Share scheme changes herald clever country thinking

A significant concession, and improvement, was announced to the Employee Share Scheme rules on Tuesday by the Federal Government. Employee shares schemes in emerging businesses had faded from relevance over the last 5 years following the implementation by the former Government in 2009 of measures that had the broad effect of taxing any discount on shares or options issued upfront to employees of most businesses.

Taxation occurred at a time prior to the employee shareholder having any cash flow with which to pay their tax bill – clearly a killer consequence. This removed the major form of employee remuneration that emerging businesses could use as an incentive to employees without affecting free cash flow. It also led to clumsy arrangements where a company would have to “loan” the employee the value of their shares to prevent then obtaining any taxable benefit.

The Tax Office become notorious for 20:20 hindsight valuation reviews which left employees unwilling to expose themselves. Many employees just would not buy the idea of their employer becoming a major creditor. What if the shares tanked? The employee could be stuck with repayment of a loan without any benefit.

The shareholder/ employee loan created a variety of difficulties ranging from potential requirements for the employee to use real cash flow to repay the loan under statutory “Division 7A” private shareholder rules. In some cases the loan became a problem for the employer who was required to manage it under the FBT regime. An employee might make a long term commitment to a company and be subject to a vesting period of 3-5 years before they became entitled to deal with the shares. However when this period expired, the employee would be obligated to “cash-out” their loan, often by taking a fully taxable one-off bonus.  This one off bonus often distorted the employee’s real earning position over their period of employment and forced them to be taxed on this component at a tax rate which was unfairly high.

Phasing issues emerged with the 50% CGT discount which generally applies to long term shareholdings. Deficiencies in these rules became so profound for early stage IT companies it became part of the reason emerging businesses began to leave the country. Most notably the IT success story Atlassian. The new rules remove some of the obstacles.

Actions to consider

  • If you presently have any form of share or rights scheme in place, it is likely that it can be “rebooted” under the new rules to drive significantly improved outcomes to employees.
  • Remuneration contracts currently being negotiated should be reviewed for the effect of the new rules.  The rules you thought applied when you inked the deal may not apply for the term of the arrangement.
  • Share schemes are not just for IT businesses.  If you have a SME business where you want to incentivise and tie employees into the growth of your business without a cash flow impact on your businesses – there is no better incentive. Costs of administration have dropped significantly in recent years.
  • If you are an SME owned “stuck” with the problem of how to exit the business and collateralise ownership interests into cash, employee share schemes can be a key tool in opening a dialogue and pathway to business succession.
  • Employee share schemes also have relevance to family businesses where they can be used as a tool to incentivise high performance in the next generation family owners. They are a form of participation which is not just a “gift”. They can be a key tool to assist with perceptions of fairness between family members who are “in the business” and those that are not.

A summary of key points in the new rules

  • Discounted options will generally be taxed when they are exercised (converted to shares), rather than when the employee receives the options.
  • Shares provided at a small discount by eligible start-up companies to will not be subject to up-front taxation, if held for three years. Options under certain conditions will have taxation deferred until sale.
  • Small discounts will be exempt from tax
    • The maximum time for tax deferral is lifted from seven years to 15 years.
  • The existing $1,000 up-front tax concession for employees who earn less than $180,000 per year will be retained.
  • The rules are expected to become effective from 1 July 2015.  Transitional arrangements are presently unclear.

Save up to $1,200 by prepaying your private health insurance

As part of the 2012 Federal Budget, the Federal Government proposes to means test the government rebate on private health insurance payments paid on or after 1 July 2012.  For those adversely affected, prepaying your private health insurance before 1 July 2012 could save you real money!  The Federal Government also propose to means test the Medicare Levy Surcharge levied on individuals without private insurance hospital cover.  These measures and what you should do is discussed below.

Private Health Insurance Rebate

For payments of private health insurance from 1 July 2012, the rebate will depend on the age and “adjusted taxable incomes” (see below) of singles and families.

The changes will adversely impact:

  • Singles aged under 70 years of age with an adjusted taxable income of more than $84,000
  • Singles aged 70 and over with an adjusted taxable income of more than $97,000
  • Family members aged under 70 years of age with a family adjusted taxable income of more than $168,000
  • Family members aged 70 and over with a family adjusted taxable income of more than $194,000

For these purposes adjusted taxable income is calculated as your taxable income, adjusted to include fringe benefits, tax free pensions, tax exempt foreign income, reportable super contributions and total net investment losses, less any deductible child support expenditure.

The tables below show the revised rebate rates.

Singles (single on the last day of the year and have no dependants)

 

Adjusted Taxable Income

 Age

Up to $84,000

$84,001 – $97,000

$97,001 – $130,000

$130,001 or more

Under 65:

30%

20%

10%

0%

65-69 years:

35%

25%

15%

0%

70 and over:

40%

30%

20%

0%

 

Families  (if you have a spouse on the last day of the income year, or are a single parent with one or more dependants)

 

Adjusted Taxable Income

 Age

Up to $168,000

$168,001 – $194,000

$194,001 – $260,000

$260,001 or more

Under 65:

30%

20%

10%

0%

65-69 years:

35%

25%

15%

0%

70 and over:

40%

30%

20%

0%

Note: The family income thresholds are increased by $1,500 for every dependant child after the first child.

Medicare Levy Surcharge

The same adjusted taxable income criteria will also be used to determine an individual or family’s exposure to the Medicare Levy Surcharge from 1 July 2012.  The rate of the Medicare Levy Surcharge will be means tested and taxed up to a maximum of 1.5% as per the tables below.

The changes will adversely impact:

  • Singles with an adjusted taxable income of more than $97,000
  • Family members with a family adjusted taxable income of more than $194,000

Singles (single on the last day of the year and have no dependants)

 

Adjusted Taxable Income

 

Up to $84,000

$84,001 – $97,000

$97,001 – $130,000

$130,001 or more

All ages:

0%

1.0%

1.25%

1.5%

Families (if you have a spouse on the last day of the income year, or are a single parent with one or more dependants)

 

Adjusted Taxable Income

 

Up to $168,000

$168,001 – $194,000

$194,001 – $260,000

$260,001 or more

All ages:

0%

1.0%

1.25%

1.5%

Note: The family income thresholds are increased by $1,500 for every dependant child after the first child.

What can you do?  What should you do?

If you would be adversely affected by these measures, you should consider:

  • Prepaying your annual private health insurance before 1 July 2012 to maximise the private health insurance rebate available to you (on a $4,000 policy, the saving could be up to $1,200); and
  • Taking up private health insurance hospital cover to avoid the Medicare Levy Surcharge (if applicable).

If you are unsure whether you might be adversely impacted by these measures or would like to talk about the implications/opportunities, contact me or your Prosperity Adviser for advice.

Michael Griffiths is a Director of Business Services and Taxation at Prosperity Advisers.


Image source; Flickr; Ryan Smith Photography