Employee share or incentive plans The scheme
An employee share or incentive plan scheme has the following characteristics.
o The employer entity establishes a special purpose company.
o Shares or membership interests are allocated to selected employees for a nominal amount in the special purpose company.
o The employer contributes a sum of money to the special purpose company, greatly increasing the value of the employees’ shares or membership interests.
o The special purpose company invests the contribution amounts on behalf of the employees, often lending the contribution back to the employer entity or their associate.
The flow of funds
An example where employees are issued with shares in the special purpose company.
The tax mischief
Employee share or incentive arrangements are designed to provide the employer with an effective incentive plan for employees. However, the only employees who generally participate in such plans are the controllers of the employer business.
The taxpayer’s legal perspective
The advantages to the employer are:
o a deduction is allowable under section 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or section 8-1 of the Income Tax Assessment Act 1997(ITAA 1997) to the value of the employer contribution into the special purpose company
o the contribution will not be subject to fringe benefits tax
o the contribution will not be subject to the superannuation guarantee charge, and
o the contribution may not be subject to payroll tax or work cover.
The advantages to the employee are:
o no tax payable on the amount of the contribution credited into the employees’ account at the date of deposit
o the contribution is not taken into account in determining the income of an employee for the purpose of the superannuation contributions surcharge
o contributions to the special purpose company are not subject to 15% tax as are super contributions
o there are no retention restrictions with the special purpose company contributions as there are with superannuation contributions
o subject to certain limitations, an employee can withdraw funds from an employee share plan (ESP) at any time, and
o contributions to the special purpose company are not subject to the age based Reasonable Benefits Limits.
What we think the legal effect is
The Tax Office has a number of concerns including (where applicable):
o calculating the discount for the purposes of Division 13A of the Income Tax Assessment Act 1936
o applying the Fringe Benefits Tax Assessment Act 1986 to the contributions made by the employer to the special purpose company, and
o providing a tax benefit, being the deduction claimed for the employer’s contribution to the special purpose company, for the purposes of the potential application of Part IVA of the Income Tax Assessment Act 1936.
In our view contributions for employees made by way of premium or otherwise, may be assessable income of the employee under Division 13A, and/or paragraph 26(e), and/or sub-section 25(1) of the Income Tax Assessment Act 1936. Also:
o part IVA may apply to include the amount of the contribution in the assessable income of the employee
o as a property fringe benefit or a residual fringe benefit taxable to the employer
o section 67 of the Fringe Benefits Tax Assessment Act 1986 may apply to increase or adjust the aggregate fringe benefit to include the premium contribution amount
o the deduction claimed under section 51(1) of the Income Tax Assessment Act 1936 or 8-1 of the Income Tax Assessment Act 1997 in respect of the value of the employer entity’s contribution to the special purpose company may be disallowed, and
o part IVA may apply to cancel the deduction that has, or may be claimed by the employer in respect of each contribution.
Furthermore, deductions under section 69 or subsection 51(1) of Income Tax Assessment Act 1936, or section 8–1 of Income Tax Assessment Act 1997 for adviser’s fees may not be allowable.
Contributions for employees made by way of premium or otherwise may also be subject to state payroll tax provisions.
The government announced in the 2008-09 Budget that it would make two legislative changes to the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997 to the tax treatment of shares or rights acquired under an employee share scheme (ESS).
End of attention
What you can do
If you are a member of an employee share or incentive plan you should contact the tax office on 1800 177 006for further advice.
If you are considering establishing an employee share or incentive plan you may wish to seek a ruling from the Tax Office on the taxation impacts for participants in the arrangement. For further information contact the tax office on 1800 177 006.
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