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new tax rules from 1 april 2018 for employee share schemes

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After a long consultation period, and a delay caused by 2017 election, the IRD’s new rules on the taxation of employee share schemes came into effect on 1 April 2018.

Companies will no longer be able to structure share purchase schemes to have the economic effect of options, while treating increases in the value of shares issued under those schemes as tax free capital gains. Instead, share purchase schemes involving limited recourse loans, partly paid shares and other risk free devices will have gains taxed on the same basis as options.

In practice, this means that:

  • most NZ startups will be best-off using simple option schemes.  Options are easy to implement (you can make an option scheme using our ESOP doc maker in a few minutes) and there is no upfront risk for the employee or cash cost to the startup. No tax is payable unless and until employees exercise their options, at which point tax is due at each employee’s marginal tax rate on the difference between the exercise price and the market value of the underlying shares at that time
  • more established companies may also use simple share purchase schemes under which shares are purchased outright by employees at market value.   As long as there are no vesting or buy-back arrangements in place, increases in the value of the shares above the initial purchase price should be tax free capital gains.  However, employees bear the risk of loss of their investment in the company.

We will discuss some of the technical detail in later blogs.  A few points to be aware of in the meantime:

  • companies are now entitled to deductions on taxable gains made by employees via employee share schemes.  The deduction will generally arise when the employee becomes liable to pay tax – so in the case of share options, this will be at the time of option exercise
  • founder vesting arrangements will not be caught by the new rules (reflecting our submissions on this topic)
  • the tax free status of existing share purchase schemes is largely grandfathered, as long as the vesting/buyback arrangements underpining those schemes expire prior to 1 April 2022.

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