Matthew McKee, Partner at Brown Wright Stein, discusses the decision in Fox v Commissioner of Taxation AATA 2791 and how it is not always a wise tax move for employees to accept shares from their employers. As was the case in Fox, employees might be paying tax on money that they never actually receive, he writes.
Giving Employees Shares: A Gift with Bite?
The decision in Fox and Commissioner of Taxation  AATA 2791 is a timely reminder that it is not always a good idea for an employee to accept shares from their employers.
Employees need to understand the tax risks and, in particular, as was the case in Fox, that they may be paying tax on an amount of money that they never actually receive.
Taxation of shares received from employer
Where an employee receives shares for no consideration or for consideration for less than the market value of the shares, the employee will be assessed either under the employee share scheme (ESS) provisions in Division 83A of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) or, if the ESS provisions do not apply, on the basis that receipt of the shares constitutes ordinary income for the employee.
The main difference between two regimes is that the ESS provisions can provide concessional treatment, including a deferred taxing point or a reduction in the amount assessed.
The ESS provisions will not apply where the shares are not ordinary shares or where the shares are being issued to persons who are not employees of either the company in which the shares are being issue or a subsidiary of the company in which the shares are being issued: section 83A-10 of the ITAA 1997. For example, the ESS provisions do not apply to an issue of shares in a “sister” company (a company with the same holding company) of the employer.
Fox – tax on amount of money not received
In Fox, the taxpayer agreed to accept Performance Rights in her employer in 2011 and 2012. Alicia converted the performance rights to shares in June 2014.
By April 2015, Alicia’s employer was in financial trouble and was placed into administration.
In May 2015, Alicia lodged her 2014 income tax return which included $106,058 in assessable income relating to the employee share scheme, being the difference between the amount she paid ($0) and the market value of the performance rights at time of conversion.
Not long after this, the administrators made various employees of the company, including Alicia, redundant.
The employer was subsequently placed into liquidation and in October 2015, the liquidators made a declaration that there was no reasonable likelihood that the shareholders of the employer would receive any distribution in the course of the winding up. At this point, Alicia’s shares were effectively worthless.
Alicia amended her tax assessment to exclude the amount included for her performance rights. The Commissioner subsequently re-amended Alicia’s assessment to re-include the amount for her performance rights.
Alicia objected to this assessment and, when her objection was disallowed, applied to the Administrative Appeals Tribunal.
Alicia sought to argue that she had been pressured to accept the performance rights such that the issue of them to her was void at law. Alicia lost in the Tribunal and the assessments stood.
The effect was that Alicia was subject to tax on the $106,058 but ultimately never received money of that amount.
Risk for employees with ESS arrangements
The decision in Fox is just one example of the risks for employees associated with employee share schemes. Part of the problem with employee share schemes is that they are drafted from the perspective of the employer and, because employees are generally receiving the interests for “free”, the risks associated for the employees are often not properly considered.
Some observations to make:
- a proposal that works in the circumstances of one company may not work in the circumstances of another. An example of this is that employee share schemes for public companies may use a limited recourse loan to the employee so that the employee is acquiring the shares at market value (i.e. there no discount) but without having to cash flow the purchase of the shares. This model sometimes been adopted for private companies without understanding that it can give rise to risks for employees under Division 7A of the Income Tax Assessment Act 1936 (Cth), which only applies to private companies;
- it is often proposed to restrict the rights under the shares issued to employees (for example, by limiting when they can share in dividends) to reduce the value of the shares so that the “discount” on the shares is a lower amount. It is important that the employee understand that the discount is only lower because what they are receiving is worth less than what it would have been had the rights not been restricted; and
- the tax position of an employee will often be determined, in practical terms, by the manner of reporting by the employer on the employee’s employee share scheme statement as the cost for the employee in having the employee scheme statement reviewed is usually prohibitive.
Some of the key takeaways from the above are as follows:
1. when advising an employee on a proposal to issue them with shares or options in connection with their employment, the tax and commercial risks associated with accepting the shares or options should be considered and explained to the employee;
2. the mere fact that an employee is not paying anything to receive the shares or options does not mean that they should always accept them. It is important that the employee understands the financial position of the company and whether it may be that they may be taxed on an amount that they will never be able to realise;
3. proposals to provide a better tax outcome should be looked at carefully to assess whether they are effective and whether they may lead to other tax consequences; and
employees need to rely heavily on their employer getting the tax position right as it will not usually be practical for an employee to have an employee share scheme statement reviewed.
Matthew McKee, Partner at Brown Wright Stein, is an experienced tax and superannuation lawyer who regularly provides tax and commercial related advice to accountants, financial planners, small to medium enterprises and private clients. Matthew regularly advises on income tax, capital gains tax (CGT), fringe benefits tax (FBT), GST, stamp duties and the SIS Act. Matthew has experience in managing all aspects of taxation disputes, including: Managing Australian Taxation Office (ATO)/Office of State Revenue (OSR) audits and investigations, voluntary disclosures; Preparing taxation objections and private ruling applications; Conducting tax litigation in the Administrative Appeals Tribunal and Federal Court; and Negotiating settlements and payment arrangements with the ATO. Matthew also provides advice on trusts and structuring as well as commercial issues including asset and business acquisitions and disposals, share sale agreements, shareholder and joint venture agreements. Contact Matthew at MPM@bwslawyers.com.au