Proposed overhaul of tax rules for employee share schemes

Thursday 19 May 2016

Authors: Graham Murray, Glenn Joblin and Hayden Roberts

​​​​​The Inland Revenue Department (IRD) has proposed reforms to the tax treatment of employee share schemes. The proposals are detailed in a 12 May 2016 officials' issues paper, a copy of which can be obtained here. Submissions on the issues paper are due by 22 June 2016

These proposals supplement the existing proposal to allow employers to withhold PAYE from employee share scheme benefits from 1 April 2017.

The issues paper seeks to align the tax treatment of benefits received by an employee under a share scheme with the taxation of equivalent cash payments that could been have received in the alternative. 

Three types of employee share schemes

The issues paper identifies three types of employee share schemes:

  • Unconditional employee share schemes: These are schemes under which shares and options are provided to employees free from any conditions,

  • Conditional employee share schemes: These schemes involve the acquisition of shares by an employee, but where retention of those shares is subject to future conditions based on continuing employment, and

  • Option-like arrangements: These schemes have terms and conditions based on the future price of shares (or similar criteria), with the conditions often being combined with continuing employment conditions.

The issues paper broadly seeks to identify cash payments that are economically equivalent to benefits under these three types of share schemes, and proposes taxation of the relevant scheme benefit consistently with that economic equivalent. 

The share scheme classifications put forward are defined by the IRD. They are not terms that are commonly used in the market. The category of option-like arrangements in particular is clearly an IRD derived construct. This category links into the IRD's employee share scheme revenue alert issued in 2015 relating to share purchase schemes which the IRD considers are in substance share options.  

What changes are proposed?

In respect of schemes that the IRD considers are conditional or option-like arrangements, the proposal is that the taxing point should occur once the employee holds the shares free from "substantive" conditions. The employee would be taxed on the difference between the market value of the shares when they first hold them free of substantive conditions and the amount paid for the shares. 

However, there are no changes proposed for what the IRD terms unconditional employee share schemes. Employees would continue to be taxed on the difference between the market value of the shares on acquisition and the amount paid for them.  

The primary guidance on when shares will be held free from "substantive" conditions is that they will be treated as such when they are held on the "same basis as any other shareholder". The appropriateness of this test and the specific details of what constitutes a substantive condition are both likely to be the subject of significant debate. 

This proposal for conditional or option-like arrangements may result in a deferral of the point at which the employee is required to determine the quantum of their taxable benefit (compared to the current rules). As a result of this change, any growth in value of the shares over the period of time between the acquisition or deemed acquisition of the shares by the employee and the satisfaction of the substantive conditions could be potentially subject to tax. 

This is a departure from the current rules, which provide scope for that growth in value to be tax-free for an employee (being a tax-free capital gain derived by the employee after the relevant taxing point). The rationale for this change is that the benefit is economically equivalent to a cash bonus that is paid once the relevant conditions are satisfied, and that in each case the full value of the benefit should be subject to tax. 

Share purchase schemes / DC 12 schemes

The issues paper questions whether the existing concessionary treatment for "share purchase schemes" (also known as DC 12 schemes) should be retained. Under current law, a benefit received by an employee under such a scheme is not taxable and the employer has a deemed notional interest deduction on loans made to employees to buy shares.

The issues paper seeks submissions on whether this concessionary regime should be repealed, retained, or modernised. The issues paper arguably implies a preference on the part of the IRD to repeal this regime. 

Tax deductibility of employer costs

Under current law, the cost to an employer of providing shares to employees is not explicitly deductible (although in some circumstances it may be possible to structure share schemes in a manner whereby deductions are available). The issues paper proposes to clarify this treatment, allowing a deduction to an employer equal to the amount of taxable income arising for its employee. 

The rationale for this position is that the employer would be entitled to a deduction for an equivalent amount paid in cash, and that providing shares to an employee is economically equivalent to incurring cash expenditure. 

The issues paper again expresses the IRD's view that the costs of issuing a share are not deductible to a company, as those costs do not present a cost to the company - although no mention is made of significant case law authority supporting the alternative view. However, the issues paper attempts to circumvent this issue by suggesting that an employee share scheme is a different transaction altogether. The issues paper suggests that the transaction is more than a simple issuance of a company's shares, and should instead be seen as the payment of a cash wage to the employee, followed by the purchase of shares in the employer. 

As a result, it is (rather conveniently) suggested that the cost being deducted by the employer is not for the issuance of the shares, but rather the implicit cash wage that the share represents. 

Start-up companies

It is recognised in the issues paper that start-up companies and their employees may have difficulty valuing shares provided under employee share schemes, and paying tax at the time that it is currently imposed. 

A proposed solution to this issue is to delay the taxing point on such shares to the point in time at which the shares are sold or listed. It is recognised that this delay could result in some increase or decrease in taxation of those shares, and the IRD has invited comments and suggestions on this proposal.

Is share scheme reporting appropriate?

The issues paper asks whether New Zealand should adopt a reporting system similar to Australia. This would involve employers providing employees with an employee share scheme statement in the year in which they should be returning income from the share scheme. In addition, they would need to provide the IRD with an annual employee share scheme report which lists the employees participating in particular share schemes, and the taxable benefits received by such employees during the year. 

While other amendments before Parliament will require employers to include employees’ share scheme benefits in the employer monthly schedule​, there is no current requirement for the employer to report specific details of the share scheme benefits. Therefore, the IRD​ is also seeking feedback on whether a monthly report, tying in with the employer monthly schedules, would be preferable in a New Zealand context.

When would the new rules come into effect?

The issues paper proposes a three year transitional period (in which the current rules would continue to be applied) for shares acquired by an employee prior to enactment of any new rules. At the end of the third full tax year following enactment, any new benefits under the pre-existing scheme would be taxed under the new rules (with an allowance for tax already paid under the current rules).​

For further information, please contact the authors or your usual Bell Gully adviser.


Disclaimer

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.

For more information
  • Graham Murray

    Partner Auckland
  • Glenn Joblin

    Partner Auckland
  • Mathew McKay

    Partner Auckland
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