Chapter 7 - Employer deductions
7.1 The amendments in the Bill provide a deduction for employers for providing employee compensation in the form of shares, just as they can claim a deduction for other types of remuneration. This is consistent with the overall policy goal of neutral treatment between different forms of remuneration. Failing to provide a deduction for remuneration by way of shares similar to that available for remuneration in cash could discourage the use of ESS.
7.2 This deduction reflects the economic reality that the issue of shares for less than full market value involves a cost to the other shareholders in the company (as it dilutes their interests).
7.3 The same principle should apply to employers who provide shares to employees under a deferred ESS.
7.4 Under a deferral regime, the employee is the economic owner of the shares at an earlier point in time than when tax is payable. To address the practical issues of valuation and liquidity, the employee becomes taxable (in most cases) upon the satisfaction of a liquidity event, when the shares are more easily able to be valued, and they become converted or convertible into cash with which to pay the tax.
7.5 The question then arises as to whether the deduction should arise for the employer at the usual taxing point or at the deferred taxing point.
7.6 From a revenue collection perspective, the same considerations that mean the Government is indifferent between taxing the employee at the usual or deferred taxing point also apply in relation to the deduction.
7.7 However, if the employee is paying tax on a deferred basis, allowing a deduction at the usual time presents an increased collection and audit risk. The Government would be allowing a deduction to the employer with no guarantee that the employee would return the corresponding income in what might be a substantially later year. This risk is greater if the deferred taxing point can be extended past the employee leaving employment.
7.8 A further argument for deferring the deduction to when tax is payable, is that the same valuation issues for employees apply to the employer. It may not be possible for the employer to calculate the amount of the deduction.
7.9 As discussed above, employers may also prefer to defer their deduction. This is because start-up companies often generate significant, unusable tax losses in their early years of operation, only to forfeit these losses when third party investors buy a stake in the company (because they lose shareholder continuity at that point). It is also at this point in time when companies are likely to be generating a net profit and would benefit from the earlier carried forward losses to reduce their current year tax bill. Therefore, it seems advantageous to the company to defer the deduction until the deferred taxing point, as well as sensible from a revenue perspective.
7.10 In Australia, generally deductions for tax deferred schemes are also deferred to when the employee receives the employee share scheme benefit.
7.11 In light of these considerations, if a deferral regime is introduced, we propose that deductions be deferred until income is recognised by the employee.
We are interested to hear from readers whether they agree that employer deductions should also be deferred in relation to shares offered under a deferred employee share scheme.