Labor Senators' Dissenting Report
Chapter 1
Introduction
1.1 Labor members are extremely concerned about the
implications of the majority report recommendations for the integrity of the
Australian taxation system, and the impact on revenue. In particular, the
report appears to allow for ongoing tax avoidance and encourage increased
concessions leading to a lack of equity.
1.2 Labor members believe that large scale avoidance has
been allowed to continue for far too long, aided and abetted by the Coalition's
failure both when in Government and now in Opposition to support any measures
to better target eligibility for the employee share scheme (ESS) tax
concessions and reduce opportunities for tax avoidance.
1.3 The Government's proposed measures have a significant
impact on revenue—$135 million over the forward estimates period. These
measures while ensuring equity and integrity will also protect Commonwealth
revenues needed to secure long term economic prosperity in face of the global
recession.
1.4 The majority report has failed to recognise the
problems with the current laws and demonstrates the Coalition committee members'
continued willingness to turn a blind eye to tax avoidance and evasion,
excessive concessions to high income earners and the use of ESS by executives
as a device for tax minimisation rather than a means by which to align their
interest with shareholders.
1.5 Labor members recognise the value of employee share
ownership, not only to companies and employees but to the broader economy. We
strongly support employee share schemes and the role of the tax system in
encouraging employees to be involved in such schemes.
1.6 However, measures to support employee share
ownerships must balance both the benefits of employee share ownership and the
need to maintain the integrity and equity of the tax system.
1.7 Labor members support the Government's measures to
improve the integrity of employee share schemes.
Summary of proposed changes
1.8 The
Treasurer announced in the 2009 Budget that the Government will better target
eligibility for the employee share scheme tax concessions and reduce
opportunities for tax avoidance. The Budget savings measure was designed to
improve horizontal equity in the tax system by treating all forms of
remuneration more consistently, to target employee share scheme tax concessions
more closely to low and middle income earners, and to reduce the scope for
losses to the Commonwealth revenue through tax evasion and avoidance.
1.9 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’ and the
scheme satisfies the existing conditions for a qualifying employee share
scheme.
1.10 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.
1.11 Employees
accessing the tax deferral arrangements will be able to defer tax until there
is no longer a real risk of the employee losing the share or right and no
restriction preventing them from selling or exercising the share or right.
Eligibility for the deferral treatment will flow from the structure of the
scheme rather than from a choice made by an employee and the maximum time for
deferral of tax is reduced from ten years to seven years.
1.12
A
new annual reporting requirement will be introduced for employers.
1.13 To
improve the integrity of the tax system the refund rules will not apply to
protect taxpayers from commercial losses. The rules are designed to refund tax
in situations where executives have failed to meet performance hurdles or
minimum employment requirements, not to protect taxpayers from the market risks
of owning shares.
1.14 In
order to simplify the existing arrangements, the new rules will be rewritten
into the Income Tax Assessment Act 1997.
1.15 The
changes aim to improve the alignment of employee and employer interests. They
recognise the economic benefits derived from employee share scheme arrangements
via tax concessions for employees participating in employee share schemes.
1.16 Tax
support is provided on the grounds that aligning the interests of employees and
employers encourages positive working relationships, boosts productivity
through greater employee involvement in the business, reduces staff turnover
and encourages good corporate governance.
1.17 The
proposed new reporting requirements boost the integrity of the taxation of
share schemes, addressing concerns that the current employee share scheme rules
are not being complied with.
1.18 Overall
the changes will:
- improve
equity and fairness in the tax system by treating all forms of remuneration
more consistently;
- target
employee share scheme tax concessions more closely to low and middle income
earners; and
- Reduce the scope for losses to
tax revenue through tax evasion and tax avoidance.
- Have an estimated revenue impact of
$135m over forward estimates
Structure of the report
The
structure of the dissenting report is as follows:
Chapter 2—deals
with the nature of employee share schemes and addresses the need for reform
Chapter 3—provides
a rebuttal of some of the majority report recommendations and views
Chapter 4—provides
Labor Senators comments on other issues raised during the inquiry
Chapter 5—provides
a summary of the report
Chapter 2
Employee share schemes
2.1 Finance Sector Union (FSU) explained that there are
generally two types of employee share schemes. The first are 'genuine' schemes
that are available to all employees and have as their 'predominant purpose' to
align the interests of employees and the employer to increase productivity and
workplace harmony. The executive share schemes are available to executive, high
income employees and 'have as their real purpose the tax effective or tax free
provision of remuneration'. According to FSU, these schemes are 'described by
the ATO as ‘blatant, artificial and contrived'.[1]
2.2 The Finance Sector Union pointed out that there is
'an acute difference in the depth of employee share ownership' between
executive and general employees, with 'wide share holdings of minimal amounts
being held by non-executive employees' and 'far deeper share holdings being
held by executives'.[2]
2.3 Labor Senators fully support bona fide ESS
plans.
Why reform is necessary
2.4 The Government is committed to
employee share ownership but will not allow high paid executives to use them to
avoid paying tax. If there is one thing that everyone agrees on, it is that
these schemes have been exploited particularly by people on very high incomes. This
is costing the Australian taxpayer many tens of millions of dollars.
2.5 The committee heard evidence from the Treasury
of examples of the current rorting of employee share schemes:
2.6 In one case, a taxpayer had acquired options over
several years and deferred tax liability to a future time. However, when
exercising the options at two different occasions, the taxpayer did not include
any discounts nor paid tax on them. An audit was conducted and determined that
the taxpayer was liable for additional tax to the amount of $439,733. In
another case, a taxpayer had acquired options, some of which the taxpayer
exercised and sold the shares. The tax payer did not include any discount in
their tax return but incorrectly included a capital gain and applied the 50 per
cent capital gains tax discount. An audit determined that the taxpayer was
liable for $580,340 of additional tax.[3]
2.7 Given the global recession has ripped $210
billion from tax revenues, it is essential to ensure everyone is paying their
fair share of tax. The proposed changes protect the tax base and cut down on
potential avoidance and confusion by those using employee shares schemes at the
high end while also maintaining the current support for employee share
ownership schemes, particularly for low and middle income employees.
2.8 The Finance Sector Union submitted:
We note recent evidence from the ATO in Senate Estimates
regarding their audit of individuals earning over $1 million per annum which
found substantial compliance issues relating to their use of employee share
schemes. The examples cited regarding two individuals (one at CEO level) who
had unpaid tax liabilities of around half a million dollars each demonstrate
that aggressive tax planning in employee share schemes by executives and high
income earners has continued unabated despite the 2000 Inquiry.
That being the case, the question then goes to how the
Government of the day seeks to amend the legislation to ensure fair application
of tax rules, while ensuring the objectives of employee share ownership are
met.[4]
2.9 Labor members oppose the majority report
recommendation 2 to delay the introduction of the proposed changes. The
changes maintain all of the options available to low and middle income earners
- $1000 per annum upfront tax concession, deferral of tax on up to $5000 of
salary sacrificed into shares, and the deferral of tax on employer matched
shares that have minimum employment period restrictions.
2.10 At the same time the proposed changes
improve the equity and integrity of the taxation system and limit excessive
concessions by improving reporting for ALL schemes, removing access to $1000
upfront concession by high income earners, capping access to salary sacrifice
tax deferral and restricting access to general tax deferral only to equity
based pay that is subject to 'a real risk of forfeiture'.
2.11 Business, the tax profession and interest
groups have acknowledged that there is an important tax integrity issue to be
addressed with this measure.
2.12 The Employee Ownership Group has advocated for improved
employer reporting and compliance over a number of years.[5]
Mr Geoff Price, Computershare Ltd, explained:
A reporting obligation placed on employers offering division
13A plans was all that was really required to secure tax integrity. No further
changes, we believe, are really necessary.[6]
2.13 Mr John Fauvet, PriceWaterhouseCoopers, supported the
introduction of reporting requirements. This:
...by definition will reduce the opportunity for people either
to not report at all or to get it wrong'. I do not think there is any doubt
that there has been some lack of compliance, so the reporting condition will
fix the compliance. The other things will not fix the compliance because they
are all points of detail and points of interpretation, but reporting
requirements will give the ATO a lot, if not all, of the information they need.[7]
2.14 The Institute of Chartered Accountants submitted that:
Following the Budget announcement there was a measure of
dismay in the business sector and many existing Employee Share Schemes were
suspended. The Government then issued a public consultation paper which sought
to better understand the concerns of industry, and canvas a number of options
to improve the taxation of employee share schemes.[8]
2.15 Evidence was also provided to the committee
that business requires certainty. Mr Yasser El-Ansary, Institute of
Chartered Accountants, explained that for businesses 'the highest degree of
certainty on the way forward is absolutely essential at this point':
...in the interests of providing certainty and not continuing
to operate in a hiatus period where businesses cannot make informed decisions
and employees cannot fully understand their remuneration arrangements I think
it is important that everyone is focused on getting to a position where maximum
certainty can be provided for business.[9]
History of the need for reform
2.16 When Labor was last in Government the then
Liberal opposition blocked the Labor Government's attempts, following
recommendations from the Treasury, to combat significant tax avoidance through
employee share schemes with the Taxation Laws Amendment Bill (No. 4) 1994.
2.17 In 1995 Labor introduced Taxation Laws Amendment
Bill (No. 2) 1995, introducing the new Division 13A that remains in place
today. The opposition again opposed these amendments however the measure was
passed with the support of the Democrats and the Greens. In welcoming the
passage of Division 13A the then Treasurer said:
The Coalition’s opposition to the legislation in the
Senate today demonstrated that if elected to Government, they would take the
tax system back to where it was when they were last in Government - riddled
with opportunities for abuse by those on high incomes while those on low and
middle incomes would be required to pay higher taxes to make up the lost
revenue. Many of the existing schemes are no more than executive remuneration
packages designed to convert salary into shares or share rights in order to
take advantage of the open ended tax deferral opportunities available under the
existing legislation.[10]
2.18 For 12 years, the Liberal Government
continued to turn a blind eye to integrity issues raised by employee share schemes.
This was to the great detriment of commonwealth revenue as they failed to
protect the tax system from exploitation by high income earning executives
attempts to avoid tax.
2.19 For over a decade excessively generous tax
concessions have been allowed to subsidise the income of Australia's high paid
executives undermining the equality of the tax system and directing revenue
away from critical areas such as health, education and infrastructure.
2.20 The failure to address these issues has done
nothing to support genuine employee share ownership, demonstrating a fiscal
irresponsibility that while never acceptable, is completely untenable given the
current economic circumstances.
Chapter 3
Promotion of ESS as an alternative to superannuation
3.1 Labor
senators strongly oppose the committee's view to promote employee share schemes
as an alternative to superannuation and consider this suggestion highly
irresponsible.
3.2 Whilst
acknowledging that having an interest in your employer boosts productivity, encourages
better employment relations and reduces staff turnover, Labor senators believe employees
should ensure that they diversify their savings.
3.3 Excessive
investment by an employee in their employer puts the employee’s savings at
significant risk. Failure or underperformance of the employer would lead to
both a loss of employment and loss of investments/savings. For example, there
has been recent evidence of employees suffering large losses in the United
States from undiversified employer sponsored savings plans due to the Global
Financial Crisis. Employees do not need to hold significant interests in their
employer for their interests be aligned.
3.4 The
Government must balance these competing priorities whilst acting in a fiscally
responsible manner.
3.5 An
important part of retirement income policy is to ensure all members of the
community have an adequate level of income in retirement. Substantial taxation
concessions are provided for superannuation in order to encourage individuals
to save for their retirement. However, restrictions are placed on the early
withdrawal of superannuation savings to ensure they are used to provide for
genuine retirement income.
3.6 Superannuation
in Australia is subject to prudential regulation which seeks to protect the
retirement savings of Australians. Other investments are not subject to the
same restrictions and therefore do not receive the same level of concessions.
3.7 The
proposed changes make it no more or less appealing for the average low and
middle income employee to invest in the company they work for than the previous
arrangements that were in place.
3.8 Employee
share schemes while they provide employees with incentives to save (with the
restrictions on eligibility for continued tax deferral limited by a maximum of seven
years or end of employment) they are not a long term tax advantaged savings
vehicle—and superannuation will always remain the most effective vehicle for
long term retirement income savings.
3.9 However,
the changes do maintain the ability for the low and middle income earners to
invest in the company they work for; have a say as a shareholder and possibly
share in growth of the company and benefit through improvements in productivity
that they have work towards.
3.10 There
are also significant difficulties in comparing the tax treatment of employee
shares or options in different jurisdictions because of different tax bases and
different employee share plan structures and the differing rationale for their
provision.
3.11 The Coalition senators did not explore application
of this concept during the hearings, including the impact of employees retiring
with shares in thinly traded companies, or the management of their portfolios
especially where employees have worked for a significant number of companies
during their working life.
Establishment of a promotional unit
3.12 Labor members note that the previous Government—having
established an Employee Share Ownership Development Unit (ESODU) in the Department
of Employment and Workplace Relations following the release of the Shared
Endeavours report—disbanded it in mid-2005.
3.13 An ESS consultative group was by established in the Treasury
in 2005—but discontinued in early 2007 as it was considered more appropriate for the sector
to raise concerns for consideration in a broader context, through the already
available channels such as the ATO’s National Tax Liaison Group.
3.14 According to the Finance Sector Union, 'there is a
broad and bi-partisan acceptance that ESOPs can have a positive affect on the
employee—employer relationship':[11]
...taken in the whole with regard to remuneration models and
with other progressive management practices that are about genuinely engaging
with employees and giving them an opportunity to have a say in the
organisation, I think we see that there would be productivity benefits. The
other benefit that we have certainly witnessed is an employee engagement in
some of the governance related decision making. For instance, their ability to
participate at AGMs, their ability to have a look at board decisions and
strategies, has been a good outcome for them, and in our experience they have
used that mainly positively to raise issues of concern that affect them in the
workplace. But, as an overall productivity measure, it is a little more
difficult to immediately say yea or nay to.[12]
3.15 Mr Rod Masson, Finance Sector Union, continued:
If we were able to say that there is a direct correlation
between lifting productivity therefore profitability therefore employment, I
think I would be quicker to respond to you in the positive about that. It has
been our experience that, whilst these schemes have been in place, there are
still people being laid off and jobs being outsourced, and the pursuit of cost
cutting is still very much to the fore of management decision making. I am
unsure whether I could give you a definitive response on that...[13]
3.16 Government
tax support is intended to be provided in tandem with support from employers. It
is primarily the responsibility of business, not the tax system, to provide
appropriate incentives to employees to encourage productivity.
3.17 That
is, as a business derives considerable benefits from greater alignment of its
employees to the business’s interests, the firm should have sufficient
incentive to offer the employee share scheme arrangement even in the absence of
Government tax support. It would be inappropriate for taxpayers to fully
subsidise the provision of employee share schemes when business and individuals
derive substantial benefits from these arrangements.
3.18 Labor senators believe that individuals in similar
circumstances should receive similar tax treatment, and that all forms of
payment for employment should be taxed consistently. Therefore, the economic
value embodied in employee share scheme shares and rights is equivalent to any
other form of employee compensation and should generally be taxed in the same
manner.
3.19 A core tax principle underpinning the proposed changes to
the taxation of employee shares scheme arrangements is horizontal equity in the
tax system. Providing additional tax concessions brings with it significant tax
integrity risks. Employers may seek to access the concessions with the aim of
subsidising the provision of employee remuneration. This would provide little
or no benefit to the employees or the public more generally.
3.20 As the level of concessionality increases so do the incentives
for the tax avoidance. That is, many tax avoidance arrangements are not entered
into because the compliance costs outweigh the tax benefits. As the tax
benefits increase, the incentive to enter such arrangements increases.
3.21 There has been a long history in Australia of tax avoidance
with employee share schemes. As previously highlighted in 1995, the then Government
reformed the taxation of employee shares scheme to address significant tax
avoidance.
3.22 The recent reforms seek to again improve the fairness and
integrity of tax law in this area.
3.23 Labor Senators also reject the call for additional
research into employee share schemes. The University of Melbourne has been
conducting research in this area. The research is being conducted with funding
from the Australian Research Council ($323,000). The aim of the study is to
continue to inform policy debate.
Consultation
3.24 Following the Budget announcement, there was a measure of
dismay in the business sector and many existing employee share schemes were
suspended. The Government then issued a public consultation paper which sought
to better understand the concerns of industry, and canvas a number of options
to improve the taxation of employee share schemes.
3.25 Labor Senators note the longstanding practice of not
discussing Budget measure prior to their announcement but recognise the need to
minimise disruption. We commend the government for responding to feedback and
making appropriate changes to the legislation.
3.26 On 1 July 2009, the
Government issued a Policy Statement setting out the taxation of employee share
schemes. This statement contained changes to the Budget announcement which took
account of industry concerns expressed in consultation, while still addressing
the acknowledged problems of tax evasion and tax avoidance. Further consultation
was then undertaken on the draft legislation.
3.27 The Board of Taxation is
the appropriate body to consider how best to determine the market value of employee
share scheme benefits. The Board of Taxation will also consider whether
employees of start-up, research and development and speculative-type companies
should benefit from a tax deferral arrangement despite not being subject to a
real risk of forfeiture.
Chapter 4
Salary sacrifice
4.1 The proposed
legislation provides that:
...employees who qualify [for $1,000 tax exemption schemes] can
also salary sacrifice to purchase more shares through subscription plans that
also allow for the deferral of tax for a period of up to ten years, thus
increasing their shareholding.[14]
4.2 Employees will be able
to salary sacrifice up to $5000 per annum of their before tax income to
purchase shares where there is no real risk of forfeiture, provided those
shares, as a requirement of acquisition, have a minimum holding period of 3
years. Tax would be required to be paid when the restrictions of trade imposed
as a requirement of attaining those shares is lifted, upon cessation of
employment or after seven years—which ever occurs earliest.
4.3 This measure limits the
tax concessionality of deferral for salary sacrifice schemes to high income
earners and better targes the benefits to the low an middle income earners.
The $5000 limit adequately reflects the amount the low and middle income
earners are currently contributing.
Unions
agree that deferred taxation is reasonable where there is a genuine risk of
forfeiture regarding the shares in question or where there is a capped salary
sacrifice scheme offering no more than $5000 worth of shares. Again, this
would allow for our members to continue to participate in the purchase of
further shares, beyond the $1000 tax exempt employer ‘bonuses’ where they are
able to do so through salary sacrifice arrangements.[15]
4.4 Employees are free
choose to invest any amount of their after tax income in shares of the company
that they are employed by.
4.5 Many employers in
recognising the value to the company of employee share ownership offer share
matching arrangements. These schemes match shares purchased by the employee
with 'rights' to shares that become available after a defined period of
employment. These schemes are designed by employers to encourage employees to
invest in the company and align the long term productivity interests of
employees and employers.
4.6 Under the new
arrangements, with the 'right' to the matched shares being dependant on a
minimum period of employment the matched shares would qualify for tax deferral.
Further tax would not be due on these shares until any further restrictions
placed on them at acquisition came in to operation (if the minimum holding
period had expired or the employee ceased employment, or a maximum of seven years,
which ever is the earliest).
Cessation
4.7 Cessation of employment
has been a taxing point in the law since 1995. Consultation on these measures
was rightly focused on the changes proposed in the Budget and then in the
following consultation paper.
4.8 Where shares or rights
vest after an employee ceases employment with a company, it is open for the
company to offer a 'partial vesting' arrangement to enable employees to dispose
of a proportion of shares or rights to pay tax crystallised by a cessation of
employment event.
4.9 On the broader issue of
the use of equity-based payments for executives, the Government has asked the
Productivity Commission to examine this issue, in coordination with both the
Australian Prudential and Regulation Authority and the Australia's Future Tax
System review as part of a broader review of executive remuneration practices.
4.10 Labor
senators consider that the direction of the proposed employee share scheme
changes is consistent with the general international corporate and risk
governance trends of having portions of executive remuneration ‘at risk’, as
they provide a tax concession in the form of deferred tax in situations where
remuneration is subject to a real risk of forfeiture.
Risk of deferral
4.11 The introduction of a
risk of forfeiture test is intended to target schemes which contrive to defer
tax without complying with the intent of the law, and to provide for deferral
of tax only when there is a genuine performance incentive to the employee
through having their employee share scheme benefits at risk.
4.12 Where there is a real
risk that the benefits of shares or rights are never realised because the ESS
interests are forfeited, deferral of taxation is considered the appropriate
treatment. Providing for the deferral of tax in these situations recognises
that the employee may never have a chance to recognise the economic value of
the ESS interest, and that having employee remuneration ‘at risk’ in this
manner is entirely consistent with the purpose of concessionally taxing
employee share schemes, namely to align the interests of employees and
employers.
4.13 The Financial Stability
Forum (FSF) Principles of Sound Compensation Practices (which have been
endorsed by the G-20 Leaders and Finance Ministers) emphasise the importance of
aligning compensation incentives with risk. Labor members consider that the
direction of the proposed ESS tax changes is consistent with this general
principle, as they provide a tax concession in the form of deferred tax in
situations where remuneration is subject to a real risk of forfeiture.
4.14 The introduction of the
risk test is consistent with both the policy rationale for the concessional tax
treatment of employee share scheme arrangements and principles of sound
compensation practices which require performance based remuneration to be ‘at
risk’.
Chapter 5
Summary
5.1 Labor members believe
the Government has an obligation to protect Commonwealth revenue to ensure
the ongoing integrity of our tax system, and that our tax system applies fairly
and equitably to all Australians.
5.2 The Government’s changes
demonstrate a real and genuine commitment to employee share ownership, striking
the right balance by boosting integrity through reporting, better targeting
support through an income threshold applying to the upfront concession and
greatly improving corporate governance outcomes by requiring a scheme to
feature a real risk of forfeiture to gain access to the deferral tax
concession.
5.3 Labor members believe
the Coalition committee members, by failing to support the Government’s changes
are not only deliberately impairing the Commonwealth tax system but are also failing
in their duty to protect the integrity of legitimate schemes and support
genuine employee share ownership in Australia.
5.4 Labor
members of the committee believe that the current proposed changes are
workable, consistent with remuneration practices and that current reviews
underway will have limited impact on the core structure of these reforms.
Recommendation
1
5.5 The
Labor senators believe that the Senate should pass the bill.
Senator Annette Hurley
Deputy Chair |
Senator Louise Pratt |
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