Australian Government Releases Draft Legislation on Taxation of Equity Awards
Further
to our Legal Alerts dated May 14, 2009 and July 6, 2009, on August 14,
2009, the Australian Government released draft legislation (including
explanatory materials) setting out the tax treatment of equity awards
in Australia effective July 1, 2009. The draft
legislation adopts most of the changes proposed in the Government's
Policy Statement (which we discussed in our Legal Alert dated July 6,
2009). A copy of the draft legislation package can be found by clicking here.
Our Sydney office has prepared a detailed alert discussing the draft legislation which can be found here. For
U.S. based companies granting or intending to grant options or RSUs or
offering an ESPP in Australia, the highlights of the new rules are as
follows:
- For
grants on or after July 1, 2009, the general rule is that equity awards
will be taxed at the time of grant, unless the awards are subject to a
"real risk of forfeiture." If tax is at grant, a tax
exemption of up to A$1,000 may be available, provided certain
conditions are met (including a requirement that the plan be offered to
at least 75% of permanent employees). Equity awards
subject to a vesting schedule which is based on continued employment
will be considered subject to a real risk of forfeiture until vesting,
provided the shares issued at exercise/vesting are not subject to any
additional restrictions (which could further defer the taxable event).
- Consequently,
most options and RSUs granted by U.S. parent companies will be taxed at
vesting when there is no longer a real risk of forfeiture. Of
course, for options, this represents a significant change and burden,
especially if the options are underwater (or barely breathing) at
vesting but are still considered to have taxable value under the
Australian valuation rules (as further discussed below).
- ESPP
rights will continue to be taxed at purchase on the discount (i.e., the
difference between the market price of the shares at purchase and the
purchase price).
- The
valuation rules in the current law (which the Government accepts are
inflexible and often result in high compliance costs) will be
overhauled - but the new rules have not yet been drafted. As
an interim measure, the Commissioner of Taxation will accept any
reasonable method of valuation of an option or RSU at the time it is
taxed. These valuations can be based on either (1) a
reasonable determination of what the taxpayer considers is the price at
which the option or RSU could be sold by a willing (but not anxious)
seller to a willing (but not anxious) buyer (the Australian Tax Office
has put together a guide, entitled Market value for tax purposes, that
taxpayers can use for the purpose of undertaking a valuation) or (2)
use the existing inflexible valuation rules in the current tax
legislation.
- Under
the existing valuation rules in the current tax legislation, options
can be valued at the greater of (a) the intrinsic value of the options
at vesting (i.e., the positive difference between the market value of
the shares at vesting and the exercise price), and (b) the market value
of the options at vesting determined pursuant to a statutory formula. RSUs can be taxed on the market value of the shares on the vesting date. To
determine the intrinsic value of an option at vesting and the market
value of the RSU shares at vesting, shares can be valued under the
current valuation method for listed shares, i.e., using the seven-day
weighted average market price. If, however, the shares are sold within 30 days of the taxable event, the sale price can be used.
- For
options that are more than 50% underwater (i.e., the market price of
the shares on the vesting date is less than 50% of the exercise price),
there will be neither an intrinsic value nor any value under the
statutory formula. Therefore, no tax will be due if the existing valuation rules are used. For
options that are less than 50% underwater (i.e., the market price of
the shares is more than 50% but less than 100% of the exercise price),
the statutory formula will produce at least some value, such that these
options may be subject to tax if the existing valuation rules are used
even though there is no intrinsic value and the employee cannot realize
any gain at that time. Similarly, it appears that for
options that are slightly in the money (i.e., where the market price of
the shares at vesting is slightly above the exercise price), the
statutory formula produces a higher value than the intrinsic value. This
means the employee can be taxed on an amount that exceeds the gain
he/she could realize if the option were exercised on the vesting date
if the existing valuation rules are used.
- If
options are forfeited after vesting but before they are exercised, a
refund for the tax paid at vesting will be allowed where the employee
had no choice but to forfeit the option. No refund is available where the option is forfeited only because the option remains underwater. In
this case, the employee will be considered as having made a "choice"
not to exercise the option, even though it would not make any sense to
exercise an underwater option. Where no refund is available, the employee should be entitled to a capital loss.
- The
Australian employer (or possibly the parent company that is the
provider of the equity awards) will be required to report the awards on
a statement in an approved form (to be prescribed) to the Commissioner
of Taxation and to the employee when awards are granted and when the
awards become taxable in a particular financial year.
- The
Australian employer (or possibly the parent company that is the
provider of the equity awards) may also be required to withhold tax -
but only if the employee fails to provide his/her Tax File Number (TFN)
or Australian Business Number (ABN) to the employer/provider by the end
of the income year. It would be very rare for the employee not to provide this information to the employer.
- It
appears that the Australian employer company may continue to take a tax
deduction if it reimburses the parent company for the cost of the
equity awards. The draft legislation mirrors the current rules in this respect. The amount of the deduction is ascertained according to usual principles of deductibility. However, there will be no deduction until the ultimate beneficiary acquires the share interest.
- The
taxation of options at vesting will present a problem for employees
transferring in and out of Australia, because it will not match the
timing of taxation in the respective other countries (where the option
will be taxed at exercise in almost all cases), which will complicate
the employee's ability to take foreign tax credits. In
this regard, a particular problem will arise for tax-equalized
employees who cannot be charged for hypothetical tax at the time of
vesting in their home country since vesting will not be a taxable event. This
could result in the company facing increased assignment costs because
it may not be able to offset the Australian tax liability it has to
bear under the tax-equalization policy with any hypothetical tax
charged to the employee.
- We
are not yet certain if or how the draft legislation will affect a
company's obligation to pay payroll taxes on the equity awards.
We will continue to monitor the progress of the draft legislation and the valuation rules in particular. The draft legislation is open for written submissions until August 31, 2009. Together
with our Sydney office, we intend to reiterate to the Australian tax
authorities that taxation at vesting for options is unfavorable and out
of step with the tax rules in the vast majority of jurisdictions. If you would like to join our submission or prepare your own submission in this regard, please let us know if we can assist. As always, if you have any questions, please contact your GES attorney.
