Chapter 6
Comments on proposed changes
General comments
6.1
This section examines the comments regarding the Government's proposed
changes to the employee share scheme regulations.
6.2
The Institute of Chartered Accountants (ICA) noted, on the pre-budget position,
that 'as a starting point, that there were no major flaws in the policy
position or the legislation giving effect to the policy that warranted
significant changes, other than changes aimed at improving and enhancing the
reporting framework to address the integrity or the perceived integrity
concerns identified by the ATO'. Their tax counsel considered that these
changes could have been achieved through the reporting requirements without 'a
need to substantially or in any material way change the underlying tax laws'.
He further noted that the top priority is 'to provide certainty for both
employers and employees'.[1]
6.3
The ICA noted that the Government's revised policy is not perfect' and
that 'there are still some issues which require further changes' but that it
'is a significant improvement on the original [policy announcement]' and
'considered to deliver outcomes which will allow many Australian companies to
re-instate [employee share schemes] that they had previously suspended'. The
ICA submitted that whilst the revised position is a 'reasonable compromised
outcome for all key stakeholders', 'there are some residual issues where
further changes to the 1 July policy announcement could be made to further
improve the overall outcome for all stakeholder groups'.[2]
6.4
According to the Corporate Tax Association (CTA), the Government's
'unexpected changes announced in the May 2009 Budget created unprecedented
levels of concern among those companies and initially resulted in many plans
being suspended' before the release of the Government's policy statement which
'largely restores the position' that existed before the Budget announcement.
The CTA regards it as 'a positive signal' of the Government's 'continuing
support through the tax system of employee participation in broad based equity
plans'.[3]
6.5
However, most submissions and commentators have been more critical of
the proposed changes and anticipate a series of consequences, including:
- Suspension of employee share schemes in many companies until
there is more certainty about the legislation;
- Increase in the number of equity allocations and requests for
private binding rulings from the Australian Taxation Office;
- Decrease in voluntary and compulsory deferred share benefit
programmes; and
- Replacement of deferred share benefits programs with deferred
cash programmes.[4]
6.6
The following section outlines the main concerns expressed in the
evidence to this inquiry. These include: consultation; tax exemption; income
threshold; taxation point; real risk of forfeiture; and legislative and
compliance matters.
Consultation
6.7
A number of submitters commented on the lack of consultation prior to
the budget announcement regarding changes to the employee share schemes. Ms
Sarah Bernhardt, Tax Adviser to Rio Tinto, noted that considering that the
provisions had been in place for the past 14 to 15 years, she 'was quite
surprised that...something like that was announced without any discussion' and
that 'some discussion would have been a good idea'. She did acknowledge,
though, that the Government mended the situation quickly afterwards.[5]
Committee view
6.8
The committee notes the lack of consultation with the stakeholders in
the lead-up to the budget announcement regarding employee share schemes and the
dismantling of the previous advisory group in this area. It considers
stakeholder consultation very important, of which the public concerns regarding
the proposed changes to the employee share scheme tax legislation and the Government's
subsequent changes to the proposal are a testament.
6.9
However, noting the recent establishment of a new advisory body, to which
the committee referred in an earlier chapter, the committee supports the Government
in its endeavour to consult the stakeholders more formally. The committee urges
the Government to ensure that the members represent a broad range of
backgrounds to ensure that all angles are considered in its advice to the Government.
The committee in particular refers to the coming together of various sets of
laws and corporate governance, including human resource, in the administration
of employee share schemes.
Tax exemption and income threshold
$1000 tax exemption
6.10
The Government has proposed a $1,000 tax exemption or concession for
employee share scheme participants earning under $180,000. Many submitters
considered the $1,000 exemption too low and suggested increasing it (to
somewhere in the range of $1,500 to $5,000) to encourage employers to set up an
employee share scheme.[6]
They pointed out that with the exemption not having been indexed and marginal
tax rates having changed 'significantly' since 1997, the tax benefit to
employees was said to be no more than $315 or $395 today.[7] With median wages having
risen by over 40 per cent, the exemption is now equivalent to less than two per
cent of the median wage.[8]
6.11
As noted in Chapter 4, the Australian exemption limit is low in
international comparison. Ernst&Young pointed out that in the UK, an
employee can annually obtain £3,000
worth of shares tax free, and if he or she contributes to the cost of shares
through pre-salary sacrifice, the annual limit doubles to £6,000 (approximately
A$12,500). These limits do not include shares paid for by employees.[9]
6.12
The Howard Government rejected the indexation of the concession on the
grounds that this 'would be anomalous given that neither personal income tax
scales or the income free threshold are indexed'.[10]
6.13
Mr Hetherington noted that some of the taxation arrangements around the
employee share schemes do not adhere to the simplicity principle. Currently, an
employee can acquire $1,000 worth of shares tax free and either pay normal
capital gains tax on 50 per cent of the gain upon disposal or defer taxation
until a later time for up to 10 years, paying tax at regular marginal rates
(deferral plan). According to Mr Hetherington, 'This level of tax can be up to
double the amount of tax paid by someone holding the shares as ordinary
investment'.[11]
Income threshold
6.14
The Government's proposal for eligibility for the $1,000 exemption is an
annual income of up to $180,000. The concessions targeted the lower and middle
income earners. This proposal has generated comments regarding both the
exemption as well as the income threshold. The Treasury stated that the
introduction of the income threshold would 'save in the order of $5 million a
year'.[12]
6.15
The main concern among submitters and witnesses was that both employees
and employers would not be able to assess employees' eligibility to participate
in the scheme, particularly because many employees would have income from other
sources.[13]
Another concern related to situations where the majority of employees in a
company earn in excess of $180,000 and employers might be reluctant to provide
a tax exemption scheme because they would be 'unable to comply with the 75 per
cent requirement' and because it would be 'unfair to large sections of their
workforce'.[14]
Guerdon Associates noted:
This uncertainty will discourage employers from offering
employee share schemes and discourage many employees from participating in such
schemes, which will prevent the new provisions from achieving their stated
objective.[15]
6.16
The Financial Sector Union supported aligning the means test to the top
marginal tax rate because high income earners are more likely to be able to
meet the immediate taxation requirements.[16]
Committee view
6.17
The committee notes that while some submitters and witnesses have argued
for no cap on the income eligible for the $1,000 tax exemption, most believe
that the Government's increase of the threshold from $60,000 in the budget
measure to $180,000 is an improvement on the budget announcement. It notes the
concerns regarding additional monitoring requirements on employers but that
there were more primary concerns regarding the legislation.
Taxation point
6.18
There was confusion among the submitters and witnesses regarding the underlying
policy rationale for tax concessions. Various aspects of the tax treatment are
said to be inefficient and biased towards listed companies. There is also different
tax treatment of employee share owners compared with other investors and
different types of employee remuneration.[17]
6.19
For example, under Division 13A of the Income Tax Assessment Act (ITAA) deferred-scheme
shares are 'effectively subject to twice the level of tax on capital gains'
relative to those acquired by ordinary means. There were calls for similar
treatment for all capital gains, including in relation to the taxation of
unrealised capital gains on shares held for more than 10 years under the
deferred-tax scheme.[18]
A report noted calls for the value of shares to be taxed as capital gains similarly
to tax exempt scheme shares, instead of as income, explaining:
As there is no limit on the amount of shares that can be
obtained through the deferred tax liability concession, this differential treatment
arguably favours the plan that is less likely to facilitate individual
employees' owning more shares. The counter argument, however, is that these
changes would only increase the complexity of the relevant taxation provisions,
and potential complexity raises the prospect of some new form of tax avoidance.[19]
6.20
A number of submitters expressed concern that the five per cent limit in
relation to share ownership and casting votes in qualifying schemes would be problematic
to small businesses and in succession planning.[20]
In the coming years, a large number of small businesses will be closing when
baby boomers retire 'unless they can find buyers for their businesses'.
Employee share schemes could facilitate retirement through maintaining and
improving productivity and employment; preserving retirement equity; and
offering the possibility of full sale to employees.[21]
However, the current five per cent restriction prevents employer buyout. The
Employee Ownership Group proposed that the new employee share scheme rules
exclude 'employees purchasing a controlling interest in a company'.[22]
6.21
Discussion during the hearing noted the risk in concentrating shares in
one entity, such as the employer company, and noted the loss some US employees
suffered in the global financial crisis.[23]
Mr Paul Ellis, Member, Employee Ownership Group, noted that 'a large part of
that issue in the US was because the employer‑funded retirement plans
were investing in the company’s own shares. We do have safeguards within the
superannuation legislation here in Australia that will prevent that happening'.[24]
6.22
Another difficulty identified in the evidence relating to small
businesses is the requirement to offer schemes to three-quarters of permanent
employees that have been employed for at least 36 months. New companies may not
be able to satisfy this requirement. However, the Commissioner of Taxation has
the discretion to determine that the condition has been satisfied if the offer
has been made at least to 75 per cent of current employees in a new company.[25]
6.23
It was understood that the proposed legislation would allow employees to
participate in both the tax-exempt and tax deferred schemes.[26]
Taxing upfront
6.24
The Government's policy proposal to tax shares and rights upfront on
acquisition is aimed at ensuring compliance, particularly in relation to
taxpayers who move overseas after ceasing employment in a company whose shares
they possess.[27]
6.25
Most submissions and studies commented on the timing of taxation of
shares and options. There was little if any support for taxing at acquisition,
with most comments supporting taxation at the realisation of income. They
pointed out that taxation on acquisition is 'out of step with global standards'.
A study found that none of the 40 countries surveyed had a similar taxation
arrangement; rather, they taxed shares at realisation of benefits.[28]
In addition, the employee receiving the award should not be prohibited from
selling the awards. Submitters agreed that the vesting date should be 'the date
the employee physically receives the shares'.[29]
'As a fundamental principle, individuals should not be required to pay tax
before they have realised the cash gain'.[30]'
Refund
6.26
Upfront tax payment gives rise to a tax refund in cases where an
employee has paid tax on rights or options that have never vested. However, an employee
is not eligible for refund if he or she has chosen to forfeit the right or
option.[31]
This situation could arise when options are out of the money. It was argued
that while choosing to forfeit the options, the options 'do not become out of
the money' as a result of an employee's choice. Denying a refund is said to 'to
create a bias towards granting options or rights with lower exercise prices to
ensure that options or rights are never "out of the money"'.[32]
6.27
Mr Michael Willcock, General Manager, Treasury, explained that the
refund provisions are not in place to 'insulate a person from market risk'. The
Government considers that a taxpayer that enters into a share scheme
arrangement needs to consider the risk of market circumstances changing.[33]
Associate Professor Ann O'Connell also noted that there is a policy issue about
whether the Government wants to provide protection for employees in share
schemes which other investors do not get.[34]
6.28
Submitters pointed out, however, that many situations falling under
'choice' are in effect not a result of a real choice, including redundancy,
retrenchment, disablement or death.[35]
Retirement due to health concerns was not considered being 'motivated by
protecting the individual from market downfalls' and 'would appear to be
contrary to the policy of the reforms'. Further concern was raised regarding
the proposed policy making entitled to a refund 'an employee who is terminated
(even be it for gross misconduct)' but not an employee who resigns for health
reasons, even in the case of a terminal illness.[36]
Guerdon Associates proposed an exemption in cases where the employment is
terminated as a result of redundancy, retrenchment, disablement or death and
certain other reasons.[37]
Deferral of taxation
6.29
The Government's proposed changes introduce limited deferral for schemes
where there is a real risk of forfeiture. This means that the taxing point for
shares and rights will be a point at which the taxpayer has no longer a real
risk of losing the share [or right] and no restriction preventing the taxpayer
from disposing of them. Further taxing points include the maximum time for
deferral at seven years and the cessation of employment. Deferral is also
available in relation to salary sacrifice-based employee share schemes that
offer no more than $5,000 worth of shares, where there is no real risk of
forfeiture and the rules 'clearly distinguish these schemes from those eligible
for the upfront tax exemption'.[38]
6.30
Numerous submissions voiced their concern about the deferral provisions.
There is said to be no clear policy objective for most of the limited deferral
conditions.[39]
The Corporate Tax Association has 'a problem' with the deferral concept as it:
...implies there is some earlier benchmark time when the
benefit should properly be taxed and compared to which taxpayers are given
concessional treatment. That is quite the wrong way to look at things. The
grant time should in no way be regarded as the benchmark since imposing a tax
at that point would be to tax a 'benefit' to which the employee may never
become entitled.[40]
6.31
Evidence showed little if any support for taxing at acquisition, with
most comments supporting taxation at the realisation of income.[41]
According to Allens Arthur Robinson, this would make it correspond to Division
13A, allowing a deferral if there are either restrictions preventing the
disposal of the shares or forfeiture conditions until those rights are
exercised.[42]
The Australian Institute of Company Directors argued that this would no longer
apply under the proposed changes.[43]
6.32
Deloitte noted that once an option has vested but has a trading
restriction, the taxing point would arise at vesting due to there no longer
being a real risk of forfeiture and no restriction preventing the employee from
exercising or disposing of the right. However, if the options are then
exercised, 'the taxing point could be deferred until the sale restrictions are
lifted', meaning that:
...employees who choose to exercise their options immediately
would be taxed at a later point than employees who choose not to do so and the
taxable amount may be very different. This would create issues for employer
reporting as well as lack of equity between employees.[44]
6.33
A number of submitters expressed concern that taxing of shares on
vesting would create liquidity limitations and distortion to share prices due
to large numbers of company shares being liquidated on the same day as a result
of companies issuing shares to employees on the same day. The Investment and
Financial Services Association (IFSA) noted that 'This could lead to material
share price declines'.[45]
6.34
Employees choosing not to sell shares take a significant risk as the tax
liability is calculated on the vesting date whereas the shares could fall in
value post‑vesting. Selling of shares is often restricted to 'designated
share trading windows which occur 3 to 4 times a year', with selling outside
the windows 'prohibited due to concerns over insider trading activities'.[46]
Fairfax proposed that the taxing point be the earlier of two years from the
date of removal of the risk of forfeiture or seven years.[47] The Employee Ownership
Group considered 'that there should be an appropriate exemption from the
insider trading prohibition for the acquisition of securities under employee
share schemes'.[48]
The recommendation to provide an exemption for non‑discretionary employee
share schemes has been accepted by the Treasury.[49]
6.35
IFSA supported taxing 'where the share price exceeds the exercise price,
and there are no other restrictions preventing the employee from disposing of
or exercising the right'. Choosing not to exercise would cause a tax event, and
if the share price dropped below the exercise price, a refund would not be
available 'as it is related to a choice of the employee and a loss in the
market value of the securities'.[50]
6.36
Mr Yasser El-Ansary, Tax Counsel, Institute of Chartered Accountants,
noted that vesting rules may cause corporates to move away from offering
options to granting of either shares or other forms of remuneration.[51]
Cessation of employment
6.37
The Government has proposed that the cessation of employment be one of the
taxing points for deferred shares and rights. According to the CTA, the Government's
policy 'stems from the misguided belief by policy makers' that the timing rules
'are highly concessional and should therefore be withdrawn immediately the
employment relationship comes to an end'.[52]
6.38
Taxing at cessation of employment caused many comments.[53] Firstly, it was regarded
as being inconsistent with international practice.[54]
Secondly, it may tax benefits that may never realise and result in financial
hardship to taxpayers when they are not able to sell the shares to pay their
tax liability on vesting.[55]
6.39
Paying tax at cessation of employment for shares that never vest may
trigger double taxation unless the employee obtains a refund on the forfeited
shares. This is because at cessation of employment, the shares would return to
the trust for reallocation to future employees 'who would again need to pay
income tax on those share benefits'. On the other hand, if the employee could
obtain a refund because the vesting conditions were not achieved, 'the employee
would be receiving up to 46.5% of the value of shares that he or she should
have never been entitled to'.[56]
6.40
Several submissions considered that the proposed policy went against
good governance and best practice.[57]
It was also seen as inequitable, as while the leaving employee was taxed at
cessation of employment, the remaining employees would be taxed at the vesting
of shares or later.[58]
It was also deemed to be 'inconsistent with the concession provided in respect
of other equity that is subject to genuine forfeiture due to long-term
performance requirements during the term of employment'.[59]
6.41
Having a taxing point at cessation of employment was also said to
conflict 'with the commercial objectives of many schemes' and work against the
goal of aligning the long-term interests of employees and shareholders.[60]
6.42
A number of submitters called for guidance in relation to performance
hurdles, retention clauses, good and bad leaver clauses and sale restrictions.[61]
Good leaver clauses often allow an employee who otherwise would have to forfeit
their shares at cessation of employment to retain them in situations such as 'death,
incapacity, disability, illness, leaving to raise children, redundancy, and
bona fide retirement', which should be included in the legislation.[62]
The Taxation Institute of Australia noted:
It is unclear whether such provisions would lead to the conclusion
that there is no 'real risk' of forfeiture (ie because even if the employee
leaves they will receive some vested shares/rights). If this was so, there
would be no deferral for any such plans.[63]
6.43
A scheme might also provide for forfeiture for bad leavers but it is
unclear whether there is a conclusion that there is no real risk of forfeiture
as gross misconduct is an unlikely risk.[64]
6.44
Mr Geoff Price, National Manager, Computershare Ltd, explained that in
Australia today, employees are not provided any particular incentive to keep
their shares after vesting or changing employment. Because cessation of
employment is a taxing point, employees are 'effectively forced to sell unless
they can afford to
self-fund the tax liability'. He argued that the policy objective of assisting
people fund their retirement is possibly not currently met.[65]
Partial vesting
6.45
The Government's proposed 'partial vesting' requirement means that companies
should enable employees ceasing employment to sell part of their shares or rights
to fund their tax liabilities. Evidence to the inquiry did not support this
proposal. It was seen to become an issue regarding employment contracts with
performance-based conditions.[66]
Also, it would represent 'a reward that has no performance basis' and would
reward good and poor performers alike.[67]
6.46
Vesting of otherwise unvested benefits to pay tax is said to count
against the salary cap for termination payments without shareholder approval,
whereas any benefits vesting after termination of employment would not.[68]
The Australian Institute of Company Directors noted that 'If the commercial
circumstances of the company require ongoing vesting conditions or sale
restrictions, taxation arrangements should not work against this practice'.[69]
Employees leaving the country
6.47
One of the underlying issues for taxing at cessation of employment is
the Government's intention to ensure that employees who have shares but move
overseas after ending employment pay tax in Australia. This was not considered a
valid reason as the problem 'is not peculiar to share schemes'.[70]
The proposed employer reporting and withholding requirements were regarded as sufficient
to address this tax integrity concern.[71]
Salary sacrifice and other schemes
6.48
The Government's tax deferral also applies to salary sacrifice-based
employee share schemes limited to $5,000 worth of shares and where there is no real
risk of forfeiture.[72]
6.49
Many submissions noted that the cap of $5,000 is too low. This affects
executive and director level employees in particular as many companies allow or
require them to obtain shares through salary sacrifice arrangements.[73]
Out of the ASX200 companies, 36 per cent 'operate plans under which
[non-executive directors] NEDs may sacrifice fees to acquire shares'.[74]
For example, each Fairfax director is required to sacrifice 25 per cent of the
director's fee into the tax deferred plan.[75]
The submissions suggested the cap 'may force the abolition of these plans' when
they are 'strongly supported by shareholders and governance advisory groups and
should not be discouraged by the application of tax penalties'.[76]
6.50
The cap was also regarded as increasing administrative requirements for
employers in ensuring that employees understand the implications of the schemes
and do not contribute over the limit.[77]
It was also seen as preventing employees from choosing according to their
economic circumstances, companies from conserving cash flow and being more
competitive in attracting and retaining employees.[78]
6.51
The submissions suggested that the cap be 'removed or substantially
increased'. However, if a cap was required, the submissions suggested it be
'commensurate with the findings' of the Australian Prudential Regulation
Authority, the Productivity Commission and the Henry Review.[79]
6.52
Submitters supported removing the cap, observing that while 'subject to
some time-based restrictions':
...salary sacrifice arrangements would not typically be subject
to any substantive 'real risk of forfeiture' conditions as it would be
unreasonable to expect that employees who direct a portion of their earned
salary...would be exposed to a risk of losing those shares.[80]
6.53
In some schemes, such as where an employer provides free matching shares
for every share purchased by an employee, or performance or other bonuses are
taken in company shares, tax deferral is often achieved through a disposal
restriction or a forfeiture condition. Under the proposed rules, a disposal
restriction (no real risk of forfeiture) would no longer trigger tax deferral.[81]
The proposed rules were said to also contribute to reduced employee savings, and
increasing the number of executive share schemes, thus decreasing the level of
broad share ownership. This appears to be contrary to the Government's
intention of increasing broad-based schemes and is said to put Australia 'out
of alignment with the rest of the world'.[82]
The Employee Ownership Group proposed that deferral apply to matching schemes
similarly to salary sacrifice schemes, and could be restricted to fixed terms
of three, five and seven years.[83]
PriceWaterhouseCoopers argued that tax deferral should be based on disposal
restrictions alone and not be subject to forfeiture conditions.[84]
6.54
To be eligible for deferral in schemes with a real risk of forfeiture, the
risk would have to be on the employer co-contribution. It is still unclear
whether additional conditions need to be met for deferral on the $5,000 salary
sacrifice component or whether it is automatic because it is within the limit.[85]
Clarification was sought regarding situations where amounts have been
sacrificed by taxpayers prior to 1 July 2009 but the matching shares or
rights were not acquired under the scheme prior to that date.[86]
Real risk of forfeiture
6.55
The Government proposed that in order to be eligible for tax deferral,
the scheme has to meet certain conditions, including the real risk of
forfeiture test, which has already been mentioned above.
6.56
The test for real risk of forfeiture is 'whether a reasonable person
would conclude that there is a real risk that the share or right will not come
home to an employee'. Real risk includes situations where shares or rights are
subject to meaningful performance hurdles or minimum term of employment. Contrived
schemes, that is, schemes with forfeiture conditions that are highly unlikely
to arise, such as 'if the sun does not rise tomorrow'[87],
fraud or misconduct, will not qualify.[88]
6.57
Taxing time for shares and rights differs. For shares, the taxation
point is when there is no longer a real risk of the taxpayer losing the share
and no restriction preventing the taxpayer from disposing of the share. For
rights, the taxation point is when there is no longer a real risk of the
taxpayer losing the right and no restriction preventing the disposal or exercise
of the right. If, however, the underlying share is subject to forfeiture and
restriction, the taxation point is when the restrictions no longer apply to the
share. Other taxing points are the cessation of employment or seven years.[89]
6.58
The evidence to the inquiry did not support certain aspects of the real
risk of forfeiture. Regarding the reasonable person test, it was commented that
it is not objective as 'people are not going to be able to agree what a
reasonable person thinks is a real risk of forfeiture'.[90]
Further, submitters did not support the definition of real risks of forfeiture
as it considers fraud or gross misconduct as not being real risks because they
are unlikely to arise. However, IFSA pointed out that:
Such a forfeiture clause does provide a real incentive for
the employee to act in the best interests of the company and thus should be
viewed as a 'real' risk of forfeiture. However this example suggests the test
is not whether there is a real incentive, but whether the forfeiture is likely
to happen.[91]
6.59
Submissions regarded the different taxation time rules for rights and
shares as 'illogical and inconsistent' and creating a 'double jeopardy' because
of the rights having been subject to performance hurdles before they were
exercised to acquire the underlying shares.[92]
It appears that usually an employee would not be subject to further risk of
forfeiture once the rights have been exercised. Having a deferred taxing point
at the time the rights are vested may have employees dispose of the rights or
exercise the rights and immediately dispose of the shares in order to be able
to meet their tax liability, which, according to the Institute of Chartered
Accountants:
...is not considered to be an appropriate reflection of sound
corporate governance as it allows taxation policy outcomes to unduly influence
the behaviour of employees to take decisions that are not necessarily in the
longer-term best interests of themselves or their employer company.[93]'
6.60
The Australian Bankers' Association (ABA) and IFSA commented that
forfeiture restrictions that have a commercial basis 'should be sufficient to
allow for tax deferral to apply'.[94]
6.61
Submitters were unclear about the meaning of real risk of forfeiture.[95]
Mr Martin Morrow, Chairman, Employee Ownership Group, observed that there
is difficulty in defining the meaning of real risk of forfeiture because it may
take three to four years until there is clarity about the effectiveness of
clauses. The tax office will provide rulings but 'if they do not like what you
are doing then you have to appeal' and the process could take a number of
years. This leaves organisations with little certainty in the meanwhile.[96]
Start-up companies
6.62
A number of submitters stated that taxation at acquisition and the real
risk of forfeiture rules are problematic in start-up and similar companies. Taxing
employees 'at any time other than sale' is said to make Australia a much less
attractive location for potential overseas employees. This is because the shares
are not liquid and there is no market for them, which leaves the employees
paying taxes on value that they are not able to realise.[97]
Submissions supported the Government's referral of this matter to the Board of
Taxation to examine whether there should be separate arrangements for these
types of companies.[98]
Executive remuneration
6.63
Executive remuneration through shares and options is perhaps the most
well-known form of employee share schemes. Many ASX listed and unlisted
companies in Australia offer employee share schemes to their employees. For
example, Fairfax executives are allocated shares annually and the shares are
'subject to substantial vesting hurdles'.[99]
6.64
Submissions argued strongly that attracting and retaining overseas talent
to take the risk and move to Australia to manage start-up and innovative
R&D companies requires competitive remuneration. Often the remuneration is
provided through shares and options because 'unlike large corporations,
early-stage companies do not have the cash-flow'.[100]
However, taxing at acquisition is said to deter overseas talent from coming to
Australia. As noted above, immature companies have no market for their shares,
which makes it difficult to establish a share value. It was argued that having to
exercise and sell shares on acquisition to pay tax 'defeats the purpose of taking
on these risky opportunities in the first place'.[101]
6.65
Hay Group submitted that 'it is important that the tax regime should not
act in conflict with good reward strategy to achieve the desirable focus on
performance and risk management'.[102]
6.66
Executive remuneration is also affected by the taxing point at cessation
of employment. The Australian Institute of Company Directors argued that the
changes work against encouraging 'long-term executive incentive plans
continuing
post-employment'.[103]
Submissions noted the need to align the taxing point with APRA guidelines on
sound executive remuneration practices.[104]
This would also be consistent with practice in the US and other markets.[105]
6.67
According to the Treasury, the Government has aligned its policy
regarding equity-based remuneration with that of APRA, considering
performance-based remuneration to be '"at-risk" of forfeiture until
the individual's performance can be validated'. This is to provide incentives
for the executive to act in the best interests of the company and observe good
risk management practices. The goal will be achieved by deferring some or all
of the 'performance-based remuneration until the end of a deferral period'.[106]
The Productivity Commission is inquiring into executive remuneration.[107]
Global businesses
6.68
Evidence to the inquiry discussed the effect of the Government's
proposals on global companies in their administration of employee share schemes
across a number of countries.
6.69
Rio Tinto explained that it has employees in over 45 countries and has to
comply with different tax laws regarding employee share schemes. It noted the
benefits of having internationally compatible tax laws to reduce double
taxation and cash flow issues for employees.[108]
The proposed changes triggering taxation of shares and rights on vesting rather
than on exercise was deemed to 'put Australia out of step with most other
countries and is likely to cause significant practical issues for cross border
employees who will be taxed on those options at a different time in other countries'.[109]
Rio Tinto explained that the proposed legislation makes their share schemes
'much less attractive' and puts its Australian employees 'at a disadvantage
compared to their overseas colleagues'.[110]
Baker and McKenzie commented that none of the 40 countries they had reviewed
had similar taxation arrangement.[111]
6.70
IFSA suggested that the 'legislation should provide a specific tax
exemption for periods of non-residency' to avoid double taxation and to
simplify taxation for employees moving between countries.[112]
The 'number of individuals that would retain equity awards where the new
employment overseas is not within the same corporate group (thus triggering a
deferred taxing point on termination) is extremely limited'.[113]
International comparisons
6.71
Support for comparing Australian tax laws affecting employee share
schemes to other countries was mixed. The Treasury did not consider it 'wise to
make apples and oranges comparisons between different countries' arrangements'
because in addition to taxation legislation, there are other tax treatments and
corporate and industrial relations law that affect the employee share schemes.[114]
The Taxation Institute argued that it is inappropriate to adopt a taxation
methodology simply because another country or countries adopt such an approach
because they do not necessarily have internally consistent policies.[115]
6.72
However, many witnesses disagreed. Ms Sarah Bernhardt, Tax Adviser to
Rio Tinto Limited, argued that understanding the fundamentals of a plan and
what it is trying to achieve makes it 'pretty easy' to compare.[116]
Witnesses supported learning from other countries' experiences as there is no
need to reinvent the wheel.[117]
Mr Paul Ellis, Member of the Employee Ownership Group, stated that the context
of comparison between countries has to be taken into account but due to similar
underlying reasons for setting up share plans across the countries, he did not
consider the context being dissimilar from country to country.[118]
Legislation
6.73
Employee share scheme legislation has been identified as a major source
of confusion and challenge.[119]
Some of the concerns included compliance and legal complexity relating to
offering schemes, valuation rules, disclosure requirements and regulation and
information gathering process.[120]
6.74
A number of submissions called for a single piece of legislation 'to
bring under one act all laws governing all employee share plans'.[121]
This could reduce the cost of administering an employee share scheme which can
be high due to obtaining external advice for each employee's circumstances,
educating employees and the need to review plans and documents as a result of
the 'rapid and numerous changes in tax law'.[122]
6.75
A University of Melbourne study noted that a 'one-size-fits-all
approach' is inappropriate considering the diversity and flexibility of the
work practices ranging from small start-up companies to large listed companies
with transnational workforces.[123]
The rules appear to make it easy for larger listed public companies to provide
schemes but for smaller or unlisted organisations the provision of schemes
becomes costlier.[124]
In addition, the 'limited terms on which [employee share scheme] benefits may
be provided and the limited component of overall remuneration which they can
provide also reflect an outdated view of the appropriate taxation treatment of
labour income'.[125]
6.76
Finally, the Employee Ownership Group noted a number of anomalies that
would take place at the start of the application of the new rules on 1 July
2009, including option schemes where offers have already been made but not yet
accepted, or if accepted, they are subject to shareholder approval; and in
tax-exempt and deferred schemes where employees have elected to participate
under the existing legislation but acquire shares under the new rules.[126]
Lack of definitions
6.77
Many concerns related to the lack of definitions in the proposed
legislation, including what is an ordinary share or a right to acquire a share.[127]
There does not appear to be a reason why the employee share schemes are
restricted to ordinary shares when in other countries, non-voting shares can be
offered.[128]
Mr Martin Morrow, President, Employee Ownership Group, argued that 'if it looks
like an ordinary share, acts like an ordinary share and behaves like an
ordinary share, treat it like an ordinary share and put it in the employee
share scheme rules'.[129]
6.78
Dwyer Lawyers called for the removal of the '75%, 5% rules as well as
the
7-year rule in the case of small business'.[130]
They explained that currently, concessionally-taxed employee share schemes
cannot be used to facilitate employee buyouts, instead, non-concessional, share
transfer or ownership plans must be used:
In a small business buyout, there will rarely be twenty
buyers with 5% each and only a small percentage of employees may be buying.
Further, the requirement to dispose of shares after 7 years to pay the tax
defeats the purpose of an enduring buyout.[131]
6.79
Further, the provisions do not seem to give the same recognition to
different types of corporate form, only dealing with employee shares and not with
businesses operating through trusts or partnerships and the like.[132]
The Employee Ownership Group called for the new provisions to 'provide clarity
in respect of the tax treatment of the instruments of unlisted entities' in
order for an unlisted employer to be able to 'offer its employees interests
which entitle the holder to dividends and an entitlement to capital', similarly
to the listed company employees.[133]
6.80
In addition, submissions called for the concept of real risk to be clearly
defined; forfeiture and refund provisions relating to choices amended to avoid
unintended consequences; and employee reporting requirements reconsidered.[134]
Confirmation is required regarding the availability of rollover relief for
shares or rights provided under a takeover or restructure.[135]
6.81
Associate Professor O'Connell observed that 'there is a lot of detail
that has not really been addressed. It has just been lifted from the old laws
and had a bit added onto it'.[136]
6.82
A submitter called for materials explaining and defining the real risk
of forfeiture to be set out in the legislation to minimise opportunities for
ambiguity and uncertainty.[137]
Mr Marty Robinson, Manager, the Treasury, told the committee that 'the real
risk of forfeiture test will be in the legislation', not in the regulations.[138]
Capital gains tax
6.83
A study argued that 'ordinary Australian workers have little or no
incentive to participate' in employee share schemes because of the impediments
associated with the schemes.[139]
One of the impediments under the tax-deferred scheme is that 'the entire
capital gain is taxable at the employee's marginal income tax rate (rather than
50% of the gain being taxable, as with other investments over 12 months)'. This
taxation regime is said to have 'no obvious economic rationale'.[140] In
some situations upfront taxation is seen to be understandable. For example, in
the UK and US an option is taxed upfront if it was granted at a discount;
otherwise, there is generally no tax upfront, with capital gains tax applying
on disposal.[141]
6.84
Allens Arthur Robinson regarded tax deferral, with taxation at marginal
rates, as coming 'at the cost of the loss of the 50% capital gains tax concession
on any capital growth'.[142]
Deferral of tax on the discount was not regarded as 'a reason to deny capital
treatment to the share itself'.[143]
6.85
In addition, applying CGT rules to shares retained after employment was
considered to be a personal investment decision; and because the shares are 'no
longer related to the source of the shares', after vesting they should not be
differentiated from the tax treatment of other shares.[144]
Valuation
6.86
While some submitters were not clear 'what the primary concern is that
the government is seeking to address' and considered valuation rules as 'a
pretty good measure', others saw valuation rules as complex and in need for
modification, particularly in relation to unlisted companies.[145]
6.87
As noted earlier in the report, unlisted companies and start-ups have illiquid
shares and in effect no market on which to sell them. Currently, the law
determines the value of unlisted rights or shares on the basis of a combination
of a couple of financial models, which does 'not necessarily reflect properly
the assumptions that are underpinning most other valuation methods'. This was
said to result in the perceived undervaluing of the rights and shares.[146]
No discount has been embedded in the provision of unlisted options to the
employee, so where a discount is provided to the employee, 'they look like they
are valued much lower, that is not accounted for in this accounting system and
therefore they are paying very little tax on the options' provided to them.[147]
6.88
Australia's current valuation rules were deemed 'extremely complex' by
worldwide standards.[148]
The complex rules pose particular obstacles to Australian unlisted companies
regarding the determination of their share value and off-market share buybacks.[149]
Division 13A requires that each time a share is given to an employee, an
independent valuation of the shares must be undertaken, and because the shares
in unlisted and small and medium-sized enterprises are illiquid, determining a
value for them can be difficult and expensive.[150]
A number of submissions called for simplifying the valuation rules.[151]
6.89
In the absence of a liquid market for unlisted companies' shares, it was
considered necessary to establish a buyback or cancellation mechanism for
employees in these companies to realise or dispose of their interests.[152]
6.90
Ms Sandra Roussel, Manager, the Treasury, noted that the valuation of
options in non-listed and start-up companies has been referred to the Board of
Taxation.[153]
Employer reporting requirement
6.91
The current withholding and reporting obligations regarding employee
share schemes were regarded as being 'towards the lower end of compliance
obligations—producing a greater than average risk of non-compliance'.[154]
Mr Price, Computershare Ltd, noted that until now, the employee share scheme
legislation had not imposed reporting responsibility on employers, which he
considered 'unusual'.[155]
6.92
The proposed legislation introduced a new annual reporting requirement
for employers offering employee share schemes. Employers will be required to
estimate the market value of shares and rights at an employee's taxing point
instead of at grant. In addition, they are required to 'report the number of
shares and rights an employee has obtained at both grant and at the taxing
point'. The legislation also introduced limited withholding requirement to
apply to cases where an employee has refused to provide their TFN or ABN.[156]
The changes aim to make it easier for employers to administer the schemes as a
result of every employee in the scheme being subject to the same reporting
requirements.[157]
6.93
Most submitters and witnesses supported the tightening of the reporting
requirements.[158]
Mr Price explained that in his plan management company, there is already a
requirement for participants to provide their TFN to the company in order to
enable the payment of dividends without withholding tax. Mr Price believed this
will make compliance with the proposed reporting requirements 'relatively'
easy.[159]
6.94
However, some witnesses pointed out that there are still parts that need
to be improved. A submission suggested that reporting could be simplified by
reporting only at the taxing point rather than in both the year of grant and at
the taxing point. This would make it correspond to the reporting regime of other
forms of salary and wages.[160]
6.95
The ASIC requirement for both listed and unlisted companies to issue a
prospectus was considered problematic particularly in the small business sector
and seen in the current form as the 'single greatest obstacle in the way of
expanding employee ownership in the unlisted company sector' in Australia.[161]
A submitter proposed that an exemption from a prospectus or disclosure document
be awarded to companies if the share offer is to fewer than 100 employees in a
12-month period and the value of shares does not exceed $2 million. For
unlisted and private companies, a disclosure document should be required only
when the share offer is under $5 million.[162]
Other amendments
6.96
The Employee Ownership Group made a number of proposals to amend the
legislation.
6.97
Section 139DB allows a tax deduction to the employer after an employee
first acquires shares or rights under an employee share scheme. The Employee
Ownership Group noted that while it seems to be followed in practice, this
section has not been re-written into the proposed legislation. It suggested
that tax deduction be deferred if no such acquisition has occurred and that the
section be replicated in the proposed legislation.[163]
6.98
Under the current legislation, an employee participating in a scheme
where shares are held in trust could be taxed on the shares at market value if
the forfeiture was due to not achieving the performance hurdles. The Employee
Ownership Group proposed that the legislation clarify that the market value
substitution rule not apply in this case.[164]
6.99
The Employee Ownership Group noted that companies may need to cancel shares
in the employee share scheme, for example if they have been forfeited or where
the shares are surplus to the plan. However, difficulties arise from the
requirement for employee agreement to the cancellation. The Employee Ownership
Group proposed an amendment to section 258D of the Corporations Act to allow
cancellation of shares if forfeited, 'provided the cancellation does not
materially prejudice the company's ability to pay its creditors'.[165]
Compliance
6.100
The reasons behind the Government's introduction of new measures to the
taxation of employee share schemes relate to identified compliance problems.
Some taxpayers had:
- retrospectively attempted to elect to be taxed upfront on the
'discount' in order to gain access to the CGT discount for gains accruing since
acquisition;
- failed to include the discount in their assessable income at the
cessation time; and
- incorrectly applied the CGT rules to the 'discount' instead of
including it in their assessable income.
6.101
Associate Professor Ann O'Connell explained that complexity often leads
to non-compliance and that in a self-assessment regime this is 'bound to be an
issue'. She considered that the proposed reporting regime should address some
of the issues. Another way to address non-compliance could be to treat employee
share schemes like 'another type of fringe benefit so that the liability is on
the employer'.[166]
6.102
The Government has aligned its policy regarding equity-based
remuneration with that of APRA, considering performance-based remuneration to
be '"at-risk" of forfeiture until the individual's performance can be
validated'. This is to provide incentives for the executive to act in the best
interests of the company and observe good risk management practices. This will
be achieved by deferring some or all of the 'performance-based remuneration
until the end of a deferral period'.[167]
6.103
A number of submitters indicated that there is no need for specific
legislation to address tax avoidance as 'the Commissioner of Taxation already
has extensive powers to obtain the information required and to identify those
individuals who have a vested interest under an employee share scheme'.
According to the Taxation Institute of Australia, additional legislation would
only increase the 'complexity of the law without notable enhancement'.[168]
6.104
Hay Group noted that while there may be individuals who seek to avoid
tax payments, 'it is clear from years of contact with plan participants that
many are genuinely confused about their obligations'. Companies are restricted
in providing advice due to legal requirements to 'keep the advice general and
yet cover all possibilities', making 'the "simple" advice statements
very complex'. Hay Group supported the Government's changes regarding
compliance.[169]
Mr Hetherington suggested that the abuse of the scheme 'can be overcome by
placing a cap...on the total value of shares...that can be claimed annually under
the scheme'.[170]
6.105
Regarding the proposed requirement for employers to withhold tax in case
of an employee not providing their TFN or ABN, Baker and McKenzie noted that
current reporting withholding and reporting obligations are 'towards the lower
end of compliance obligations—producing a greater than average risk of
non-compliance' and welcomed the Government's proposal for a more comprehensive
regime.[171]
6.106
On the contrary, the Taxation Institute of Australia did not support the
proposal. It considered the requirements to place 'an unfair burden' on
taxpayers, potentially leaving them without a salary for a period of time. In
addition, employers might be unwilling to offer shares to employees who do not
provide a TFN.[172]
Mallesons Stephen Jaques considered that the withholding regime 'is likely to
discourage and prevent smaller companies from offering employee equity, due to
the compliance costs'. It observed that 'only the largest companies will have
sufficient resources to develop and operate a system that would be able to
ensure compliance' with the TFN obligations.[173]
6.107
The Australian Information Industry Association (AIIA) explained that
their members in the US and the UK 'can only sell their shares or exercise
their options through [the] organisation's globally nominated broker' that
withholds the tax at the rate determined by the Government and which the
employer is obliged to pay to the tax authority. It said 'There is no way for
an employee to override the withholding': organisations only issue shares or
options in the employee's name, not to a trust or super fund. Exercised rights
are reported as ordinary income against the TFN, 'which makes evasion virtually
impossible'.[174]
6.108
CTA supported the proposed reporting requirements and believed that
'that is the most important part of the package, and should account for most of
the projected revenue gains'. CTA also recommended that ATO redesign the
personal income tax return form 'to better assist taxpayers'.[175]
Current reviews
6.109
As noted earlier in the report, there are a number of reviews being
undertaken that relate to employee share schemes. A submitter proposed that the
Board of Taxation review of 'start-up, research and development and
speculative-type companies extend to the taxation of employee equity granted by
unlisted companies more generally'.[176]
6.110
Another submitter suggested that the executive remuneration arrangements
as part of employee share schemes be reviewed as a result of the global
financial crisis, with particular focus on 'whether the changes will exacerbate
this problem or create new inequalities'.[177]
6.111
Associate Professor Ann O'Connell pointed out that there are
inconsistencies regarding the different legislative provisions regulating
employee share schemes. She explained that corporate law considers shares in an
employee share scheme as an investment and insists on disclosure, bringing
costs and potentially discouraging employers from offering them. However, the
tax law considers shares as a non-cash benefit that 'needs to be taxed as soon
as possible'.[178]
6.112
Because of the employee share scheme rules interacting with other
legislative provisions, the following provisions are said to need amending to
implement the scheme rules:
- capital gains tax rules
-
temporary resident rules
- fringe benefits tax legislation
- rules governing employee termination payments, and
- State payroll tax legislation that was 'recently harmonised
across all the states to ensure it applied consistently with Division 13A'.[179]
Conclusion
6.113
The committee has heard concerns regarding the Government's proposals
affecting employee share schemes. While the submissions supported certain
aspects of the proposal, such as the introduction of reporting and withholding
requirements for employers, and considered the Government's proposal to be an
improvement on the original budget measure, there were still many concerns
about the rules.
6.114
Of the more general observations, the committee draws attention to four
of them. Firstly, the committee notes the lack of consultation in the lead-up
to the budget announcement. The committee is disappointed that the Government
chose to change policy without warning, without consultation and, according to
some witnesses, without any major reason. It hopes that the lesson has been
learnt about the importance of consultation—the effects of not consulting have
been loud and clear.
6.115
Secondly, there is a lack of data regarding the prevalence of employee
share schemes in Australia. The committee made a recommendation that this
situation be rectified (Recommendation 1).
6.116
Thirdly, submitters noted the need for this policy and legislation to be
consistent with the findings of the reviews underway addressing related
concerns, such as executive remuneration. In addition, as part of this inquiry,
the Government has initiated a Board of Taxation inquiry into start-up
companies and the valuation of unlisted and start-up company shares. The
committee strongly agrees with the need for consistency and has recommended
that the Government delay the introduction of employee share scheme legislation
to take notice of the findings of the other reviews (Recommendation 2).
6.117
And finally, submissions noted that Australia's employee share scheme
laws are inconsistent with the international practice. While the Australian
legislation mainly regulates companies and individuals in Australia, it also
needs to provide for those who work across countries and continents. The
committee urges the Government to ensure that our legislation does not trigger
double-taxation for either our own citizens and companies or international
employees.
6.118
The committee understands that employee share scheme policy and
legislation have a dual function: it is expected to motivate workers to
participate in the schemes and to provide incentives to companies to set up
employee share schemes to enable that. However, the committee is contemplating
what the Government's role should be in encouraging employee share ownership
through concessions. The Government has to balance between the interests of
those who benefit from the schemes and those who work outside of the private
sector and cannot obtain these benefits; and between scheme shareholders and
general investors.
6.119
The committee notes Associate Professor O'Connell's comments about the
various laws treating employee share scheme shares differently and considers
that this may be a sign of the Government not being clear about its position in
relation to the employee share schemes. The committee encourages the Government
to develop a coherent employee share scheme policy, building its views on
current and accurate data. This would include taking note of the current
reviews by the Productivity Commission, Board of Taxation and the Henry Review.
6.120
In relation to the data, during the inquiry, the committee heard about
the effect of employee share schemes on employees and employers. There appears
to be no information available on their effect on the economy as a whole,
although based on overseas information, schemes seem to generate national
benefits. Once the statistical data about prevalence of employee share schemes
in Australia is available, the committee sees significant benefits in the Government
conducting a study on the effect of employee share schemes on the Australian
economy. The committee looks forward to learning about the results in due
course.
Senator Alan Eggleston
Chair
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