The Federal Government’s planned changes to employee share schemes continue to be attacked by business leaders, lobby groups and unions, desperate to protect the tax benefits received by their staff and members under the equity grants. The Financial Review continued its campaign against the changes, noting the views of NAB Chairman, Michael Chaney, who dubbed the move “inexplicable … counterproductive … and totally unfair.” (The timing of Chaney’s comments and his defence of executive share schemes is ironic, given The Age’s revelation today that between 50 and 100 senior NAB executives are currently enjoying a secret shareholder-funded junket in San Francisco).
Some critics of the proposed laws suggest valid points. Crikey received several excellent comments in relation to yesterday’s commentary regarding changes to the taxation of employee share schemes. The general theme was that while tax evasion by executives in relation to non-reporting of equity instruments can be solved by other means (such as withholding tax or mandatory employer reporting) and that the Government’s initiatives go to far in requiring upfront payment of tax on not-yet vested instruments.
Andrew Carter noted yesterday that:
Taxing the share or option at grant is more generous than the existing system, the problem the business community has with the change is that it is completely impractical.
It imposes a tax liability on an employee that can’t be funded because the share or option is wrapped up in, typically, a [three] year vesting period. It can’t be sold to fund the tax bill, and this is the fundamental problem with the new rules (not only can’t it be sold, the option may never be earned if performance hurdles aren’t met).
In a practical sense, Carter’s points are completely valid — some employees would be unable to participate in share schemes due to their personal financial position precluding them from funding the tax payable immediately. (Admittedly, this problem would not be universal, given that tax is paid at the taxpayers’ marginal rate on a steeply discounted accounting value”. Also, the tax paid can be re-claimed should the option never vest).
Leaving aside the mechanics of the planned changes — the overarching (and seemingly ignored) issue is whether employee equity scheme are actually beneficial to the economy (and to the companies operating them). They are certainly a good thing for the employees who receive the shares who are able to benefit from concessional tax treatment.
Importantly, such share schemes are only available for employees who work at public companies. Therefore, certain workers are able to receive concessional tax treatment (in the form of deferred taxation and later discounted taxation) at the expense of all other taxpayers (such as employees at private companies, small business owners, partnerships or not-for-profit organisations). Why should one worker be able to defer tax while another not simply because they happy to work at a public company as opposed to an accounting partnership or small business? There is nothing to stop an employee using their disposable income to purchase shares in their employer, the only reason most people don’t is because there are no tax benefits to such actions.
Moreover, there are significant doubts whether the granting of equity incentives to employees actually provide any benefit to the company itself. For non-executive staff, the notion of handing a middle-manager a couple of thousand dollars worth of shares will alter their performance is bizarre. Most employees would consider receiving equity grant as a kicker to their income and a handy way to defer tax. For example, it would be difficult to believe that employees of Visy would be less motivated than employees of Amcor. Judging by their relative performance, one would suspect the contrary is the case. (Some may even argue that the main reason companies continue to operate share schemes is because executives benefit from them and human resources staff who have a job because of them).
As far as executives go, while they have a greater degree of control over their company’s fortunes than lower-level employees, it is doubtful that providing equity instruments to executives reduces the spectre of agency costs. The theoretical reason for granting executives equity in the first place (in the form of options, shares or performance rights) is to align their interests with those of shareholders. In reality instead of minimising agency costs, granting equity may actually have the opposite effect.
For example, by providing an executive with options containing an EPS or market-based performance hurdle, executives would benefit from a short-term spike in earnings by say, reducing capital expenditure or by undertaking risky lending or trading. While such actions would likely lead to lower long-term returns, they would increase the chances of executives’ seeing their options vest.
By the time investors realised that the profit were only temporary (and most likely, damaging to the company’s long term prospects), the now-wealthy executive would be long gone. (In other cases, executives don’t bother to goose short-term earnings, rather the equity instrument will re-testing performance hurdles constantly while other companies will simply backdate the terms of equity instruments to ensure that executives are paid regardless of actual company performance).
Equity schemes are an unfair burden on the majority of the community and in most cases, are of little or no benefit to anyone except the executives and employees receiving the grant. If the Federal Government’s proposed laws lead to petulant companies cancelling share schemes due to taxation implications, that may very well be a good thing for shareholders and taxpayers.
Clearly there are major issues with the imposition and collection of this tax. Rather than impose an immediate tax obligation on an individual payable when there are limited or no resources to make such a payment wouldn’t it make sense to create an indexed contingent tax liability (similar to a HECS obligation) linked to the vesting or exercise date of the share or option grant.
Assuming that these schemes are not cancelled wholesale by companies as you suggest it seems unfair that the imposition of a tax regime like this benefits the wealthy executive who can fund the tax payment while those without the resources to make the payment has to opt out of the scheme. The way the tax is being implemented is regressive in that it allows the rich to get richer while the poor (relatively) miss out again.
The thrust of this article ignores one basic fact: All taxpayers hate the lack of symmetry in the tax system, it smacks of unfairness and punishes with one hand but provides no reward from the other. Clearly there is no symmetry in the way this tax has been implemented. On the one hand the government taxes the share or/option grant, the taxpayer pays the tax, presumably with borrowed money. The interest on the tax debt is not deductible as it is a personal expense and not for income producing purposes. On the other hand if the shares/options vest well and good, if they don’t the government refunds the tax but not the interest and it’s never deductible. In situations where the options or shares never vest the government has an interest free loan from the taxpayer while the taxpayer remains out of pocket to a substantial extent.
The idea of taxing people before they receive the money is fundamentally unfair. Because someone has promised me something it doesn’t mean that I will ever receive it.
We should only be taxed when we get the benefit – not when the promise is made.
Using the logic of taxing people when a promise is made then any predefined bonus scheme would taxed at the time of making the agreement.
We would tax people up front if they had a contract for employment for the next five years.
We would tax people upfront on the interest on a term deposit.
This approach is unfair and unworkable. Shares should not be taxed until they are realised in one form or other. E.g. the person receives a dividend on them, they sell them, they take out a loan using the shares as security.
In reference to:
“Why should one worker be able to defer tax while another not simply because they happy to work at a public company as opposed to an accounting partnership or small business? ”
I’m not tax or shares expert, but believe there are tax concessions and deductions available which vary greatly based on type of employment. For example, tax free (before tax) salary packaging is available to many staff in Not For Profits, but remains unavailable to staff in other workplaces. Travel to work costs may be deductable for small business owners & partnership type workers (depending on circumstances of course), whereas those same deductions are essentially inaccessible to employees in public companies. No doubt more informed readers could name many other examples.
So as far as I can tell, differences in the availability of tax concessions or allowable deductions are not necessarily unfair over all, but most likely balance out between types of employment. Otherwise, wouldn’t all of the workforce would move to the especially tax advantageous employment type, or try to do so?
I can’t say I’ve ever heard of anyone moving into employment for a public company for share scheme tax advantages (alone) … unless they’re at the stratospheric end of the payscale anyway. Of course, I could be overly naive, and am open to explanation of why my view is plain wrong.