares and rights acquired under an employee share scheme at an employee's taxing point.

- Eligibility for the deferral treatment will flow from the structure of the scheme rather than from a choice made by an employee.

- The deferral arrangements applying to a capped salary sacrifice based schemes will be limited to $5,000 worth of shares.

- The maximum time for deferral of tax is reduced from ten years to seven years.

- The upfront tax exemption will be means tested. The $1,000 tax exemption will only be available to taxpayers with an adjusted taxable income of less of than $180,000.

- In order to simplify the existing arrangements, the new rules will be rewritten into the Income Tax Assessment Act 1997.

- The Board of Taxation will be asked to consider:

- how best to determine the market value of employee share scheme benefits; and

- whether employee share scheme shares and rights that are provided by start‑up, research and development and speculative-type companies should be subject to a tax deferral arrangement, despite not being subject to a real risk of forfeiture.

The Government will announce the terms of reference for the Board of Taxation reviews shortly.

The real risk of forfeiture test

- The "real risk of forfeiture" test, as foreshadowed in the consultation paper does not require employers to provide schemes in which their employee share scheme benefits are at grave risk of being lost.

- Rather, it is intended to target schemes which contrive to defer tax without complying with the intent of the proposed law, and to provide for deferral of tax when there is a real incentive to the employee through having their benefits at risk.

- This is consistent with the policy rationale for the concessional tax treatment of employee share scheme arrangements.

- The test of "real risk of forfeiture" is whether a reasonable person would conclude that there is a real risk that the share or right will not come home to an employee by a particular time and be forfeited. The consultation paper notes that:

- the risk must be a real risk - contrived schemes, where the risk is highly unlikely to arise, will not qualify (for example, 'your shares are forfeited if the company's value falls by 95 per cent during the next 12 months' and 'your shares are forfeited if you request they be forfeited').

- a real risk includes situations in which a share or right is subject to meaningful performance hurdles or the securities will be forfeited if a minimum term of employment is not completed. However, a condition that merely restricts an employee from disposing of a share or right for a specified time carries with it no real risk of forfeiture.

- Explanatory materials and Tax Office materials are being developed to assist taxpayers with applying the principle of real risk of forfeiture to their particular facts and circumstances.

- These will be developed in consultation with interested parties as part of a further round of consultation on the legislation.

- Whilst the presence of a real risk of forfeiture will serve as an access point to the deferred tax concession arrangements, the removal of such a real risk forms part of one of the three taxing points (in combination with the ability to trade in the shares over which the real risk has been removed).