Simple is best for employee share plans

Most large ASX-listed companies have employee equity plans that utilise tried and tested tax deferral or tax-exempt features enshrined in part 83A of the Income Tax Assessment Act.

However, some smaller ASX-listed and private companies have been lured into adopting more complex and purportedly more tax effective employee equity plans based on private tax rulings.

A recent case has highlighted pitfalls with this approach, and emphasises that when it comes to employee share plan design, simplicity is usually the best approach.

In Yip and Commissioner of Taxation [2011] AATA 758 (4 November 2011) the Administrative Appeals Tribunal (AAT) applied the general anti-avoidance provisions of Part IVA of the Income Tax Assessment Act 1936 to uphold objections made by the Commissioner of Taxation to two private tax rulings. The case is now on appeal to the Federal Court.

Part IVA applies if two criteria are met. The first is that a person obtains a tax benefit (such as an allowable deduction) in connection with an arrangement. The second is that it can be concluded that the arrangement, or any part of it, was entered into, or carried out, by any person for the dominant purpose of enabling a tax benefit to be obtained. Where both criteria exist, the effect of the provisions in Part IVA is to cancel the tax benefit the person would otherwise enjoy.

In Yip, the tribunal held, in relation to two private rulings, that salary sacrificed contributions made to an employment trust arrangement remained assessable to the employee under s 6-5(4) of the Income Tax Assessment Act 1997. The trust funds were to be used to provide loans to allow the employee to apply for share units in the employee share trust. The trustee would use the application money to acquire shares in the employer or its holding company. The loan would be fully repayable by the employee.

Interested readers, including those who have implemented such plans, can refer direct to the AAT decision, available HERE.

The underlying premise is not that companies should not try anything new or different. But only on the basis that these are explicitly and transparently compliant with the letter and intent of Australia’s laws and regulations. To be transparent, equity plans cannot be complex. So be very careful if you do not fully understand how an adviser’s suggested share plan works.