The New Zealand Inland Revenue has released an officials’ issues paper entitled “Taxation of employee share schemes” (Issues Paper) that proposes a number of amendments to the New Zealand tax treatment of employee share schemes.
The Issues Paper follows Inland Revenue’s “Revenue Alert” on November 13 2015, which advised that certain types of employee share schemes being used in New Zealand could be subject to the general anti-avoidance provision.
Under existing law, the taxation of schemes in which employees acquire shares in their employer is straightforward. In short, the amount of taxable income arising for an employee equals the market value of the shares acquired by the employee, less the amount paid or payable by the employee for those shares. That income is subject to tax at the employee’s marginal tax rate in the income year in which the shares are acquired.
In recent years, Inland Revenue has challenged a number of share schemes, including on tax avoidance grounds, resulting in a degree of uncertainty regarding their tax treatment. Inland Revenue was concerned that Parliament’s intention, that shares be valued at the time they are acquired, was being avoided due to the operation of some conditional and reclassification schemes. This concern resulted in Inland Revenue issuing its “Revenue Alert”, which put taxpayers on notice that it was investigating such schemes.
Two key proposals in the Issues Paper are:
- Allowing employers a deduction for the provision of shares under a share scheme; and
- Deferring the point of taxation for employees under conditional share schemes until the employee has all of the risks and rewards associated with share ownership.
Inland Revenue has proposed that employers be entitled to a deduction for the provision of shares under a share scheme. The deduction will be limited to the extent to which the provision of shares gives rise to taxable income for an employee. This change is designed to ensure tax neutrality between cash remuneration and employee share scheme benefits.
Inland Revenue has also proposed that the point at which employees are taxed under conditional share schemes (schemes where conditions must be fulfilled before employees obtain unrestricted ownership of the shares) will change. At present, the point of taxation is when the employee first acquires the shares, rather than when the employee obtains the shares free of any conditions. Inland Revenue is concerned that the two points in time are often years apart and that, under current law, increases in the value of the shares during that intervening period would be categorised as capital gains rather than as employment income. Capital gains are not generally subject to tax in New Zealand.
Inland Revenue has proposed to tax employees at the point when the shares become free from “substantial conditions”. The term “substantial conditions” is not defined in the Issues Paper, but Inland Revenue has indicated that it will effectively be when the employee has all of the risks and rewards associated with share ownership.
Inland Revenue has acknowledged that share schemes are often long term arrangements. Accordingly, Inland Revenue has proposed a set of transitional measures.
Under the transitional measures, the existing rules will continue to apply for three full tax years to shares acquired by an employee under a share scheme before enactment of the proposed amendments. For example, if the amendments were enacted in June 2017, the proposed transitional measures would expire on March 31 2021 (i.e., three years after the end of the tax year in which the amending legislation is enacted). Transactions occurring after that date would be taxed under the new rules, with an allowance for any tax already paid under the old rules. For shares acquired after enactment of the new rules, the new rules would apply.
Multinational enterprises operating in New Zealand often offer participation in global share schemes to their New Zealand based employees. The terms of such global schemes are often not designed with New Zealand tax law in mind and are unlikely to be amended to address Inland Revenue’s concerns. The proposed changes (if enacted) will likely require the documentation disclosed to New Zealand based employees in respect of such global schemes to be updated to outline the changes.
This article was first published in the International Tax Review
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