Inland Revenue has issued an update on the proposed changes to the employee share scheme tax rules released in May this year. Click here to read our previous article.
The update revises the May proposals in light of submissions received and invites further comment by 30 September.
Timing of share scheme benefits – the taxing point
The update confirms the May proposal that a share scheme benefit be taxed when all “substantial conditions” relating to the shares have been released. The update paper indicates that the substantial conditions test would be satisfied when the employee holds the shares on the “same basis as a non-employee shareholder”.
The paper suggests that this will be when there are no put or call options or downside/upside protections relating to the shares subject to the scheme. Arrangements relating to the shares that would exist in the absence of an employment relationship, or which do not affect the employee’s right to economic ownership of the shares, would be ignored in applying this test.
If there is a possibility of a change in the relevant share rights, such as a reclassification of the shares, then the substantial conditions test would not be satisfied until there was no significant risk of that change occurring.
The update illustrates the above principles with examples.
Deductions for employer
The update confirms the May proposal for employers to have a deemed deduction for shares issued for the purposes of an employee share scheme. The proposal for that deduction to match the timing and amount of the benefit derived by the employee for tax purposes remains unchanged.
However, the update clarifies the relationship between this deemed deduction and other deductions that are available under current tax rules. Employers would be allowed a deemed deduction matching the employee’s taxable benefit, but would not be entitled to deduct:
- actual amounts paid to a share scheme trust to fund the purchase of shares on the market, and
- recharges paid by subsidiaries to parent companies who issue shares.
Where a bonus is paid to an employee that is used to purchase shares, the bonus would be deductible to the employer but that deduction would be adjusted up or down based on the total taxable benefit derived by the employee. The principle appears to be that the overall deduction after adjustments must equal the deduction that would be available had the employer issued shares to the employee rather than entering into the bonus arrangement.
The May proposals had suggested a special regime for start-up companies. The regime was intended to provide relief where a taxable benefit was derived by an employee if the underlying shares could not be sold to fund the tax liability due to lack of liquidity. Inland Revenue no longer sees a compelling case for this special regime, noting that liquidity issues can be managed by taking steps to defer the taxing point for the employee.
Tax exempt schemes (DC 12 schemes)
The proposal to repeal the special regime for tax exempt schemes has been abandoned in favour of modernising the existing regime. The changes to the regime that are floated include (among others):
- The shares allocated to employees cannot exceed $5,000 per annum, but any discount to market value offered to employees cannot exceed $2,000. If the employee pays nothing, then they could not practically receive more than $2,000 worth of shares under this proposal. The current limit is that the employee cannot spend more than $2,340 on shares over a three year period and that limit does not apply to amounts spent by the employer. There is no current restriction around the amount of discount to market value offered to employees.
- If employees are required to contribute, the employer must offer an interest-free loan over the three year restrictive period, with greater flexibility over repayment terms signalled.
- Schemes applying the regime would register with Inland Revenue, rather than present requirement to obtain the approval of the Commissioner of Inland Revenue.
In addition, employers would not be allowed a deduction for the cost of shares committed to the scheme, and the existing 10% notional interest deduction would be removed.
The May proposals included a complex transitional rule for existing share schemes. Where a benefit was derived under existing rules before enactment of the new proposals, existing rules would continue to apply provided that the taxing point for that benefit applying the new rules occurred within a three or four year period after enactment (the exact period being determined by the enactment date).
In response to submissions that the transitional rules were too restrictive, the updated transitional rules would allow the existing rules to be applied in two situations:
- Where the scheme existed on 12 May 2016 and the benefit (applying current rules) was derived no later than 6 months after the enactment date for the new rules.
- Where the benefit (applying current rules) was derived no later than six months after the enactment date for the new rules, and the taxing point for that benefit applying the new rules is before 1 April 2022.
For this, relief to apply the benefits must have been made in the ordinary course and without a purpose of avoiding the application of the new rules.
Inland Revenue has called for submissions on the revised proposals by 30 September.
This will most likely be the last opportunity to comment on the proposals before they are released as draft legislation.
Please contact your usual Bell Gully advisor if you have any queries relating to the updated proposals.
This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.