With companies due to provide ESS Statements to their employees and the Australian Taxation Office (ATO), it is now time to start preparing the information required to meet the reporting requirements.
Listed below are 5 tips on issues, and items to consider when preparing that information.
1. Recognising that an ESS interest has been provided to employees
This might sound like a simple task, but with the level of complexity in some share based payments, it is important to recognise whether employees have received an ESS interest.
More importantly, it is necessary to determine what the interest is – whether it is a share, option, performance right, or some other form of equity can make a big difference in the way it is reported, when it is reported, and how it is valued.
It is also vital that an employer recognises when an ESS interest has been provided to employees to identify what type of scheme applies to the interest, and when that interest must be reported to the ATO.
In some cases, that interest might not be reported in the year in which it is issued, and therefore adequate records must be kept in order to identify when the taxing point might occur.
2. Working out if a taxing event has occurred
As important, or even more important, than recognising whether an ESS interest has been provided, is determining whether a taxing event has occurred within the financial year.
There are 4 types of taxing events:
(a) Taxed up-front scheme – eligible for reduction
Generally, all ESS interests are taxed up-front except in limited circumstances.
To be eligible for a reduction, the following conditions must be met for the ESS interests:
- The employee is employed by the company or a subsidiary when the ESS interest is acquired;
- The ESS interests relate to ordinary shares;
- The predominant business of the company is not acquisition, sale or holding of shares;
- The ESS is operated on a non-discriminatory basis in relation to at least 75% of the permanent employees who have completed 3 years of service;
- There is no real risk of forfeiture of the ESS interest;
- You are not permitted to dispose of your ESS interest before the earlier of 3 years, or when you cease employment; and
- No employee holds more than 5% beneficial interest in the shares of the company immediately after the acquisition of the ESS interest.
(b) Taxed up-front scheme– not eligible for reduction
Unless any of the special conditions above are met, then most ESS interests will fall into this category.
This will be especially so where the ESS is operated for only a select group of employees such as senior management and executives, and directors.
(c) Deferral schemes
An ESS will have a deferred taxing point where the following conditions are met:
If the interest is a share:
- points 1, 2, 3 and 7 from the conditions above apply; and
- at least 75% of the permanent employees with at least 3 years of service are, or have been, entitled to acquire ESS interests under the scheme; and either
- there is a real risk of forfeiture; or
- the market value of the ESS interests acquired are less than $5,000 and the amount was salary sacrificed.
If the interest is a right to acquire an interest in a share:
- points 1, 2, 3 and 7 from the conditions above apply; and
- there is a real risk of forfeiture.
(d) Discount on ESS interests acquired pre 1 July 2009
Where ESS interests were acquired before 1 July 2009 under the previous ESS rules, and the cessation time under those rules occurs during the financial year, the market value of those interests at the cessation time must be reported.
3. Getting the acquisition date correct
Where ESS interests are taxed upfront, the relevant date for determining which income year they fall into, as well as the value of the ESS interest, is the acquisition date.
The acquisition date is different under tax law to the date used for accounting purposes when reporting the expense in the financial statements.
The important aspect of acquisition date for tax purposes is when the share or right actually came into existence and hence was “acquired”, as this is the date on which the interest will be valued.
Commonly, shareholder approval is given at an Annual General Meeting, but there is a delay in the share registry issuing the interests to the employees.
This delay can see a significant change in the market value of the underlying share price, and this in turn can see a dramatic change in the amount that needs to be included in the assessable income of the employee.
A more thorough discussion of when is the correct “acquisition date” can be found on the Value Logic website.
4. Calculating the correct value of the discount to report
For taxed upfront schemes, the value that must be reported is the discount provided to the employee.
The discount = (market value – amount paid by employee) x number of interests received
The key information that must be determined includes:
- Number of interests with taxing event in current year
- Correct acquisition date on which to value the share or right
- Correct price of share /option/right at the taxing point/acquisition date
- The market value of options/rights, either market value or as determined by the formula in the Regulations.
Determining the value of a right (including options and performance rights) is especially vital, as most often these interests are not quoted on a stock exchange and therefore a market price cannot be readily found.
5. Reporting to employees and the ATO by the relevant dates
An ESS statement must be prepared and provided to employees if:
- The employee acquired ESS interests under a taxed upfront ESS at a discount during the financial year
- A deferred taxing point for ESS interests acquired under a tax-deferred ESS has arisen or could have arisen in the financial year.
The ESS statement must be provided to employees by 14 July after the end of the financial year.
Australian Taxation Office
Where an ESS statement has been provided to an employee/s, an Employee Share Scheme (ESS) Annual Report must be provided to the ATO by 14 August after the end of the financial year.
Where an employee has not quoted a Tax File Number and receives a discount on ESS interests acquired, the employer is required to withhold tax at the top marginal rate.
Reporting the amount withheld to employees is important to allow the employee to lodge their tax return with the correct information, and give the employee a chance to obtain a refund if the amount withheld is more than their tax liability.
Given the impact that receiving an ESS interest can have on an employee’s taxable income, it is vital that the correct details are reported to employee and to the ATO.
Amendments can be made to reports that have been lodged, so if any errors are detected there is an opportunity to correct them.
However, in the interest of keeping good relations with employees, clear and timely communication and advice is the key.