Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Employee share schemes
Overview
5.1 The Bill will amend the employee share scheme provisions of the Income Tax Assessment Act 1936 (the Act) to broaden access to benefits, increase the benefits available in some cases and to make other, mainly technical, amendments.
Summary of the amendments
5.2 The overall purpose of the amendments is to clarify and improve the operation of the law and to broaden access to, and increase the benefits of, participation in employee share schemes.
5.3 Schedule 3 amends the law to:
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- ensure that section 26AAC cannot apply to a transaction that has been taxed under Division 13A [item 1] ;
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- exclude acquisitions of shares or rights from the application of section 26AAC where no benefit is gained by the taxpayer [item 2] ;
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- validate employees' elections under subsection 26AAC(15A) in relation to shares acquired by a trustee on their behalf [items 3 to 5] ;
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- increase the potential benefits, to employers and employees, of participation in certain types of employee share schemes under Division 13A, from $500 to $1,000 per employee per year [items 6 and 12] ;
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- reduce the percentage of employees who must be invited to participate for a scheme to gain access to benefits under Division 13A from three quarters to two thirds, and apply the percentage to permanent employees only [items 8, 9, 20 and 21] ;
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- increase the time in which employers should provide information to employees concerning the market value of shares or rights, from thirty to sixty days [item 17] ;
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- provide for the calculation of market value of shares and rights where they are offered to employees on the first day of trading on a stock market [items 13 and 14] ;
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- include the value of a right to acquire unissued shares in the cost base of a share purchased by its exercise [items 23 and 24] ;
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- make minor technical amendments to Division 13A, including correction of subsections 139C(5), and 139CD(8), and 139CE(4) and section 139FN; and to correct the application of section 139FH through amendment to section 139FA [items 7, 10, 11, 15, 16, 18, 19 and 22] .
5.4 The amendment to section 26AAC to exclude shares or rights from its application where they were taxed under Division 13A has the same date of effect as Division 13A [item 25(1)] . The amendments to validate elections under subsection 26AAC(15A) apply to shares acquired on or after 20 September 1985 [item 25(3)] .
5.5. The amendments to the calculation of the cost base of shares purchased through the exercise of rights apply to rights exercised on or after 20 September 1985 [item 25(5)] . Taxpayers will be able to amend their prior year assessments to give effect to this amendment.
5.6 The amendments increasing the maximum exemption concession and matching income tax deduction from $500 to $1,000, and reducing the employee participation requirements from three quarters to two thirds of permanent employees apply to acquisitions of shares or rights on or after 1 July 1996. [Item 25(4)]
5.7 The amendment ensuring that section 26AAC can not apply to a transaction where no benefit was obtained by the taxpayer will apply from the date of Royal Assent. The amendment increasing the time in which employers should provide information to employees concerning the market value of shares or rights will also apply from Royal Assent. [Item 25(2)] .
5.8 The amendments providing for a statutory calculation of the market value of listed shares or rights which are first listed on a stock exchange on the date of valuation, or where no market transactions have occurred in the shares or rights on or before the date of valuation will have the same application as Division 13A. The technical amendments to Division 13A and the replacement of section 139FH with an amendment to paragraph 139FA(b) will also have the same application as the Division itself. [Item 25(1)]
Background to the legislation
5.9 The taxation of benefits arising under employee share schemes in respect of shares, or rights to acquire shares ('rights'), issued after 6 pm ACT time on 28 March 1995 is generally covered by Division 13A of Part III of the Act. Section 26AAC of the Act continues to apply where Division 13A does not.
Explanation of the amendments
Acquisitions excluded from the application of section 26AAC
5.10 One important difference between section 26AAC and Division 13A is that Division 13A does not apply to the acquisition of shares or rights 'if the consideration paid is equal to, or more than, the market value of the share or right at the time that it is acquired' (subsection 139C(3)).
5.11 Subsection 26AAC(4AA) is amended by item 2 to provide that subsection 26AAC does not apply to shares or rights which have been acquired at or above market value. Market value has the same meaning as in subdivision F of Division 13A of the Act. This means that shares or rights which are acquired at or above market value after the date of Royal Assent to this Bill will not come within the scope of the employee share scheme taxation provisions.
5.12 Consequently, section 26AAC will not apply to any shares or rights which are acquired after the date of Royal Assent to this measure. Acquisitions of shares or rights to which Division 13A does not apply will therefore be subject to the normal taxing provisions of the Act.
Subsection 26AAC(15A) elections
5.13 Where a taxpayer acquires shares or rights under an employee share scheme covered by section 26AAC, and the taxpayer's right to dispose of the shares is restricted or the taxpayer is subject to a condition, the taxpayer is deemed to acquire the shares or rights when the restriction or condition ceases (subsection 26AAC(15)). The consequence of this rule is that the value of any discount received on the acquisition is taxed when the restriction or condition ceases, and any increase in the value of the shares or rights from the time they were issued until the time the restriction or condition ceases is also included in the taxpayer's assessable income in the year that the restriction or condition ceases.
5.14 Taxpayers who were issued shares or rights with restrictions after 19 September 1985 were given the option of electing to have the benefit assessed at the time those shares or rights were issued to the taxpayer (subsection 26AAC(15A)). Any increase in their value following acquisition is subject to capital gains tax (CGT) on sale. The purpose of this election is to alter the time at which a discount on acquisition of shares or rights are taxed and to give the taxpayer the benefit of the CGT indexation provisions.
5.15 An election under subsection 26AAC(15A) must be made on or before the date of lodgment of the taxpayer's income tax return for the year in which the share was issued unless the Commissioner allows a further period for lodgment of the election (subsection 26AAC(15B)).
5.16 In a recent Federal Court decision, it was held that where shares are issued under an employee share scheme to a trustee on behalf of a taxpayer, subsection 26AAC(15A) does not apply to allow the taxpayer to make an election as s/he is not the person to whom the shares were issued. However, many taxpayers in the circumstances in question believed they had made elections under subsection 26AAC(15A). On 20 August 1996 the Treasurer announced the Government's intention of amending the law to validate these elections.
5.17 Item 3 amends subsection 26AAC(15A) to provide that a taxpayer can make an election under the subsection when shares or rights are acquired by him or her. This allows a taxpayer to make the election when shares or rights are issued to another person, such as a trustee, on his or her behalf, as well as when shares or rights are issued directly to the taxpayer.
5.18 Until the decision referred to in paragraph 5.16 above, it was generally accepted that taxpayers could make the election if shares were issued to a trustee on their behalf. Therefore, many taxpayers made elections they believed to be valid. To ensure these taxpayers are not disadvantaged, item 3 applies from 24 June 1986, which is the date the election became available.
5.19 Subsection 26AAC(15AB) is also amended to apply to shares acquired and not shares issued. Item 5 amends the subsection as it applies now, and item 4 amends the subsection as it applied from 24 June 1986, so that overall the amendment has the same application as that made to subsection 26AAC(15A).
5.20 Subsection 26AAC(4AA) is intended to prevent section 26AAC from applying to discounts taxed under Division 13A. However, the wording of the subsection may not operate as intended where shares or rights have been issued to the associate of an employee and thus the person making the acquisition is not the person subject to tax. Item 1 amends the subsection to correct its application.
5.21 The two broad types of mutually exclusive income tax benefits which may be obtained by employees under Division 13A are (1) deferral of income tax, and (2) an exemption concession. The requirements which must be met for participants of the scheme to obtain the deferral of income tax benefit include a requirement that at least three quarters of employees are or have been entitled to acquire shares or rights in the employer under the employee share scheme, or in the employer or a holding company of the employer under another employee share scheme (subsection 139CD(5)). This requirement applies to shares, but not to rights to acquire shares (subsection 139CD(1)).
5.22 The Bill alters the proportion of employees mentioned in subsection 139CD(5) from three quarters of employees to two thirds of permanent employees [items 8 and 9] . This will mean that, where two thirds of permanent employees of an employer are or have been entitled to acquire shares or rights in the employer under the employer share scheme, or in the employer or a holding company of the employer under another employee share scheme, and other requirements listed in section 139CD are met, participants in the share scheme will be entitled to the deferral of income tax benefit. This makes it easier for an employee share scheme to qualify for concessional tax treatment under Division 13A.
5.23 On a discount on acquisition that qualifies for the exemption benefit, up to $500 can be excluded from assessable income (section 139BA) and claimed as a deduction from income by the provider (section 139DC). For an acquisition under a scheme to qualify for this concession, a number of conditions must be met in addition to those applicable for deferral of income tax. These include a condition that participation in the scheme is open to at least three quarters of permanent employees (whether the scheme involves shares or rights), and that the essential features of the offer of shares or rights and of any offer of financial assistance are the same for at least three quarters of permanent employees (subsections 139GF(2) and (4)).
5.24 Items 20 and 21 alter the proportions in subsections 139GF(2) and (4) respectively, from three quarters to two thirds of permanent employees. This makes it easier for discounts on acquisitions under employee share schemes to qualify for the exemption from tax provided to employees by section 139BA, and the deduction to employers provided by section 139DC.
5.25 Subsection 139BA(2) is amended by item 6 to allow an employee who acquires shares or rights which attract the exemption concession to claim an exemption from tax on the discount received, of up to $1,000. This will allow an employee who is eligible to claim an exemption from tax on the discount, to claim the amount of the discount, up to a maximum of $1,000 per year.
5.26 Paragraph 139DC(2)(a) is amended by item 12 so that an employer who provides shares or rights which attract the exemption concession can claim an income tax deduction for the discount provided, of up to $1,000. This will allow an employer who is entitled to claim a deduction under section 139DC for discounts provided to employees, to claim a deduction of up to $1,000 per employee per year under that section.
5.27 An employee needs to determine the market value of shares or rights acquired under an employee share scheme in order to determine the amount of any assessable discount. Division 13A contains provisions to assist taxpayers in determining the market value of shares or rights, by requiring the provision of information to interested parties and by providing statutory calculations and definitions in relation to market value.
5.28 Employers are required to take all reasonable steps to provide an employee with the information necessary to determine market value within thirty days of a request by an employee (section 139FI). This Bill increases that time limit to sixty days [item 17].
5.29 A statutory method for calculating market value of listed shares or rights is provided by section 139FA. This method determines the market value by averaging the weighted value of trading prices during the week before the day of valuation. However, the method cannot determine a market value where the valuation is made on the day that shares or rights are first listed or where there has been no market trading in the right. Item 13 amends paragraph 139FA(a) to provide for a calculation of market value determined over a period which includes the day of valuation. Item 14 provides for valuation of shares or rights as though they were unlisted, where there has been no trading in the shares or rights.
5.30 Section 139FH provides a definition, for the purposes of Division 13A, of the term 'published price'. This term is not actually used in the Division. The section is repealed by item 16 , and the reference to the definition is omitted by item 22 . As the terms of section 139FH also allow taxpayers to choose which stock market valuation to use if more than one is appropriate, item 15 inserts a similar provision into section 139FA.
5.31 In addition, there are some technical errors in the Division. Subsection 139C(5) refers to a trust where a reference to a trustee of a trust would be more appropriate. This reference is corrected by item 7.
5.32 Subsection 139CD(8) currently refers to 'shares or rights' with reference to subsection 139CD(5), while that section applies to shares only. Item 10 amends subsection 139CD(8) so that it refers to shares, rather than to shares or rights. This will not affect the operation of section 139CD, but will clarify the operation of subsections 139CD(5) and (8).
5.33 Subsection 139CE(4) provides a reference to section 139GE which is corrected to a reference to section 139GF by item 11 .
5.34 Section 139FN which deals with the calculation of market value is intended to define an exercise period then refer to that period. A technical error in the wording of subsections 139FN(2) and (3) makes the operation of the subsections unclear. This is corrected by items 18 and 19.
Capital gains tax - cost base of shares
5.35 Where a right ('option') is exercised and the share acquired by that exercise is disposed of, the capital gains tax (CGT) provisions of the Act do not operate as intended. The intention of subsections 160ZZC(8) and (9) of the Act was to include the cost of acquiring an option in the cost base of any share purchased by its exercise. However, under the current law, where the option results in a new share being created by a company, the cost of the option is not included in the cost base of the new share.
5.36 The amendment made by item 23 allows the cost of acquiring an option to be included in the cost base of the share purchased by its exercise, where the shares are issued by the company they are in. This ensures that the original intention of the provisions is achieved. Item 24 allows taxpayers to amend their income tax returns to give effect to item 23 , regardless of the date assessments were issued for those returns.