The 2009 Budget announcement about the taxation of employee share schemes effectively kills the way in which options and shares are used as an integral part of employee remuneration, especially for senior executives.
These changes are profound and apply to options and shares acquired after 7.30 pm on 12 May 2009. Shares or options already held by employees will not be affected by these changes, even if the options have not yet been exercised or the vesting periods remain unexpired.
Any plans to grant options or shares that have not yet been fulfilled should be put on hold and the new measures considered before proceeding.
What are the announced changes?
The discount on all shares and options (qualifying and non-qualifying) acquired after 7.30 pm 12 May 2009 will be included in an employee's assessable income in the year in which the shares and options are acquired. This will be the case even where there is a vesting period or performance hurdles such that the shares or options are effectively unearned or whether the employee will ever hold the share.
Example
On 13 May 2009, ABC Ltd grants 1,000,000 shares to Bill subject to ABC Ltd achieving 15% annual EBIT growth over 3 years. If the growth target is met, the restriction on the shares will be lifted and Bill can deal freely with the shares.
The market value of an ABC Ltd share is $1 at the time of grant and Bill does not pay anything to acquire the shares. The discount of $1,000,000 is part of Bill's assessable income for the year ended 30 June 2009. If Bill's marginal tax rate is 46.5%, Bill must pay $465,000 in tax (including the Medicare Levy). This will be the case even though Bill's shares are contingent on performance targets, are not yet earned and cannot be disposed for 3 years.
This example shows that the tax bill has to be funded even though the share or option that gives rise to the tax debt cannot be sold to facilitate its payment.
Executive share plans were precipitated by a desire to align shareholders' long-term interests with those of a company's management. The Budget announcement curtails this practice and will result in Australia being isolated as one of the few OECD countries where equity participation is not used to align shareholders' interests with management.
This announcement also precedes the Productivity Commission's review of Australia's executive remuneration framework announced in March 2009 and led by Professor Alan Fels. The review's Terms of Reference included the taxation of remuneration benefits and it is disappointing that such a decision wasn't left to be considered by the Commission.
If you are considering issuing shares or options to employees that have a vesting period, the employee may be left with a significant tax liability they are unable to fund. Furthermore, the market conditions may deteriorate such that performance hurdles are never met or options are never exercised.
Action Now
As a matter of priority, employers should:
- stop the issue of any new shares or options before obtaining advice;
- review all existing employee share and option schemes; and
- look to restructure existing plans by introducing loan plans or cash bonuses or other alternatives.
If you require further assistance in this area, please contact a member of our
Taxation team. A key strength of the Hall & Wilcox Taxation team is the size, depth and breadth of expertise, with a number of our people considered leaders in their field. Our advisers have combined legal and accounting tax expertise, with wide-ranging experience in 'Big 4' chartered accounting firms, the State Revenue Office, the Australian Taxation Office and on the Board of Taxation of Australia.