New tax rules for employee share schemes

The passage this week of new employee share scheme (ESS) rules makes it a good time for companies with, and thinking of adopting, an ESS as part of their remuneration package to seek professional advice.

We provide a summary of the tax law changes.

Commencement

The changes were introduced via the Taxation (Annual Rates for 2017–18, Employment and Investment Income, and Remedial Matters) Bill and will come into force on Royal Assent (expected in the next few days).

Grandparenting provisions will apply to benefits arising from shares which were:

  • granted or acquired before 12 May 2016 (the release date of the IRD issues paper), or
  • granted within six months of the new Act, where the taxing point under the new rules would arise before 1 April 2022 – provided the shares were not granted to avoid the Act’s application.

Key changes

Shifting the taxing point
The new rules shift the taxing point:
  • from when the shares were acquired (the taxable benefit being the difference between the market value of the shares and the amount paid by the employee)
  • to when the employee holds the shares on the same terms as any other shareholder (generally this will be after all the conditions to vest have been satisfied). Some conditions will not shift the taxing point – e.g. the requirement that an employee sell the shares back to the company at market value if leaving their employment.

The rationale for changing the taxing point is to align remuneration under ESS with other forms of remuneration where employees are taxed at the time they actually earn the income.
Scope of rules
The new rules apply to share benefits awarded to past, present and future employees or shareholder-employees as provided in the new definition of ESS. There are also carve outs, such as arrangements that put shares acquired for market value at risk where the scheme provides no protection against a fall in the share price and none of the acquisition money was provided by the employer under the ESS agreement.

Employer deduction

The Act provides a new deduction rule for companies providing ESS benefits to employees, with the amount and timing of the deduction matching the amount and timing of the employee’s income. The new deduction brings remuneration under an ESS into line with the tax treatment of remuneration in cash.

Exempt schemes

Officials originally favoured repealing the concession for widely-offered exempt schemes but were persuaded against this by feedback received during the public consultation process. Instead, the Act introduces a simplified set of rules, increases the amount of exempt benefits that are able to be provided and allows more flexibility in terms of structuring the scheme.

Miscellaneous

Other miscellaneous matters in the Act include:

  • allowing the employer company to increase its available subscribed capital by the full market value of the shares (as opposed to the amount that is actually paid by the employee)
  • treating an ESS trust as a nominee of the company whose shares are being granted to the employee. This change removes the requirement for ESS trusts to file tax returns (accounting for trustee and beneficiary income) and extends the treasury stock regime to share acquisitions by an ESS trust, and
  • introducing a new anti-avoidance rule to counteract tax avoidance transactions with respect to ESS.

Changes to the Bill since introduction

The Select Committee rejected submissions opposing the policy to treat ESS in a similar manner to cash remuneration. However the Bill was clarified in a number of respects to refine how the new rules will operate or to make the legislation more workable. They include:

  • changing the “real risk” test to a “material risk” test in relation to determining the “share scheme taxing date” (for example, when there is no material risk that beneficial ownership in the shares will change)
  • clarifying that arrangements that are not connected to a person’s employment or service are not caught by the rules
  • renaming the term for widely-offered share purchase schemes to “exempt ESS”
  • clarifying that the deductibility of establishment and management costs in relation to an ESS (including exempt schemes) is determined under the general tests for whether an item is deductible
  • moving the date that deductions are denied under exempt ESS from the date the Act was introduced to the House to the date of enactment
  • clarifying that the period of restriction for exempt ESS is three years (unless the employee ends their employment)
  • changing the disclosure requirements for exempt ESS to a single annual disclosure for all employees, and
  • introducing examples into the Act.

Most of Chapman Tripp’s submissions were adopted.

Employer reporting reminder

From 1 April, employers will need to disclose the amount received by an employee under an ESS in the “other emoluments” section of the employer monthly schedule, unless the employer has elected to withhold PAYE on the benefit.

Thanks to Conor Tinker for writing this update.

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