In this month’s update: Important changes in Australia, Kenya and Ireland, as well as a reminder about Germany.
Draft laws affecting the tax treatment of employee share schemes
Our collaborating law firm in Australia (Minter Ellison) has kindly shared with us an article regarding the draft laws introduced by the Australian government which will affect the tax treatment of employee share schemes. We have summarized it below.
The Australian Government has introduced draft laws affecting the tax treatment of employee share schemes. The intention with the new laws is, in part, to reverse some of the more controversial aspects of the 2009 tax changes. The proposed changes, as set out below, should have positive outcomes for employers and employees.
Stock option tax treatment
Currently, tax-deferred share options are generally taxed at vesting, when there is no longer a real risk of the employee forfeiting them, even if they are not actually exercised at that time. under the draft laws, the taxing point for tax-deferred stock options will generally be when the employee exercises the options or, if there are transfer restrictions on the underlying shares that had been in place since the options were acquired, when those restrictions are first lifted. This will restore the position that existed pre-2009.
It also appears that employees will be taxed at exercise on fully vested rights, even if they are not subject to a risk of forfeiture. All that seems to be required is a disposal restriction on the right and an express statement in the plan rules that Subdivision 83A-C of the Income Tax Assessment Act 1997 applies (the tax deferral rules). However, an earlier taxing point can still arise if an employee leaves group employment and keeps their options/rights, even if they cannot exercise them at that time and sell the underlying shares in order to fund the tax liability.
Changes to valuation methodology
There are also changes to the rules for valuing unlisted rights. The tax laws use ordinary market valuation guidelines to determine the taxable value of ESS interests. However, as a safe harbour for valuing unlisted rights with an exercise price, employees can use statutory tables which are based on a Black-Schöles option valuation methodology. The tables have been updated include the use of an assumed dividend yield and volatility factor. This is likely to result in a more favourable outcome for employees. However, despite the fact that the maximum tax deferral period has been extended to 15 years, this is not reflected in the updated tables, which still ‘max out’ at 10 years. This would seem to mean that employees will not be able to use the safe harbour tables to value options with a greater than 10 year ‘life’ and will instead need to use their own valuation.
Other changes to the tax deferral rules
Two other changes are in respect of the ‘significant ownership’ rules and the tax refund rules:
Significant ownership rules: Under the current laws, tax deferral is not available to any employee who, after acquiring their ESS interest, holds a beneficial interest in more than 5% of the shares in the company or is in a position to cast, or control the casting of, more than 5% of the maximum number of votes that might be cast at a general meeting of the company. Rights to acquire shares are not counted towards determining whether the 5% threshold has been met. This 5% threshold has now been increased to 10%, measured by reference to both shares, and rights to acquire shares, held by the employee after they acquire their ESS interests (regardless of whether those rights qualify as ESS interests or not).
Tax refund rules: Currently, if an employee pays tax on their ESS interest, but the ESS interest is subsequently forfeited, they cannot claim a tax refund if the ESS interest is forfeited as a result of:
a choice that the employee makes (other than a choice to leave employment); or
a condition in the scheme that has the direct effect of protecting the employee against a fall in the market value of the ESS interest (‘downside risk protection’).
This means that if an employee holds rights that are ‘underwater’ at vesting, but which have a material (and taxable) value, they will be denied a refund if they subsequently let those rights lapse because the forfeiture results from a choice they have made. However, under the draft laws a tax refund would not be denied in these circumstances. This is a welcome change but may not have broad practical application due to the proposal to shift the taxing point for rights to the point of exercise and because a choice to leave employment will be retained as an exclusion from the ‘choice’ rules.
New tax regime for eligible start-ups
Employees of eligible start-up companies will benefit in two main respects under the new rules:
for shares, a ‘qualifying’ discount will not be subject to tax and the shares will then be subject to the CGT rules (so, in practice, employees will only be taxed on discount shares when they are sold); and
for rights, a ‘qualifying’ discount will also not be subject to upfront tax and the right and underlying share will thereafter be subject to the CGT rules (based on the announcement last year, the intention is for employees to only be taxed when they sell the underlying shares – meaning there is not a taxing point when they exercise the option – although it is not entirely clear from the way the new laws have been drafted whether options can be at a ‘real risk of forfeiture’ and still benefit from this concession). There are a number of conditions that must be met to be eligible for the concession.
Start date July 1, 2015
Submissions on the draft legislation and explanatory material can be made until 6 February 2015. The final changes will apply to shares or rights to acquire shares that are acquired on or after 1 July 2015. The changes will not be retrospective and there are no transitional provisions for awards acquired before this date. This means that any options granted before this date would still be taxed at vesting.”
Capital gains tax on sale of shares
From January 1, 2015, capital gains tax has now been introduced at a rate of 5% and will be payable on the sale of any shares.
Introduction of an Electronic Form RSS1 Return of Share Options
Any companies operating share plans in Ireland need to submit an annual RSS1 form by March 31 to the Office of the Revenue Commissioners (“Revenue”) in relation to the grant, assignment or release of rights, allotment of shares on the exercise of a right, or the transfer of any asset under rights granted under a stock option plan (regardless of whether these are in the form of market value options, discounted options or nil cost options) to employees who are taxable in Ireland.
For the 2014 tax years and any subsequent years Form RSS1 must be delivered in an electronic format approved by the Revenue. The first electronic filing must be submitted by March 31, 2015. The electronic RSS1 takes the form of an excel spreadsheet.
Tab 1 of the spreadsheet gives an explanatory note and instructions on how to upload the form via Revenue Online Service, ROS. Tab 2 is the electronic Form RSS1.
There is a requirement to register for the online service (ROS) before a secure upload to the system can be made. Details to be included on the form have not changed since last year, and can be found on the spreadsheet.
The German employer must issue a wage tax certificate (“Lohnsteuerbescheinigung”) at the end of a calendar year (or when an employment is terminated). The wage tax certificate contains information about the calendar year income, as well as information on social security contributions. The wage tax certificate must be sent electronically on an official form to the tax authority at which the employer is registered and a copy must also be provided to the employee. The deadline for filing is the last day in February after the end of the tax year.