On 6 April 2017, the New Zealand Government introduced draft legislation, containing proposals to modernise the tax treatment of employee share schemes (ESS) in New Zealand. Broadly, the new rules apply to benefits provided under ESS which are not taxed under existing rules within 6 months of enactment of the draft legislation.
The main proposals contained in the draft legislation include:
- New core rules for determining the amount and timing of derivation of income under an ESS
- Allowing employers providing ESS benefits a corporate tax deduction which matches the income to employees in timing and quantity
- Simplified rules for widely-offered ESS (exempt schemes)
- grand-fathering provisions to ensure existing and proposed ESS have time to take account of the new rules.
While the draft legislation does not contain any measures specifically aimed at start-up companies, the Government has indicated that it will release a refined public consultation document relating to start-up companies in due course.
The draft legislation aims to ensure a neutral tax treatment of ESS, to ensure the tax outcome for ESS benefits is largely the same as the outcome that would have arisen had the employee received cash remuneration rather than shares.
There has recently been considerable uncertainty following concerns expressed by the IRD regarding the taxation of ESS in New Zealand.
The uncertainty resulted from the release of several IRD publications including two issues papers released in May 2016 and September 2016 which contained proposed changes to the taxation of ESS.
Following public feedback, these proposals have now been updated and refined in the draft legislation contained in the Taxation (Annual Rates for 2017-18, Employment and Investment Income, and Remedial Matters) Bill.
The public will be able to provide feedback on the draft legislation during the New Zealand Government’s Select Committee process.
The amount of employee income
The amount that will be subject to tax is the difference between the value of the shares and any amount paid by the employee for those shares. If the amount paid is more than the value of the shares, the difference is deductible to the employee.
The proposed new rules include an income apportionment formula to determine the amount of foreign sourced income which may be excluded from tax in New Zealand if the person is neither New Zealand resident nor deriving other New Zealand sourced income.
The timing of income derived by an employee
The proposed rules defer the time at which an employee derives income from an ESS in certain situations. Under the proposed rules, ESS income will be considered derived by an employee and subject to tax at the earlier of the date:
- The shares are transferred to the employee or cancelled for consideration, or
- The employee owns the shares in the same way as any other shareholder.
Examples of where the employee will not own the shares in the same way as any other shareholder include cases where the employee is required to forfeit the shares if they decide to leave the company, or where the employee is entitled to compensation for a decline in the value of the shares.
Under the proposed new rules, employers will be entitled to a corporate tax deduction for the value of the ESS benefit provided, with the value of the deduction being calculated in the same way as the income derived by employees. The deduction may be claimed at the time that the income is derived by the employee.
Other costs that may be considered as a deduction are limited to:
- Costs of operating an ESS, such as legal and accounting fees incurred in setting up the scheme, along with ongoing management fees, and
- The amount of any cash bonus paid to an employee associated with an ESS.
No deduction is allowed for payments to fund an ESS trust to acquire shares, or to reimburse a parent for providing shares.
Widely offered schemes (exempt schemes)
The Government considers the current rules for exempt schemes to be outdated and complex. Following public feedback, it has been decided to retain exempt schemes but introduce amendments to make them less restrictive and simpler to operate.
The new rules include the following proposed changes:
- The maximum value of shares provided will be $5,000 per year
- The maximum discount an employer can provide to an employee is $2,000 per year, meaning that the most an employee can spend buying shares per year will be $3,000 (i.e. $3,000 plus the $2,000 discount equals the maximum value of $5,000).
- The cost of the shares to employees must not exceed their market value.
- Any minimum spend requirement per employee must be no more than $1,000 per year.
Other key changes to the regime include:
- Removal of the current 10% notional interest deduction for employers providing an interest free loan to employees
- Employers are no longer able to claim a deduction for the cost of providing the shares (other than scheme management and administration costs)
- If there is a cost to the employee to acquire the shares, an interest free loan must be provided, or the employee must be allowed to pay for the shares in instalments (currently discretionary)
- Exempt schemes will no longer require IRD approval. However, the IRD must be notified of the scheme’s existence and the employer must advise the IRD when grants are made under the scheme.
Benefits provided under existing exempt schemes will continue to be exempt from tax under the new rules, although such schemes may be amended to increase the benefit to their employees to the proposed monetary limits.
It is proposed that the amendments to exempt schemes will generally apply from the date of enactment, including denial of the notional interest deduction. However, the provision denying employers a deduction for the cost of providing the shares will apply from the date on which the Bill was introduced, i.e. from 6 April 2017.
The Bill contains grand-fathering provisions to ensure existing and proposed ESS have time to take account of the new rules.
Under the grand-fathering provisions, the new rules do not apply to ESS where the shares were granted or acquired before 12 May 2016.
In addition, the new rules do not apply to ESS where all of the following are satisfied:
- The shares were granted or acquired before the date that is 6 months after the date of the Bill’s enactment
- The shares were not granted or acquired with a purpose of avoiding the application of the new rules, and
- The share scheme taxing date for the shares is before 1 April 2022.
While the Bill does not contain any special rules for start-up companies, the Government has signalled that officials are currently developing a public consultation document that refines the proposals for start-up companies. This consultation document will be released for public feedback in due course.
From 1 April 2017 employers are required to report to the IRD the amount of income their employees derive under an ESS. Large employers are currently required to report the amount of income in the pay period after the ESS derivation point.
Under the proposed PAYE reporting rules, the Bill proposes to amend the recognition point of ESS income to 20 days from the ESS derivation point for all employers. It is proposed that this change will become effective from 1 April 2019.
Companies with existing ESS should review their schemes to determine how they will be affected by the draft legislation.
In addition, companies considering implementing ESS should consider how the draft legislation will apply to any proposed scheme.
Please contact your EY tax advisor if you would like to discuss any of the measures contained in the draft legislation, or if you would like to talk about making an independent submission on the draft legislation.
EYG no. 01685-175GBL
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