Guidance for valuation of shares for tax reporting and changes to the tax treatment of employee share plans
Over the last 18 months, the New Zealand Inland Revenue Department (IRD) has focussed on various issues affecting the taxation of employee share plans. In a Tapestry newsletter last year (which can be found here), we discussed the introduction of employer withholding for share plan income and the tax treatment of certain types of share plans. In this newsletter we will cover:
- new guidance on the valuation of shares for tax reporting; and
- proposed changes to the tax treatment of employee share plans.
Valuation of shares for tax reporting
From 1 April, employers have been able to elect to apply withholding on income under an employee share plan. Under the new rules, employers must report the taxable value of benefits that employees receive under employee share plans. To support this reporting obligation, the IRD recently released a Commissioner’s Statement (CS17/01) which provides guidance to employers in calculating the value of share benefits.
Why is the guidance necessary?
The Statement recognises that although the new reporting rules oblige employers to disclose the ‘value of the share benefit’ received under a share plan, tax legislation does not provide the tools for calculating this value. The guidance aims to give employers safe harbour valuation methods which will be accepted by the IRD. The Statement also provides guidance with regard to the information a company should retain to support a valuation.
Do employers have to follow the IRD’s guidance?
Employers can use other valuation calculations so long as the method used determines the value of the share benefit based on the market value of the shares on the acquisition date. If the employer chooses an alternative valuation method, it must retain all supporting documentation in case the Commissioner queries the valuation.
What share plans are covered by the Statement?
Although the Statement refers to Share Purchase Agreements, this is broadly defined to include any plan which involves the acquisition of shares in a company at less than market value by an employee. The share plan may involve the immediate transfer of shares, the granting of share options or deferred share schemes where shares vest or are transferred at a later date.
What does the guidance say?
The Statement sets out several different valuation methods linked to the type of shares to be delivered under a share plan (listed shares, unlisted shares or shares in an unlisted start-up company). Interestingly, the Statement accepts that absolute accuracy is not expected in all cases, acknowledging that this may be affected by the available data, but requires that a reasonable process must be followed. The employer is required to keep the documentation used to make the valuation.
What are the valuation methods for listed shares?
For shares in a listed company, the valuation options are:
- volume weighted average price (VWAP) over the last five trading days (including the acquisition date) for the listed share. The VWAP for a share is calculated by adding up the dollars traded for every transaction relating to that share (price multiplied by number of shares traded) and then dividing by the total shares traded for the day; or
- the Closing Price of listed shares on the acquisition date; or
- if the shares are sold on the acquisition date, the actual proceeds of sale.
For shares offered to employees in a newly listed company as part of an IPO, the valuation is made using the published offered price in the offer documentation.
What exchange rate applies?
For shares in an offshore company, the value should be converted to NZD using the closing exchange rate on the acquisition date.
What is the timing for the application of the guidance?
The guidance applies to any shares acquired by employees from 1 April 2017.
It is unusual for a tax authority to provide this type of specific valuation guidance. In our experience, in most jurisdictions there is no specific method provided and any valuation is permitted so long as it is it reflects the fair market value of shares on the relevant date. The NZ IRD seems to be tying up what it sees as loose ends – having imposed a reporting obligation on employers, it is providing certainty as to how the to fulfil this obligation. There is also flexibility as companies which already use a different form of valuation will not be required to adopt the options in the Statement.
Taxation changes – proposed changes to tax treatment of equity share plans
In the newsletter referred to above, we also reported on the IRD’s proposals for changes to the taxation of conditional and ‘option-like’ share plans. Following consultations on these proposals, amendments to the taxation of share plans generally forms part of the recently introduced omnibus legislation- the Taxation (Annual Rates for 2017-18, Employment and Investment Income, and Remedial Matters) Bill (the Bill).
What is the aim of the legislation?
The Bill is a wide ranging piece of legislation which seeks to modernise and simplify aspects of the NZ tax system. For share plans, the stated aim of the Bill is to achieve neutral tax treatment of employee share plan benefits. This reflects the IRD’s concern that some share plans have been structured with the intention of giving employees tax-free remuneration. Under the new rules, the tax position of both the employer and the employee is intended to be the same whether remuneration is paid in cash or shares, so that there is no tax advantage to the employee receiving shares rather than cash salary.
How are share plans taxed now?
Under the current rules, share plan income is taxed when shares are acquired, on the positive difference between the value of the shares and the amount paid by the employee. The tax is due in the year the shares are acquired. The IRD is concerned that some plans are structured in such a way as to artificially reduce the value of the shares on acquisition, resulting in a lower taxable benefit. The new rules aim to treat all share plans equally by deferring the moment of tax.
How will this work?
The Bill provides that the taxable amount of the benefit will be the difference between the market value of the shares at the ‘share scheme taxing date’ less any amount paid by the employee. If the amount paid is more than the value of the shares, the difference is deductible to the employee. Under the new rules, an employee will be subject to tax on the ‘share scheme taxing date’. This is the date when:
- there is no real risk that the beneficial ownership will change, or that the shares will be required to be transferred or cancelled;
- the employee is not compensated for a fall in share value; and
- there is no real risk that there will be a change in the terms of the shares affecting their value.
This means that employees will be taxable on the value of their shares when they have done everything they need to hold them like any other shareholder (for example, there is no risk of forfeiture if the employee leaves the company or the employee is not protected from incurring a loss if there is any drop in share price).
Is there anything else?
The Bill also proposes:
- employers will be entitled to a corporate tax deduction of the amount that is taxable to the employee (being the difference between the market value of the shares and the price paid for them);
- simplified rules for tax advantaged share plans (called ‘widely offered’ or ‘exempt’ share plans). The rules propose an increase in the value of shares that can be issued to employees from NZD2,340 over a three year period to NZD5,000 a year and removal of the deemed tax deduction now available for employers (with effect from 6 April 2017).
A separate discussion paper has been issued to address the treatment of taxation of share plans for start-up companies.
Are there transitional provisions?
Under the Bill, grandfathering rules apply so that the Bill will not apply to shares granted or acquired before 12 May 2016 or, generally, within six months of the enactment of the Bill where the taxing point under the new rules would arise before 1 April 2022, provided that the shares were not granted with a purpose of avoiding the application of the Bill.
What is the timeline?
The Bill is in the select committee stage and is open to submissions from the public until 5 July 2017. It is likely that the Bill will not come into effect until 2018.