A common situation that arises when companies issue options and performance rights to employees is a delay between agreeing on the terms of the options and the company issuing the rights to the employee.
This delay can also see a significant difference in the company’s share price between when the terms are agree and the options are actually issued.
Where there is an increase in the share price, this can affect the option valuation with the employee going from a position where there is little or no taxable value when the terms are agreed, to a position where there is a significant taxable value when issued – which can result in a significant tax liability.
The key issue is to accurately determine the day on which the options or performance rights are considered to be acquired, so that the proper option valuation can be calculated.
Tax vs accounting
The Income Tax Assessment Act 1997 provides that an employee includes in their assessable income any discount given in relation to rights received in the income year in which they acquire the ESS interest (s. 83A-25(1)).
The ATO provides further guidance on their website that a share or right is acquired when:
- the share or right is transferred to you, other than by a share issue;
- in the case of a share, the share is allotted to you;
- in the case of a right, your employer or another person creates a right (to acquire a share) in you;
- you otherwise acquire a legal interest in the share or right;
- you acquire a beneficial interest in the share or right.
This contrasts with the grant date defined in AASB 2, which is the date at which the employer and employee agree to the share based payment arrangement. If the agreement is subject to an approval process (such as shareholder approval), the grant date is the date when that approval is obtained.
Getting the date right
This difference has been highlighted in two recent case before the Administrative Appeals Tribunal.
As can be seen with two cases, it is vitally important to ensure that the relevant date of acquisition is determined properly so that the correct amount of assessable income is reported.
In the case of Re: Willis and Commissioner of Taxation (2010) 79 ATR 287, the company passed a resolution at the AGM on 3 May 2004 approving the issue of options to Willis, who was a director and chairman of the company. However the options were not issued and allotted by the company until 8 April 2005, as evidenced by the holding statement which was issued at that time.
In Case 2/2012,  ATA 142 a partner in a prominent law firm was offered a position with a public company, which included being granted options in the company as one of the components of his remuneration package. Discussions took place during May 2003 and agreement was reached via email and phone, however the draft contract of employment was never executed by either party. The taxpayer commenced employment with the business on 1 July 2003, and was appointed a director of the company on 11 September 2003. The issue of the options was approved at the Annual General Meeting on 28 November 2003, with the actual issue occurring on 22 December 2003.
The judge in Willis concluded that there was no evidence that the options were created prior to 8 April 2005, and “while the act does not define a time of acquisition, it is difficult to see it being prior to a time when the right is created”.
In Case 2/2012 it was considered that the employee had a right to receive options when he commenced his employment on 1 July 2003, as the terms of the unsigned employment agreement were agreed upon in emails, phone calls and by the virtue of the commencement of employment on 1 July 2003. It was also considered that shareholder approval was not a necessary condition to be satisfied before the right to receive options was created. As such, the acquisition date was 1 July 2003, not the later date of approval or actual issue.
The judge in Case 2/2012 concluded that the decision in Willis was distinguishable on the following bases:
- there was no contract with Willis which gave him an immediate contractual right to the options as there was in the more recent case;
- shareholder approval was not required in this recent case as at the time of the contract (1 July) the taxpayer was not a director and approval was not necessary for the grant of the right to the options under the contract.
How to determine the right date?
In most circumstances where options are to be issued to directors and key management personnel, shareholder approval will be required prior to the issue of the options.
In those cases, the views in Willis would seem to be the more correct interpretation of when options are acquired. The acquisition date will be when the options are actually issued by the company, as the right cannot be acquired before it is created. Even where shareholder approval is given prior to the issue of the option, that does not give the employees a contractual right to receive options, but merely authorises the company to take the necessary steps to issue those options to the relevant employees and executives.
In circumstances where options are to be issued under the terms of an employment contract agreed upon (particularly where signed) prior to the commencement of employment, and shareholder approval is not required, then this latest case provides precedent that the date of acquisition of a right to acquire shares can occur upon signing the contract.
Should shareholder approval be a condition of the issue of the options in the employment contract, then that right would not be satisfied until the shareholder approval is obtained, and the acquisition date would be at that later point in time.
How do I determine the acquisition date?
Each situation will be different, so it is extremely important to review the circumstances of each case on its own facts.
The key things to review are:
- terms of the employment contract – is the right created in the contract, or is further action required?
- details of shareholder approval and general meeting notices – does the resolution merely give approval, or does it confirm an earlier issue of options?
- The date recorded on the holding statement – when were the options actually issued by the company?
If in doubt, contact Value Logic to have your situation reviewed and be certain of your tax obligations.