Ernst & Young Submission regarding
Employee Share / Option Plans
This submission relates issues which have not been directly raised by or mentioned in
discussion papers issued by RBT. We refer in particular to the taxation rules and the
administration of those rules governing offers of and participation in employee share and
option plans and the disposition of property arising from that participation.
In this submission we refer to the subject generally as "ESAS".
ESAS participation is essentially a corporate issue because the subject property is
equity or rights to equity in the company offering participation. However, the taxation
rules are aimed at the employee participants most of whom would be unlikely to adequately
understand the impact or potential impact of those rules and/or the administration of
those rules without substantial guidance from the employer. In fact, following the
insertion of Division 13A into the Income Tax Assessment Act and the associated changes to
the Capital Gains Tax rules, there has been a great deal of confusion and concern
regarding how the law should be interpreted and administered. Many corporations and their
advisers have had a number of meetings with Treasury and the ATO regarding these matters
of concern but only a handful of changes have been made to the law and it remains the case
that without a statement of the Commissioners opinion it is virtually impossible to
construct and administer ESAS plans with any certainty of outcome. Unfortunately, whilst
there are a number of errors, ambiguities and unintended consequences in the legislation,
there are many more issues which, with the benefit of hindsight, reflect a lack of
understanding of the issues at the time the policies were developed. As it now stands,
only amendments to the law will achieve an appropriate outcome.
Having stated that ESAS is essentially a corporate issue albeit, in relation to the
employees, Ernst & Young explains that its focus on these issues has arisen from many
years of worldwide experience in ESAS plans and particularly since 1994 when the
Australian Tax changes were first flagged. Since then, we have been working with a very
large group of Australian and Internationally based public companies regarding their
concerns with the new rules. This work included a number of meetings with Treasury and ATO
officers following submissionsand the discovery of specific issues but we have concluded
that the significant barrier to resolution of these issues is a reluctance of the
Government to make further amendments having already absorbed a number of sessions of
Parliament to achieve the handful of amendments already made.
ESAS plans are a critical factor in achieving profitability and shareholder value. This
fact has been proven in the United States and many other countries where the taxation
rules have been developed over many years to achieve a stable and reliable basis for the
development and operation of appropriate plans.
We wish to emphasise the fact that we are not talking about abusive plans which of
concern to the ATO. This submission discusses only the issues which arise from
participation in plans generally covered by Division 13A and usually implemented by listed
or about to be listed companies. These could sensibly be described as "plain
vanilla" plans based on precedents established over many years in the United States,
UK, Canada and other countries and adapted specifically to accord with the taxation rules
in Australia. Unfortunately, the existence/discovery of other types of plans has created
an aura of suspicion around the very mention of employee share/option plans. This aura has
often inhibited rational discussion regarding plans of the type discussed in the
Attached is an outline of "some ESAS issues" demonstrating the existence of
errors, ambiguities, unintended consequences and inappropriate policy applicable to ESAS
On behalf of the many corporations and employees affected by the inadequacies referred
above, Ernst & Young submits that RBT should recommend to Government that meaningful
consultation be established, in a spirit of cooperation, to get Australias ESAS
rules and administration much closer to the international benchmarks to which we aspire.
Should you have any inquiries regarding this submission, please call Mr Jon Kirkwood of
this office (02-9248-4717).
List of ESAS Issues
||How can there be any certainty about the value of a share (or
right) where an offer is made based on the then current price of a listed share but the
price changes through the acceptance period. Uncertainty is a huge issue for
shop-floor/blue collar employees. The date of acceptance should be the date of acquisition
and the market value at the date of offer should be the value for ESAS purposes. Shares
that have not been traded or are only traded on the particular day appear to fall outside
||The width of the "no forfeiture" provision in
Section 139CE (the exemption provision) operates too harshly and should not apply where
the reason for the forfeiture is a bona fide allegation of fraud/dishonesty or misconduct.
||Many plans are now subject to amendment / replacement /
termination as a consequence of a take-over or merger forcing acquisition of shares /
options from employees. The resultant "disposition", whether or not replaced by
shares in the acquiring group,appears to give rise to a CGT liability and a
"cessation" event under Div13A. Surely this was not intended? Worse, where it is
an "exemption"plan, the requirement that the shares / options be held for three
years is breached and the exemption claimed is jeopardised. Surely this was not intended?
||ESAS trusts have a primary purpose of preventing transfer of
shares/options before conditions are met. For example, no transfer is permitted before a
loan is repaid or a specified period of service is completed or a price hurdle is reached,
etc. Accordingly, the establishment of the trust, transfers to the trust and from the
trust to or for the benefit of the employee, should not be taxable transactions. This
should be made clear by a special exception provision for both Section 26AAC and Division
13A (and now in the rewrite - 130-90 "PAYE earner").
||The valuation tables are very unfair and inappropriate where
the share or right cannot be transferred or realised. In addition, the tables do not
recognise an amount paid for an option, nor do they recognise a restricted open period for
exercise and/or price hurdles for exercise (often the hurdle is substantially above the
exercise price). Where the share or option cannot be traded, the value should be
determined as the simple difference between the market value of the share and determined
in accordance with Section 139FA or FB, less the amounts which must be paid to obtain the
share (including amounts for and the exercise of an option where relevant). There are also
problems where the exercise price is variable but cannot be determined until it is paid.
139C(3) consideration for the right does not include exercise price.
||Both the qualification and amendment rules apply
harshly where an associate of the employee is the participant. Given that the employee is
the person taxable under Division 13A, qualification for the shares or rights should be
available under Section 139CD on the basis that subsection (3) refers to the taxpayer or
the employee in respect of whom the taxpayer acquired the share or right.
||Why is cessation of employment a cessation time? Is this
intended to catch retirees? What if the participant retires and the option lapses
(139DD(3))? Why is the exemption forfeited because the participant retires? Why is a
participant taxed because they have retired but have not exercised options? Why does
Section 139DD apply only to options (not shares)?
||Div 13A gives rise to ordinary income but if no amendment or
a loss arises there is only a capital loss! Should be an ordinary loss! The Div 13A view
on MV is entirely speculation and there is no certainty of income or gain! Alternative
revenue deduction in year of lapse/loss should be introduced.
||What is the ATO view on the application of 26AAC and Div 13A
to non residents:
(i) No service connection with Australia/shares in foreign company/never become
(ii) No service connection with Australia/shares in Australian company/never become
(iii) Service connection with Australia/shares in foreign company/never become resident.
(iv) Service connection with Australia/shares in Australian company/never become resident.
(v) Same as (i) but become resident before shares are sold.
(vi) Same as (i) but become resident before rights are exercised.
(vii) Same as (ii) and (v).
(viii) Same as (ii) and (vi).
(ix) Same as (iii) and (v).
(x) Same as (iii) and (vi).
(xi) Same as (iv) and (v).
(xii) Same as (iv) and (vi).
||How is S139C(3) [and (4)] intended to operate? Why is the
exercise price for an option excluded from "consideration" for a right? What if
there is consideration for the right equal to or greater than the Div 13A discount? What
happens to cost base calculations if no amount is included in assessable income under Div
13A? (include rewrite)
||Is it intended that "no discount" participation
cannot be included in 139CD(5) umbrella? What if the consideration for the option exceeds
||Why cant the umbrella rules look back to all
participation before Div 13A and/or have a 3 year rolling test period?
||The third qualification condition (in S139CD (1)) requires
all the relevant shares to be "ordinary shares". Whilst this requirement is
understandable where the relevant shares represent only a small percentage of issued
shares or are not widely held or easily tradeable or listed, the requirement is onerous,
unduly restrictive and not sensible where there is a ready market for the securities (eg.
listed preference shares or preferred ordinary shares), or the shares/securities represent
a fair percentage of all issued shares. Perhaps the requirement should simply be
"ordinary shares or widely held or listed" shares or similar securities (listing
usually requires widely held).
||The cost base rules in the 1936 and 1997 Acts do not work as
intended. For example, the amount included in assessable income under Div13A should form
part of the cost base but faults in the law prevent this from happening.
||What does "right" mean? A right to anything? What
if a new or "escalating" employee acquires (or is granted) a right to
(additional) remuneration. S139C(1) appears to apply. But clearly, 139CD cannot apply
therefore 139B(1), (2) applies ® 139CC(2) ®
139FC ® 139FE; but there is no share.
||Where shares or options are offered to employees with less
than 3 years service (not permanent employees) the company should be able to elect
to include all employees in the denominator and all offerees in the numerator. This is a
big problem for companies with very few permanent employees, most of whom are not intended
to be covered by the "egalitarian" plan. 139CD(5)/CE/GB/GF
||The tests for employment in 139CD(3) and DD(3) should only
apply at the time of acquisition, otherwise a takeover will trigger a failure. Also
the tests should cover employment in joint ventures, partnerships and trusts where the
shares are in a company which has say 25% or greater interest in the venture/ partnership/
trust. Further, proxy votes should be disregarded for 139CD(7) and 139CD(6)
is unworkable if it requires a prediction of the position at any future time. There are
also difficulties in determining the "permanent employee" status of a person who
moves employment from one group company to another before 3 years are attained.
||What is a restriction (s139CA and CB) "preventing
the employee from disposing of the share". A trading block which will only be removed
||3 years employment is attained?
A particular employment
status is attained?
The price of the share reaches $x?
A loan is paid off?
The employee retires?
A call option over the share?
||Why should the FIF rules apply to unvested interests in
shares or rights under ESAS?
||The Commissioner should quickly promulgate "reasonable
methods" of valuation of unlisted shares (otherwise little private company ESAS
arrangements wil be inhibited).
||Why should S139E apply to all qualifying participation by the
employee in that year instead of selected participation?
||How is Section 139G intended to operate? Is it the earliest
of the events or the most relevant of the events that counts? What if a beneficial
interest arises before the transfer / issue / allotment occurs and how does the outcome
align with the valuation rules re a "particular day"?