Alert

Who does this affect?

Any companies or employees that offer or participate in employee share schemes, or are considering offering or participating in employee share schemes

What do you need to do?

Consider whether any of the issues raised are likely to impact you, and whether to make a submission to Government as part of the consultation process

Author
Kai-Chen Chang  
Solicitor

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Andrew Clements  
Partner
T +61 3 9643 4089

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Sydney
Michael Barker  
Andrew Gray  
Brian Murphy  
Richard Snowden  
Karen Rooke  

Melbourne
Andrew Clements  
Murray Kellock  
Alison Lansley  
Diana Nicholson  
 

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The Federal Government's announcement yesterday that it would fast track a consultation process on its proposed amendments to employee share schemes, as set out in the recent Federal Budget, is welcome news.

Mallesons issued an alert on the proposed changes on 14 May and has now prepared a submission to Treasury outlining our concerns. We believe it is important these matters are dealt with quickly, to provide the necessary certainty to companies and employees.

The key issues and anomalies that must be addressed, irrespective of the ultimate design of the amendments, include:

• ensuring appropriate transitional relief for existing shares and options. It is critical that shares or options acquired under offers or invitations made before the announcement of the proposed amendments in the Budget should be properly grandfathered.

• preventing the potential double taxation that arises for employees who are taxed upfront on their participation in employee share schemes and who subsequently forfeit their shares for any reason, and

• providing certainty regarding the treatment of shares or rights acquired in connection with a takeover or restructure that replace existing shares or rights acquired under an employee share scheme.

These issues are outlined in further detail below.

Policy concerns regarding the proposed amendments more generally

As has been reported extensively in the Australian business and popular press, the proposed amendments have been widely criticised by industry as well as employee groups. Generally, the view amongst most companies and employee representative groups appears to be that if the proposed amendments announced are enacted as they have been announced, they will have a significant adverse impact on employee share ownership in Australia.

We have a number of concerns, from a policy perspective, in relation to the proposed changes. These include:

• adverse impact on broad based schemes - the adverse impact that the proposed amendments will have on the desirability of implementing broad based employee share plans under which all employees of a particular company or group can participate

• increased complexity - the increased complexity regarding the tax treatment for employees of participating in the employee share schemes that is likely to result if the proposed amendments are implemented, and

• tax funding mismatches -the mismatch between the taxing point for employees and when participating employees actually receive the benefit of their participation in the relevant plan (in short, employees must fund any tax on benefits even though they have not yet received the actual benefits of their participation).

We believe that it should be possible to design and implement changes to the employee share scheme rules that not only achieve the Government’s goals, but which are consistent with the Government’s ongoing support of employee share ownership in Australia. We intend to make a more detailed submission in relation to these matters.

As a part of the fast track consultation process with respect to the proposed amendments, the Government announced that it would release a policy options paper within the next fortnight. The Government has indicated the policy options paper will canvass options that include:

• the reporting requirements which should be applied to address tax avoidance concerns, such as the application of withholding arrangements or enhanced Tax File Number (TFN) reporting

• the level of the income threshold for accessing the $1,000 tax exemption for upfront taxation, which would ensure the continued availability of employee share schemes for low and middle income employees

• whether there are circumstances under which it may be appropriate to provide for the deferral of taxation, the period of deferral and what those limited circumstances would be (such as when there is a real risk of forfeiture), and

• whether the tax law provisions which determine the market value of discounted and deferred shares or rights result in undervaluation.

Important transitional and design issues relating to the proposed amendments which should be considered by Government

It will be vital for these issues to be properly addressed by Government in re-assessing the proposed amendments to avoid any unintended or undesirable consequences from arising in relation to the proposed amendments for employees and companies offering employee share ownership.

Double taxation for employees who forfeit shares must be removed

The existing Australian tax rules provide that in certain situations, employees who forfeit their shares they receive in connection with employee share scheme will not be able to obtain a refund of tax paid in respect of their participation and may, in certain situations, realise an additional deemed capital gain on the forfeiture of their shares.

This gain can be based on the market value of the share when forfeited, even though the employee will receive nothing for the forfeiture of their shares.

This is an inappropriate outcome both from a legal and policy perspective as it effectively results in an employee being taxed, potentially twice, on the receipt of benefits that the employee does not keep or receive the benefit of.

Rules addressing these anomalies will be particularly important if any amendments restricting the availability of tax deferral are introduced. Previously, the ability to defer tax to a point that was likely to arise after forfeiture, if there was a risk of shares being forfeited, assisted in addressing the adverse tax consequences arising on the forfeiture of shares.

Application of proposed amendments should exclude offers or invitations made before announcement

The Government initially announced that the proposed amendments would apply to shares or rights acquired after the announcement of the proposed amendments, regardless of when the offer or invitation under which those shares or rights would be acquired was made.

This announcement resulted in a number of companies that had made offers or invitations prior to the announcement to consider withdrawing those offers due to the uncertainty regarding the tax treatment for the relevant employees.

The tax treatment for employees of participating in a particular employee share scheme can be an important factor in whether or not the employee wishes to participate in the employee share scheme.

Many employees may have accepted offers or invitation before the announcement of the proposed amendments, but not acquired the share or right until after the announcement. This creates a significant inequity as employees may be caught by the proposed amendments, but may not have wanted to participate had they been aware of the proposed amendments and the anticipated treatment of the shares or right under the proposed amendments.

It is not equitable for employees who receive offers or invitations prior to the announcement of the proposed amendments on the basis that a particular tax outcome would be obtained to be caught by the proposed amendments.

The proposed amendments should exclude shares or rights acquired pursuant to an offer or invitation made before the announcement of the proposed changes. This approach is consistent with the approach that has been taken in the past in enacting amendments to the employee share scheme rules, particularly where the amendments are likely to result in an adverse tax consequence for employees.

Application of proposed amendments to corporate transactions generally

The existing Australian tax rules provide rollover relief for employees of companies that are subject to takeovers or restructures under which shares or rights they hold under an employee share scheme are disposed of and they receive replacement shares or rights that reflect the new corporate structure.

These rules are important in ensuring that employees of companies undergoing such transactions are not disadvantaged, from a tax perspective, as a result of such transactions being undertaken.

It is important to provide certainty to companies undertaking such transactions. This can be achieved by clarifying that the proposed amendments will not apply to awards made after the announcement of the proposed changes where those awards qualify for the rollover relief.

If the proposed amendments did apply to such awards, this would effectively defeat the purpose of the rollover rules. This is because the proposed amendments would result in the employees experiencing a taxing point at the time of the transaction, notwithstanding that rollover relief is available.

While this may be an unintended result, it is important that certainty is provided to companies that may be undertaking takeovers or restructures so as not to adversely impact on those transactions.