Employee Share Scheme discount tax delayed no more - Employee tax options limited in 2008 Federal Budget Announcement

On Budget Night on 13 May 2008, the new Federal Treasurer, Wayne Swan, detailed a change to the treatment of employee share schemes under Division 13A of the Income Tax Assessment Act 1936 (ITAA36). The change focuses on the timing of when an employee is able to make a choice under Div.13A to be taxed upfront on any discount they receive on certain employee shares or options. The Federal Government believes that the change will close an unintended 'loop hole' in Div.13A.

The current rules under Div 13A of the ITAA36

Employee share schemes (which are taxed under Div 13A of the ITAA36) often provide employees with an opportunity to purchase shares or options in their employer company at a discount to the market value. But, the law requires the employee to pay income tax on the discount (being the difference between the price paid for the shares or options and their market value). Employees who are issued with shares or options under an ESS on terms which enable the shares or options to be characterised as 'qualifying' shares or rights, were able to choose between:

  • deferring their taxing point on any discount for up to 10 years,
  • being taxed upfront on the discount.

If the employee doesn't specifically choose to be taxed up front, then the tax liability on any discount is automatically deferred until the employee's 'cessation time'.

Generally, deferral is seen as an attractive option when it comes to tax. However, this is not always the case when it comes to these employee share schemes and Div.13A because the amount of the assessable discount at the deferred time may be different to the amount of the assessable discount at the issue date.

When the tax is:

  • assessed upfront, the discount is the difference between the market value of the share/options at the issue date and the amount (if any) paid for the shares/options by the employee;
  • assessed at the cessation time, the assessable discount is the difference between the market value of the shares/options at the cessation time and the amount (if any) paid for the shares/options by the employee.

Therefore, if the value of shares or options increases after their issue date, then the assessable discount will generally be larger at the cessation time than at the issue time. Because of the operation of the CGT rules (and in particular the application of the 50% CGT discount), this can increase the overall tax for an employee who chooses to be taxed under Div. 13A on a deferred basis.

Under the current rules, an employee can choose to be taxed upfront by declaring their choice in their income tax return. The rules do not require this income tax return to be lodged on time or in the year the employee is issued with the shares or options under the scheme.

The reason for reform

The Federal Government was concerned that the rules in Div.13A were being exploited:

  • by employees who delayed making their choice to be taxed upfront until they knew whether the shares had increased or decreased in value. In turn, this let them know whether it would be better to be taxed up front, or later. Employees achieved the delay simply by not lodging their income tax returns until the facts were known; and
  • by employees who once they knew how the shares had performed, lodging an amended assessment to vary their initial choice.

The new rules prevent both of these practices.

New rules

The new rules (which are yet to be legislated) will require employees who have received qualifying shares or options under a scheme and who want to be taxed upfront under Div.13A to lodge their choice in the year in which the shares or options are issued.

If an employee does not choose in the year the shares or options are issued, then they will automatically be taxed on a deferred basis (at their relevant cessation time).

Effectively, from 1 July 2008, the changes close what the Federal Government considered was a flaw in the operation of the Div.13A ESS rules.

Questions and Further Information

For questions and more information about employee share schemes, call Maddocks in Melbourne on 03 9288 0555 or Sydney 02 8223 4100 and ask for a member of the Maddocks Revenue Team.