Following an officials’ issues paper released by the Inland Revenue Department in May this year, an updated consultation paper on the New Zealand tax treatment of Employee Share Schemes (ESS) was issued earlier this month.

Revision of the New Zealand tax treatment of ESS is mentioned as overdue for review, with issues of potential over-taxation and potential under-taxation cited in the May report.

The tax rules currently do not mirror those for other categories of employee remuneration including bonuses. Consequently, unintended taxation events can arise, resulting in the taxation upon share issuance for some employees with tax-free capital gains being derived in other situations. The latter situation can arise when share options are exercised, that is the point of taxation, and then the shares are subsequently sold for a gain. Under New Zealand income tax legislation the ensuing gain is not taxable to the employee shareholder.

The intention of the proposed changes is to ensure that all types of employee remuneration are taxed equally, that is, tax neutrality exists. Through tax neutrality, decisions around how to compensate employees are not affected by how the employee will be, or will not be, taxed.

In addition to considering how ESS impact how an employee is taxed in New Zealand the May paper considers the fact that the employer gets no tax deduction by way of ESS whilst the employee is taxed and recommends that a deduction be allowable to employers providing ESS.

The recommended amount of the deduction is the cost of providing the shares under an ESS to the employees, up to the amount of employment income taxable in the hands of the employees.

The September update on the proposals contained in the May paper reinforces the Tax Policy’s views that share options should remain taxable upon exercise, employers should be entitled to a deduction, and that employees should be taxed on ESS only when the employment conditions forming part of the ESS have been met.

Currently, employees are taxable on ESS at the time that shares are issued, even if the ESS is one with future conditions on the employee, such as length of service, and which have not been fulfilled at the time the shares are issued.

To Summarize:

  • Currently proposed is that ESS will impose a tax on the employee only once all conditions imposed on the employee with respect to the share issue have been met by the employee.
  • There is one exception which arises, should an employee be required to transfer ESS shares for market value under the terms of an ESS; deferral of income will not be applicable.
  • The taxation of options under ESS will remain status quo, ie, options will be taxable at the time of being exercised.
  • Employers will be entitled to a deduction for the costs in providing the ESS, up to the amount of taxable income to the employees.

Submissions are being accepted on the latest round of proposals up until Friday 30 September 2016.