Employee share schemes (ESS) is treated as income ?

My wife got 23k worth of share in the last financial year. ATO website shows that this amount added to her calculation of Total Taxable income of the financial year. So, if income is 200k, then total taxable income becomes $223K for the financial year.

This seems odd to me because you normally pay tax (CGT) when you sell shares not buy.

Isn't this double taxation for ESS

1) When shares are allocated (Income Tax)
2) When shares are sold (CGT)

Any opinions?

 

No, it's not double taxation.
$23k is the cost base for CGT calculation purposes.
So if you sold within 12 months at $25k, then CGT is based on $2k Capital Gain.
If you sell after 12 months, then 50% CGT discount can be used.

 

Thank you for your response.

I get that part - CGT upon sale.

My question is why we have to add $23k to total taxable income for this financial year (and hence pay more income tax) - when we are not selling it yet !

 

It's income, whether received in cash, shares or something else...

 

Same as dividends. Treated like income.

 

Basically its the same as participation in a DRP.
You receive shares instead of cash (an income) and also as mentioned above the shares recieved in leiu have a cost base (23k) for future CGT.

 

its a benefit provided by an employer which has value.

 

Employee share schemes(ESS) are complex and many scheme elect the "deferred" basis of taxation. This delays tax on the "income" sacrificed as "free" shares until a trigger occurs. They arent free they are income exchanged for shares. Often right to shares vest aftre some time. Vesting is a trigger. Vesting means the value at the date they vest is determined and the employee discount on those shares is the assessable sum...not what they were worth when orignally issued. Its a trap of course as deferred can mean more tax but doesnt mean you must pay for the shares. (eg Assessable ESS sum is Value less $0 initially paid) The employer issues a ESS PAYG summary. No tax is withheld.

Care must be taken with option schemes. Options create a right that may have no discount or a discount ad many or not be capable of valuation at issue. However when the opts reach a options exercise point thatt may then be exercised. This creates a new CGT asset and the 12month CGT clock starts fresh. I have seen many people sell their shares straight away to learn that they have no CGT discount.

Understanding the specifics of each ESS is important. The ATO have been very vigilant in dragging many foreign employers into their reaches.

There is also the exempt basis. This tends to apply to limited value under $1k offerred to all employees eg CBA , ANZ etc. The first $1k is exempt except if you are a very high income earner. So you get a free CGT costbase in exchange for $1K of tax`free income.

Employee share schemes

ESS employees also need to consider timing and strategy to lodgement dates as the employer will be subject to PAYG instalments in most cases after lodgement of the first year. This can also overlap with the second. Tax adviser guidance is typical. It can be very complex and confusing.

 

The best ESS schemes are the ones that qualify for the startup concessions.

Equity in unlisted companies gets that much more complicated because of valuation troubles.

In a very simplified view, the discount on ESS rights (options or shares) is considered remuneration and hence taxable income. If a deferring tax point applies then the "discount" is calculated at the DTP time - which may or may not work in your favor.

Once the DTP triggers and income tax liability arises, it is held in capital account and the usual CGT rules apply with some 30-day rule caveats.

If your wife didn't pay anything for the $23k worth of shares and there are no restrictions on disposal then yes that $23k is remuneration and is added to her income.

 

Thank you for a very clear response.

Looking at the attached ESS statement (removed PII information), I can see that she got a 100% discount and hence tax will be on full $23K. Am I reading this correctly?

Is there is more tax efficient approach to deal with this or I have to pay tax on full $23K ? Since my wife is in highest tax bracket , this will be 45% of 23K. Big money

 

You wont pay a single cent in tax on that income. All ESS schemes issue guidance to employees and the deferred tax issue is well known. Its not going to be tax free if you were hoping it may.

Of course the tax paid means there is a costbase that equates to the value of the shares granted based on the vesting date. So future CGT will consider the $23K as a element of the costbase since its what was paid for the shares. However the acquisition date isnt the vesting date but the issue date (shares, NOT options)

 

Thanks Paul. Not sure if I understood that fully. You said “ I won’t pay tax on that income” ( 23k worth shares allocated to my wife) but later you say “ it’s not tax free if you are hoping”. I understand that I will have to pay CGT upon sale, let’s say after 3 years time. Is there any tax , I have to on 23k now or later after eventual sale (in addition to CGT)? The current default tax assessment in ATO tax portal have added 23k to net income for the FY and counting it towards 45% tax.

 

You won’t pay any tax on the shares. Your wife will

 

As others have said, the shares vested to your wife are income and you pay income tax on that income. That is separate to capital gains, assuming there is a gain, when you sell those shares.
I was vested ESS shares over several years which pushed me into the highest tax bracket, it killed me every year having to pay that extra tax. One year I sold some shares to pay the tax but that incurred a CGT as well. After my first return, ATO put me on quarterly PAYG over and above what my employer deducted, but I still had a big tax debt at the end of each year even with my property deductions.
Not only did I have to pay tax on the shares as income, they were USD shares and the tax was calculated based on the value when vested, and at one point with a rising AUD the tax in real terms was even higher.
All that said, I now have a nice lot of shares that have literally tripled in value from the original deemed amount due to the original business being bought out.
My advice is to budget for the tax bill. If you can’t afford it you will need to consider selling shares to cover it. Talk to an accountant on the timing of that as it is important.
Think of the shares as income you are getting. That is what it is. CGT is something else and a completely different matter.

 

Tip : One strategy many ignore is using the vesting date wisely. That is the date that triggers the CGT costbase but not the CGT start date which remains at the date the shares are issued.. So in many cases where the shares are being retained it may even make sense to transfer these shares to a trust or spouse...but often NOT a smsf without advice. That way any future CGT (after 12mths) may alter so its not the ESS employee as owner but another taxpayer at a lesser marginal tax rate.

Yes, it means the transfer / sale on the vesting date triggers a CGT issue...but the costbase and the value will be the same on that date (unless its a new float issue on that date which may be unusual) so the CGT value may be $0. So no extra tax but future CGT could be taxed at a lessr tax`rate. This is especially the case where the employee has a high income. There can also be super strategies to sell the shares to a SMSF but that needs personal tax and even financial advice. The value of the shares may count to caps of the employee and / or spouse etc and must be carefully managed...and will be preserved. But may mean a very low tax rate applies to profit on sale. 0-10% or 15% max.

Tip 2: Foreign currency denominated ESSs can come with a exchange rate tax`issue. Gains and losses on the exchange rate may not be eligible for a CGT discount. Its a complex issue but the FX issue may be a distinct right to that of the shares and theFX gain may not be discounted. Also FX rules take precedence over CGT rules and that means no discount too.....The CGT rules contain a rule that addresses a tax issue when CGT and ordinary incme both apply. This cancels the CGT matter and leaves it fully taxable.
Guide to capital gains tax 2021

All reasons why good tax support and strategies around PAYG variations and sales need ongoing support.

 

I am trying to understand this using terms used by the ATO and on my ESS statements. For a scheme taxed up front (which seems to be the case for the OP) the taxable date is the vesting date, yes? I am not sure what you are getting at with the CGT start date (date shares are issued). Can shares be vested and not issued? I guess I am asking, what do you mean by “shares are issued”?
In my case, the date the shares were issued (and therefore available to sell) is the vesting date, and so also the taxable date setting both the cost base of the shares and the exchange rate to apply for that date.

 

There are a few different methods.

Upfront scheme tax on issue of shares. Deferred schemes tax delay that and tax the empoyee on vesting or other triggers events. eg a termination of employment or disposal will trigger the assessability also. The there is the exempt scheme....Its for broad employer scheme like banks, wesfarmers etc. It basically allows the employees to receive up to $1k tax free. But the catch is it mmust be a broad scheme eg not an executive scheme.

 

Check with your accountant but the "eligible for reduction" part is, well eligible for reduction up to $1000 so the $975.82 should not incur any extra tax

The shares that are under the deferral scheme seem to have vested on 30th Aug 2019 and probably didn't have any further disposal restrictions so that triggered the differing tax point and $22,885.01 is taxable income as it was the discount received for the ESS rights "at the deferring tax point"

Your wife will be up for 45% + 2% medicare levy in FY19-20 on that additional income.

For shares that are intended to be kept long term, a well known strategy is to transfer them to a lower income earning spouse or even better, a family trust at the deferring tax point time.

Transfer to an SMSF is more complex but could be an option too. Watch out for Div 293 issues as well.

PS: I am not an accountant. Seek professional advice.

 

The terminology is indeed a bit confusing. I settled for ATO's broad definitions: Concessional schemes and Non-Concessional schemes - Not to be confused with superannuation terminology

Generally speaking:
The first thing to consider is if there has been a discount to begin with. No discount, no issues. Most ESS schemes will have some sort of discount, otherwise it wouldn't be much of an incentive. A lot depends on how the ESOP is structured. For the sake of this discussion, let's assume that the ESS rights were received with a discount. Most common one being that nothing was paid for the ESS rights (options or shares)

The easiest to understand is Non-Concessional schemes. This is counter-intuitively defined as any scheme that doesn't qualify as a Concessional scheme.

Concessional scheme - ATO does a reasonably good job in trying to explain this - Concessional schemes (concessional tax treatment can apply)

The OP's scheme is not a taxed upfront scheme, a small part indeed is but the bulk of it is a deferral scheme with DTP (deferring tax point) being the vesting date.

When Paul says "issued date", I think he means the date the ESS rights were originally granted. The cost base is "reset/re-calculated" at vesting but the "acquistion" date will remain as the grant date? This maybe true if the ESS rights are shares but not for options.

Paul raises a good point with FX issues. ESS stock options from an unlisted foreign company (that doesn't qualify for start-up concessions) is no fun at all.