Upcoming Mallesons seminarsCompanies offering employee equity through option based schemes.
What do you need to do?Transfers to the share capital account related to employee equity schemes should be reviewed in light of the share capital tainting rules.
Darren McClafferty
Senior Associate
Andrew Clements
Partner
T +61 3 9643 4089
Phillip Davies
Partner
T +61 3 9643 4106
Companies may be required to recognise debits to their franking accounts, pay additional tax and be prohibited from making capital distributions following the recently released ATO ID 2009/87 on the share capital tainting rules.
ATO ID 2009/87 highlights that the accounting for deductions for employee options may result in the tainting of a company’s share capital account. Similar issues may arise in respect of employee share schemes.
The share capital account may be tainted even where the company has complied with the accounting standards in dealing with employee options.
This is because the ATO ID limits the application of the exclusion to the share capital tainting rules which applies to options generally, from also applying to the accounting for deductions for employee options.
As a result the accounting treatment applied to employee options may give rise to significant and unintended consequences.
Share Capital Tainting
The share capital tainting provisions, contained in Division 197 of the Income Tax Assessment Act 1997, are integrity provisions designed to prevent a company from distributing profits as part of a tax preferred capital distribution.
The current share capital tainting provisions were introduced with effect from 26 May 2006. Under these provisions a company taints its share capital account where it transfers any amount to its share capital account, unless that transfer is specifically excluded under the provisions.
There are a limited number of exclusions to the provisions, including exclusions for transfers of certain option premiums.
The consequences of a company tainting its share capital account are significant, and may include, inter alia, paying an amount of untainting tax.
ATO Fact Sheet
Significant concerns were raised in respect of the share capital tainting provisions at the time they were introduced.
As a result the ATO issued a Fact Sheet on share capital tainting on 12 September 2007 which provided some broad guidance on the operation of the rules.
At that time the ATO advised that private rulings should be sought on more specific concerns.
Option premiums
The Fact Sheet considered the application of the ‘option premium’ exclusion from the share capital tainting rules. That exclusion provides, broadly, that a transfer of an option premium from an “option premium reserve account” to a company’s “share capital account” does not give rise to a tainting (see s197-25).
The Fact Sheet did not consider whether amounts credited to an option premium reserve account to record the tax effecting of the options may be considered an option premium for the purpose of the exclusion.
A tax effecting credit to an option premium reserve account may arise where the deferred tax asset recognised for a period for an offer of options exceeds the income tax expense for that period.
The ATO ID confirms that the exclusion from the share capital tainting rules does not apply to an amount credited to an option premium reserve account to tax effect the relevant options. Rather, the ATO ID confirms that a transfer of this amount to a share capital account constitutes a tainting of the share capital account.
Additional concerns
The ATO ID highlights the technical and mechanical approach which is applied to the tainting provisions in areas which have not otherwise been addressed by the Fact Sheet.
One particular concern is that the Fact Sheet also does not address whether a transfer from a typical equity based payment reserve account to a share capital account may result in a tainting of the share capital account.
ATO ID 2009/76 released on 31 July 2009 indicates that amounts may be “reversed out” of a reserve account before the amount is transferred to share capital in these circumstances, without an adverse tainting consequence.
Some market participants have modified the ordinary approach to accounting for employee equity which they may have otherwise sought to apply in accordance with Accounting Standard AASB 2 “Share-based Payment” to take this issue into account.
It is important you consider these issues carefully in accounting for employee share and option schemes to ensure you do not bring about adverse unintended consequences in respect of your share capital account.
Legislative change
This area of the law is in need of legislative change so that companies may properly account for their employee equity arrangements without adverse tax consequences.
It is hoped that legislative change may be adopted to address these issues comprehensively.