Tax Watch: Edition 4, June 2017

Overhaul of tax regime for employee share schemes

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Proposed new rules released for public feedback

There has recently been considerable uncertainty around the taxation of employee share schemes (“ESS”). This uncertainty resulted from the release of several Inland Revenue publications, including two issues papers released in May 2016 and September 2016.

Following public feedback, these proposals have now been updated and refined, and draft legislation has been released for public feedback.

The proposed new rules seek to modernise the tax treatment of ESS and aim to ensure a tax neutral treatment.

The tax outcome for employee share benefits will soon be largely the same as the outcome that would have arisen had the employee received cash remuneration rather than shares.

The new rules will generally apply to benefits provided under ESS which are not taxed under existing rules within six months of enactment of the draft legislation.

Once enacted these changes will clarify any misunderstandings that taxpayers had in the past in relation to the taxation of ESS benefits. Going forward there will be consistency and certainty regarding the taxation of ESS awards.

Timing and derivation of employee income

The current rules for the taxation of ESS benefits can result in outcomes that are neither tax-neutral nor consistent with the taxation of employee share options.

The proposed new rules address these issues by deferring the time at which an employee derives income from ESS in certain situations. ESS income will be treated as having been derived by an employee and subject to tax at the earlier of the date when:

  • The shares are transferred or cancelled for consideration, or
  • The employee owns the shares in the same way as any other shareholder.

Examples of where the employee will not own the shares in the same way as any other shareholder include cases where the employee is required to forfeit the shares if they decide to leave the company, or where the employee is entitled to compensation for a decline in the value of the shares.

The amount that will be subject to tax is the difference between the value of the shares and any amount paid by the employee for those shares. If the amount paid is more than the value of the shares, the difference is deductible to the employee.

The proposed new rules include an income apportionment formula that is applicable to all employees and not just transitional tax residents. This formula excludes from taxable income ESS benefits which accrue while a person is not a New Zealand tax resident and is not deriving other New Zealand sourced income.

Employer deduction

Under the proposed new rules, employers will be entitled to a corporate tax deduction for the value of the ESS benefit provided.

The corporate tax deduction will match the income to employees in both timing and quantity.

Other costs that may be considered as a deduction are limited to:

  • Costs of operating an ESS, such as legal and accounting fees incurred in setting up the scheme, along with ongoing management fees, and
  • The amount of any cash bonus paid to an employee associated with an ESS.

No deduction is allowed for payments to fund an ESS trust to acquire shares, or to reimburse a parent company for providing shares.

Grandparenting provisions

Grandparenting provisions are intended to ensure existing and proposed ESS have time to take account of the new rules. Under the proposed grandparenting provisions, the new rules do not apply to ESS where the shares were granted or acquired before 12 May 2016.

In addition, the new rules do not apply to ESS where the following conditions are all satisfied:

  • The shares were granted or acquired before the date that is 6 months after the date on which the changes are enacted, and
  • The shares were not granted or acquired with a purpose of avoiding the application of the new rules, and
  • The share scheme taxing date for the shares is before 1 April 2022.

Widely offered schemes (exempt schemes)

The current rules for exempt schemes are considered to be outdated and complex. Following public feedback, the Government has decided to retain exempt schemes but to introduce amendments to make them less restrictive and simpler to operate.

The proposed new rules include the following changes:

  • The maximum value of shares provided will be $5,000 per year.
  • The maximum discount an employer can provide to an employee is $2,000 per year, meaning the most an employee can spend buying shares per year will be $3,000 (i.e. $3,000 plus the $2,000 discount equals the maximum value of $5,000).
  • The cost of the shares to employees must not exceed their market value.
  • Any minimum spend requirement per employee must be no more than $1,000 per year.

Other key changes to the regime include:

  • Removal of the current 10% notional interest deduction for employers providing an interest free loan to employees.
  • Employers are no longer able to claim a deduction for the cost of providing the shares (other than scheme management and administration costs).
  • If there is a cost to the employee to acquire the shares, an interest free loan facility must be made available, or the employee must be allowed to pay for the shares in instalments (currently discretionary).
  • Exempt schemes will no longer require Inland Revenue approval. However, Inland Revenue must be notified of the scheme’s existence and the employer must advise Inland Revenue when grants are made under the scheme.

Benefits provided under existing exempt schemes will continue to be exempt from tax under the new rules, although such schemes may be amended to increase the benefit to their employees to the proposed monetary limits.

It is proposed that the amendments to exempt schemes will generally apply from the date of enactment, including denial of the notional interest deduction. However, the provision denying employers a deduction for the cost of providing the shares will apply from 6 April 2017.

We applaud the proposed relaxation of the administrative requirements for tax exempt schemes. The proposals will make it easier to implement such a scheme to incentivise and retain employees.

Start-up companies

The proposed new rules do not contain any special rules for start-up companies. However, the Government has recently released a public consultation document which expands on the proposals for start-up companies contained in the May 2016 issues paper.

The proposal would provide the ability to defer the taxation point of ESS benefits for employees of start-up companies (with a corresponding deferral of the companies’ deductions). Submissions on the proposals are due by 12 July 2017. Contact us if you are interested in making a submission.

Payroll reporting

From 1 April 2017 employers are required to report to Inland Revenue the amount of income their employees derive under an ESS. Large employers are currently required to report the value of the ESS benefit in the pay period after the ESS derivation point, while an employer that is not a large employer is required to report the value of the ESS benefit in the same pay period that it is derived. It is proposed that from 1 April 2019, the recognition point of ESS income will be amended to 20 days from the ESS derivation point for all employers.

Valuation of ESS

Inland Revenue has recently issued guidance for employers on how to determine the value of the share benefit received by employees under an ESS. This guidance will be particularly useful given the introduction of the mandatory reporting requirement for ESS benefits from 1 April 2017.

Take action today

The proposed new rules represent a significant change to the taxation of ESS benefits. If you have concerns about how the new rules will apply to your current or contemplated ESS, do not miss your chance to make your views heard. Get in touch with us today to talk about making an independent submission.