A number of Australian and Multinational companies have employee share plans in place to assist with retaining and motivating employees. Typically, these plans and the issuance of shares are done as a bonus to recognise individual and overall organisation performance.

Employees participating in these plans could receive stapled securities, options, preference shares and normal ordinary shares, depending on the company’s plan or plans. These plans are potentially very lucrative, however the impact on your taxable income is complex and if not applied correctly can lead to penalties and unforeseen tax bills.

Tax on Employee Share Plans

The default position on all employee share plans is that they are taxed upfront on the benefit the employee receives, when granted. However, there are instances where an employee could benefit from deferred taxation, being if:

• The shares are subject to a “real risk of forfeiture”; or
• The shares are acquired under a salary sacrifice arrangement and the employee receives no more than $5,000 worth of shares under those arrangements in an income year.Additionally, employees are eligible to reduce the benefit they receive by $1,000 provided their ‘adjusted taxable income’ is $180,000 or less.

Real Risk of Forfeiture

The facts and circumstances of each scheme and the individual circumstances will determine whether there is a real risk of forfeiture.

Australian Taxation Office (ATO) Interpretive Decision (ATO ID) 2010/61 broadly states that shares acquired by an employee is at real risk of forfeiture if a reasonable person would consider that there is a real risk that the employee may forfeit or lose the shares, other than by intentionally taking no action to realise the benefit. The ATO explains that the meaning of ‘real’ in this context is something more than a mere possibility. In this regard, shares will not be at real risk of forfeiture if a reasonable person would disregard the risk as highly unlikely to occur, or as nothing more than a rare eventuality or possibility.

Real risks of forfeiture in a scheme may include conditions where retention of the shares are subject to performance hurdles or a minimum term of employment.

The ATO states there is no real risk of forfeiture where a share plan simply includes a condition which:

• Restricts an employee from disposing of shares for a specified time period;
• Allows an employee to request that the shares be forfeited; or
• Provides for an employee to forfeit any shares if they are dismissed for fraud or gross misconduct.

Where the taxation of shares is deferred, the discount or benefit will be included in the employee’s income tax return at the earliest of the following times:

• When the employee ceases employment;
• The year in which there is no longer any risk of forfeiture and the restrictions regarding disposal are lifted; or
• Seven years after the shares/rights were granted.

Deferred Taxation Point

Assuming the shares issued to an employee are at a ‘real risk of forfeiture’, the deferred taxation point in most cases will be the date the shares or options are freely available to sell or activate.

The taxable value of the shares or options will be determined as follows:

• Where the share/right is quoted on an approved stock exchange, it will generally be valued at the most recent offer, or weighted average price if more than one offer has been made in the past week.
• Non-traded shares will be valued in accordance with the valuation of an independent valuer.
• Rights not listed on an approved stock exchange will be valued according to the valuation tables in the legislation.

Where an employee disposes of their shares or rights within 30 days of the deferred taxing point, the deferred taxing point becomes the date of sale. Consequently, any capital gain or loss on disposal (i.e. the gain or loss within the 30 day period) is disregarded and the market value sale price is used to determine the taxable value.

Taxation Upfront

If your shares are deemed to be not at risk or in some instances you may wish to forgo the deferred taxation point and elect to have your shares taxed upfront, the value at grant will be added to your taxable income in that year. The benefit of electing to have your entitlements taxed up front is the access to the 50% general capital gains tax discount. The discount is available to individuals who hold their interests for greater than 12 months.

For example: You are issued 1,000 shares at $20 ($20,000 value) and will receive these shares upon completing a further 3 years service. In 3 years time the share price has jumped to $30, an increase of $10,000. As these shares have been taxed upfront and held for greater than 12 months, the gain on these shares can be discounted by 50%, thereby reducing the taxable amount from $10,000 to $5,000.

Conclusion

Each company’s share plan contains different rules and each employee participating in the plan has different circumstances. It is for this reason that we encourage you to talk with your Altitude Accountant to determine how to best manage your employee share plan entitlements.