Yahoo Finance Employee share schemes and tax: What you need to know
There are many pros and cons of employee share schemes, including how much tax you'll pay and when you'll pay it.
Employee share schemes are a popular tool used by companies to reward their employees, but they do carry tax implications.
These schemes allow workers to take a share in the equity of their employer, and the financial perks are attractive. However, these schemes often come with a “loyalty” element built in. So, while you might get a share-based reward for your hard work in the current year, you might not be able to access it for several years. Restrictions attached to the shares mean the benefits of ownership (such as the ability to receive dividends or sell the shares) only crystalise several years down the track, maybe upon meeting certain performance conditions.
So, let's break down the pros and cons of these share schemes.
Pros and cons of employee share schemes
The pros:
You benefit financially if the company performs well
It could motivate you to stay longer with the company
You may be able to buy shares at a discount to the current market price
You may not have to pay a brokerage fee when you buy or sell shares
You could get tax benefits, depending on the features of the share scheme and your financial situation
The cons:
There are likely to be limitations on when you can buy or sell shares
You may have to give back or sell your shares when you leave the company
Your share package could come with restrictions - for example, you may have to meet performance targets or stay with the company for a certain number of years
You could lose money if your shares go down in value or the company goes out of business
For tax purposes, employee share scheme interests can be divided into 'taxed-upfront' schemes or 'tax-deferred’ schemes. Certain start-up companies are also entitled to additional niche concessions, which can make the scheme very attractive.
Taxed-upfront schemes: How you’ll be taxed
Generally, if you receive employee share interests at a discount - you pay less than market value for them - this discount is treated as income when it comes to tax time.
For example, if you acquire shares in a scheme free but the market value of those shares is $20,000, you will have received those shares at a discount of $20,000. Unless the scheme is structured as a tax-deferred scheme or falls within the start-up concession, that $20,000 discount will need to be reported as income earned in the financial year in which the shares were acquired. This will incur a tax charge at your marginal tax rate.
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This means you could be required to pay tax on the employee share scheme interest before you have realised any financial benefit from the scheme - such as through dividends or by disposing of the shares.
Obviously, this will be a major issue in many cases. However, a significant benefit of a 'taxed-upfront' scheme is that, once the discount has been taxed, any future growth in the value of the employee share scheme interest will usually fall within the capital gains tax (CGT) rules. You are deemed to acquire the shares for the amount that is subject to income tax, and any future growth will qualify for the CGT 50 per cent discount (provided the shares are kept for at least 12 months). CGT will be payable at the time you dispose of your employee share scheme interests.
Whether a taxed-upfront scheme is appropriate will depend on several factors, including:
The value of the discount (if any) that is being offered, and the amount of tax you are required to pay
Your willingness and/or ability to meet an upfront tax liability
The future growth prospects of the company and the attractiveness of potential future CGT relief
Whether a tax-deferred scheme or start-up concessions may provide a better overall outcome
Tax-deferred schemes: How you’ll be taxed
To qualify as a 'tax-deferred' scheme, it will need to meet certain criteria, such as:
The interests are acquired at a discount
The start-up concessions do not apply to the interests
The interests are ordinary shares or options or rights that will convert to ordinary shares
The employer is an Australian company
The participant is employed by the company (or subsidiary) that issued the interests
The company's predominant business is not as a share-trading or investment company
There may be additional eligibility criteria, depending on whether the interests are shares or options (or rights). For example, if options are issued, you will only be able to defer paying tax on any discount on the options if the following criteria are met:
The options relate to ordinary shares
Immediately after receiving the options, you will not hold a beneficial interest in more than 10 per cent of the company's shares
The scheme is available to at least 75 per cent of Australian-resident permanent employees who have completed at least three years of service (continuous or otherwise)
There is a real risk that, under the conditions of the scheme, you will forfeit the right, lose it other than by disposing of it, exercising it, or letting it lapse (the 'real risk-of-forfeiture' test)
The scheme genuinely restricts you from immediately disposing of the option
The scheme expressly states that it's a tax-deferred scheme
Under a tax-deferred scheme, you will be able to defer your tax liability until the earliest of the following:
For shares, when there is no risk of forfeiture and no restrictions on disposal of the shares
For options and other rights, when you exercise the option or right and there is no risk of forfeiting the resulting share and no restrictions on its disposal
15 years after you acquired the employee share scheme interest
One drawback of a tax-deferred scheme is that, although you may be able to defer paying tax, the total amount of tax you ultimately have to pay may be higher than under a taxed-upfront scheme. This is because you are liable for income tax on the market value of the shares (or other interest) at the date on which any restrictions fall away - in other words, on the date on which you have an unrestricted right to the shares. This will always be later than under a ‘taxed upfront’ scheme.
CGT treatment will only commence from this later date, which will have the effect of deferring the period that any CGT relief might be available. Consequently, when you sell your shares under a tax-deferred scheme, your tax bill following the disposal of your interests could be higher than would have been the case had you been taxed upfront.
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