The Employee Share Scheme (ESS) tax treatment for expats and non-residents is often an area of confusion. The article below outlines the Australian ESS rules and broadly how they apply to Australian expats and non-residents of Australia.
Employee Share Schemes
The concept of an ESS is defined as a scheme under which “ESS interests” in a company are provided to employees or associates of employees in relation to the employee’s employment. ESS interests can either be by way of shares or options in the company.
The taxable value of the ESS interest is the discount received relative to the market value at the taxing point. The discount is the difference between the market value of the share (or option) and the consideration paid by the employee when it is acquired or exercised.
Upfront or Default Taxing Point
Broadly, the default taxing position is that a taxpayer who acquires an ESS interest under an ESS at a discount to market value is taxed on the discount calculated at the time of the grant of share or option.
Where upfront taxation applies, the value of the discount is included in the taxpayer’s assessable income at the time of grant of the shares/options.
Deferred Taxing Point
However, where certain conditions are satisfied, a deferral of tax may be available to a later income year where the shares or options are subject to a “real risk of forfeiture”.
Where the shares or options satisfy the criteria for deferred taxation, an amount will not be included in the taxpayers assessable income at the time of acquisition of the ESS interest but rather deferred until the “deferred taxing point” which is broadly the gain made on the ESS interest up to the ESS deferred taxing point.
Where the taxing point of the ESS interest is deferred, for Australian CGT purposes the recipient will be treated as having acquired the ESS interest at the ESS deferred taxing point for its then market value (effectively future increases in the value of the shares at this point will be taxable under the CGT provisions. The 50% CGT may be available going forward).
ESS Start-Up Concession
The ESS start-up concession is available to employees of certain small start-up companies who acquire shares or options in the employer on or after 1 July 2015.
Broadly speaking, where the concession applies, an income tax exemption is available for the discount received on the shares and the deferral of the income tax on the discount received on certain options. Further, the ultimate gain in respect of the sale of the shares/exercising the options will be taxable under the CGT rules with the 50% CGT available where the shares or options held for greater than 12 months and by an Australian resident taxpayer. Broadly, the CGT cost base will be exercise price paid in respect of the options.
Importantly, there are a number of strict conditions that which must be satisfied in order to access the start-up ESS concessions.
International Tax Issues for ESS Interests
Where Australian expats or foreign resident taxpayers receive ESS interests, it gives rise to further complexities.
Whether an ESS interest is included in a taxpayer’s assessable income under the ESS rules will depend on the taxpayer’s residency status and the source of the income.
Australian resident taxpayers are subject to Australian income tax on discounts they receive under ESS interests regardless of whether they received it in relation to employment in Australia or outside Australia. However, this may be impacted by Australia’s double tax treaties and the temporary residents rules.
Non-resident resident taxpayers are only subject to Australian income tax on discounts they receive under an ESS to the extent that the discount relates to employment in Australia- that is, the employment has an Australian source. Whether or not the employment has an Australian source will be a question of fact based on the circumstances of the taxpayer’s employment. Therefore, where a non-residents ESS interests are fully vested prior to commencing Australian tax residency, there should be no Australian income tax implications. However, note that there will be Australian CGT implications relation to the shares going forward.
Where an Australian resident taxpayer relocates overseas, no capital gain (or loss) should result under CGT event I1 at the time of leaving Australia if the deferred taxing point in respect of the ESS has not yet occurred and no amount has been included in the taxpayer’s assessable.
Where relevant, the applicable Double Tax Treaty would also need to be considered where an Australian resident taxpayer relocates overseas and subsequently disposes of the shares. For example, under the Australia and US DTA, any future Australian CGT arising from the disposal of the shares where an election is made to defer the Australian CGT ‘exit charge’ may only be taxable in the United States where a sale of shares occurs when the Taxpayer is resident in the United States.
For temporary residents of Australia, Capital gains (and losses) realised on ESS interests acquired under an ESS are eligible for the temporary residents CGT exemption in a similar manner as other CGT assets provided the income taxing point has occurred under the income tax provisions.
Please do not hesitate to get in contact with us if you have any questions in relation to your ESS and we would be happy to assist you further.