Australia: significant changes to the rules governing the taxation of shares and rights to shares - 12 May 2009

On May 12, 2009 the Australian Federal Treasurer delivered the 2009/2010 Federal Budget (the "Budget").  The
Budget includes substantial changes to the taxation of equity awards,
including stock options, stock purchase rights, restricted stock and
restricted stock units.  However, limited guidance is available until implementing legislation is enacted.  The
proposed changes are not yet law and need to be passed by the
Australian Parliament, so there is a chance that these amendments may
not be enacted in their current form, especially in light of the fact
that the immediate reaction to the proposal has been overwhelmingly
negative. It has been reported that many Australian issuers have
postponed the grant of equity awards until full details of the proposed
legislation are known.  These new measures, if enacted,
are proposed to apply to shares and rights to shares acquired after
7.30pm Australian Eastern Standard Time ("AEST") on May 12, 2009.

Taxation on Grant of Awards

Under
the prior tax rules, if an employee was awarded a "qualifying" share or
right to shares (which is typically the case for equity plans offered
by U.S. multinational companies), the employee would generally be taxed
at a "Cessation Time" (i.e., at a later time), unless the employee affirmatively elected to be taxed upon grant.   This
election was rarely made by employees, and in most cases, the Cessation
Time (taxable event) would be the date of "vesting" (in the case of
restricted stock and restricted stock units), the date of exercise (in
the case of stock options), or the date of purchase (in the case of
stock purchase rights). 

In
contrast, the Budget proposes the introduction of law that provides
equity awards acquired after 7.30pm AEST on May 12, 2009 (including  "qualifying" shares and rights to shares) will be subject to immediate income taxation on the date of grant.  There
does not appear to be any election available to defer the taxation on
the awards until a later time (such as exercise or vesting). Further, the employees will be subject to tax on such awards regardless of any vesting restrictions or sales restrictions.

Limitation of AUD$1,000 Exemption

Under
the prior tax rules, if an employee elected to be taxed at grant, up to
AUD$1,000 of the taxable amount at grant would be exempted from
taxation, if certain conditions were met.  The Budget
indicates that this AUD$1,000 exemption will be limited to employees
with an adjusted taxable income of less than AUD$60,000.

Many Unaddressed Issues

The
current Budget announcement provides limited details on the operation
of these measures and enacting legislation to give effect to these
measures has not yet been introduced. For instance, under prior tax
rules, if the employee elected taxation at grant, there were fairly
specific valuation rules regarding the amount to be taxed at grant.  In
particular, typical U.S. issuer stock options would be valued based
upon a statutory formula incorporating the fair market value of the
underlying shares on the date of grant and the length of the exercise
period.  For example, under this statutory formula, stock
options with a ten-year term could be valued at 20% of the market value
of the underlying shares subject to the stock option.  Restricted
stock units and restricted stock would generally be valued for taxation
at grant purposes based upon the market value of the underlying shares
(disregarding vesting conditions) and in most cases, using the weighted
average of trading prices during the one week period prior to and
ending on the date of grant.  The Budget does not provide
any indication of whether these existing valuation methods will be
retained or replaced with new methods. 

Although
it is clear that the new tax rules cover new awards, it would be
helpful if some detailed transition rules are provided in connection
with awards granted prior to May 12, 2009.  Would the
substitution of those existing awards in the context of a corporate
transaction or option exchange program result in the new tax rules
being applicable to the replacement awards?

In
addition, under the prior tax rules, there was an ability to amend
individual tax returns in certain cases and claim capital loss
deductions where an employee elected to pay tax on the grant of an
award.  Hopefully, a mechanism will be available for
employees to recover tax paid on awards that did not ultimately provide
any economic value to the employee or provided significantly less
benefit than the amount taxable on the date of grant.

It
is also not certain what the effect of these changes will be with
regard to the payroll tax obligations of the Australian employer. Many
Australian states currently require that the income from equity awards
be included in wages for the calculation of the local employer's payroll tax obligation.  For most states, it is possible for the local employer to defer this payroll tax obligation from grant until the Cessation Time and many local employers have elected to defer.  It may now be the case that the payroll tax liability will be due at grant if these new rules take effect.

Finally, the scope of these rules also needs to be addressed.  For example, will restricted stock units settled in cash be subject to these new taxation rules?

ACTION ITEMS

U.S.
companies granting awards in Australia should immediately review grant
practices in Australia and assess the impact of these Budget measures
on any future awards to employees in Australia.  This
development is likely to make equity compensation much less attractive
to participants subject to Australian taxation. Further, while current
rules do not generally require local employer withholding of income tax
on equity compensation awards (and this does not appear to have changed
under the Budget), Australian participants will be significantly
impacted by this change and likely will require assistance with the
determination of the appropriate taxation values on the date of grant
to be used in connection with their annual individual income tax
returns (Australia uses a June 30 taxable year). Companies should also
monitor the adoption of the implementing legislation and be sure to
update tax disclosures provided to employees in Australia to notify
them of the changes.  Companies relying upon the Australia
Securities & Investments Commission ("ASIC") Class Order Exemption
03/184 to the prospectus filing requirement in connection with an offer
of securities in Australia likely will need to amend any offer
documents (because they typically include a tax discussion) and file
the amended grant documents with ASIC if the Budget proposals are
enacted as proposed.

We
will monitor future developments on this issue, including any
amendments that are made by the Australian Parliament, which is the
next step for the enactment of the Budget proposals.