The Government has introduced draft legislation to overhaul the taxation of employee share schemes. The draft legislation:
introduces a new taxing point for share scheme benefits,
rationalises the deduction rules for share schemes and
amends the existing rules for tax exempt share schemes.
This development follows the Government’s
May 2016 and
September 2016 discussion documents on share scheme taxation. The draft legislation complements the extension of PAYE rules to share scheme benefits that has already been enacted.
The “share scheme taxing date”
The main focus of the reforms is the timing (i.e. the taxing point) for deriving employee share scheme benefits. This has always been an area of uncertainty in relation to share schemes. The new rules propose a concept of the “share scheme taxing date”. Broadly, the share scheme taxing date will be (according to the proposed legislation) the first date on which:
there is “no real risk” that beneficial ownership of the shares provided pursuant to the scheme (including by means of a trust arrangement) will change or the shares will be required to be transferred or cancelled;
the employee will not be compensated for a fall in the value of the shares; and
there is no real risk that there will be a change in the terms of the shares affecting their value.
The Inland Revenue Department provides a series of examples in its Commentary on the draft legislation, to illustrate the meaning of these rules. The examples can be found at pages 94 through 98 of the Commentary, a copy of which can be located here.
In our view the proposed definition of “share scheme taxing date” is vague and will lead to uncertainty. The definition cannot be readily understood without recourse to the Inland Revenue Department’s examples. While those examples are helpful, this continues a recent trend of tax legislation which is vague and open to misinterpretation. The result is that undue reliance needs to be placed on non-legislative guidance such as the Inland Revenue Department’s examples.
To illustrate the effect of the change, take as an example a scheme under which an employee forfeits shares held on trust for the employee if he or she leaves employment within three years. Under current law, the employee would be taxed on the value of the shares at the commencement of the arrangement and any growth in value over the three year period would be tax free. Under the new rules, the employee would be taxed at the end of the three year period on the value of the shares at that later date. Any growth in value would therefore be brought to tax.
Calculating taxable value
New rules will regulate the calculation of the taxable value of the benefit under an employee share scheme. The taxable value will continue to be the difference between the market value of the benefit provided to the employee on the taxing point and the value of any consideration paid by the employee for the shares (such as the exercise price for an option or a part payment for a share). This approach is not materially different from current law but the new rules provide useful clarification.
The reforms will give deductions to employers in respect of shares issued under employee share schemes. The deductions will match the timing and amount of the income derived by employees under the schemes. Deductions will also be allowed for costs incurred in the administration or management of the scheme (such as legal or accounting fees) and amounts equal to employees’ taxable income derived other than as employee share scheme benefits (for example, the amount of bonuses paid as part of the schemes). No other deductions will be permitted in relation to share scheme expenditure, such as for amounts paid to share scheme trusts to purchase shares or for recharges paid to offshore parent companies for the issue of shares.
New rules regulating apportionment of income from share schemes where employees spend time in New Zealand and overseas: There has always been uncertainty as to the calculation of benefits in these circumstances. Under the proposed rules the value of benefits which accrue while employees are neither New Zealand residents nor deriving New Zealand-sourced income (such as salary or wages paid by a New Zealand employer) will be excluded from tax.
Rollover relief on entry into new scheme: Provisions will be introduced confirming that no taxable benefit will arise on the rollover of share scheme participations into new schemes. This can be an issue where an employer cancels an existing share scheme but provides an equivalent benefit under a new or different scheme.
Penalties for non-disclosure of share scheme benefits: Penalties will apply where employers do not comply with the requirement applying from 1 April 2017 (i.e. under existing law) for disclosure of share scheme benefits provided to employees in their employer monthly schedule. This disclosure requirement applies regardless of whether those benefits are taxed in accordance with the PAYE rules or under ordinary rules.
Changes to exempt share schemes
The draft legislation contains changes to the existing regime for tax exempt schemes. Those changes (broadly):
amend the eligibility criteria that tax exempt schemes have to comply with (see below for further detail),
remove the 10% notional interest deduction currently allowed to employers which provide interest-free loans under tax exempt schemes, and
limit deductions for costs incurred by employers in relation to such schemes.
particular significance are the changes to the eligibility criteria, which include:
replacing the requirement that the employee pay no more than $2,340 over a three year period;
introducing new requirements that employees have a maximum share award value of $5,000 per annum, with a maximum discount of $2,000 per annum;
increasing the minimum loan amount cap (if the scheme specifies a minimum loan amount) from NZ$624 to NZ$1,000 per annum; and
allowing the employee to access the shares within the three year restrictive period if they paid full market value for them or if they have repaid any loan made to them in full.
In addition, the changes would mean that a tax exempt scheme would not need to utilise a trust. The concept proposed appears to be that an employee could hold the shares personally subject to a three year restriction on disposal. However, in practice we expect that trust structures may continue to be popular because of the relative ease of enforcing the three year restrictive period where a trust is used.
further significant change is that there will be no requirement for the scheme to be Inland Revenue approved. There will however be a requirement to provide notifications to the Inland Revenue in relation to the scheme.
It is intended that existing tax exempt schemes will continue to qualify for exempt treatment. Companies with those schemes may be able to offer awards that reflect the revised criteria, subject to the terms of the scheme documents.
Date for reforms
The proposed application date of the new rules will be driven off the timing of share scheme benefits provided under the existing tax rules. If the existing rules do not trigger the taxation of an employee’s participation in a share scheme within six months of the enactment of the new rules, then the new rules will apply and the taxing point of a benefit under the new rules will be determined by the new rules. There will be crediting provisions to ensure no double taxation of benefits under both new and old rules.
The new rules for tax exempt share schemes will apply from the date of enactment, except for the deduction changes which will apply from the date the bill was introduced.
For further information, please contact the authors or your usual Bell Gully adviser.
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.