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tax overhaul for employee share purchase schemes

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Last week saw the introduction to Parliament of an IRD Bill that will overhaul the tax treatment of employee share purchase schemes.

The aim of the IRD’s new rules is to put employee share purchase schemes on a similar tax footing to share option schemes.  Put simply, if a share purchase scheme has similar economic features to an option scheme, it will be taxed in more or less the same manner as an option scheme.

what does this mean in practice?

For share purchase schemes caught by the new rules, employees will be required to pay tax on gains made between the date of purchase and the share scheme taxing date.  This is the date at which the shares cease to be subject to contingencies such as vesting or put/call arrangements (excluding vesting/put/call arrangements at fair market value).

The IRD provides a bunch of examples of how this will work in practice at http://taxpolicy.ird.govt.nz/publications/2017-commentary-areiirm-bill/employee-share-schemes.

how will this affect Kiwi tech companies?

We think the Bill will increase the popularity of share option schemes and reduce the use of share purchase schemes.

Share option schemes are simple to implement and carry no risk of capital loss for employees.  They also the norm internationally, whereas share purchase schemes require some explanation when dealing with international VC’s and acquirers.

For companies that wish to offer the opportunity for tax free capital gains to employees, purchase arrangements will need to ensure that employees bear the full risk of loss of value in the shares up to the point that the shares cease to be subject to any vesting/put call arrangement and beyond.  This is likely to be most suitable for senior hires, or where the shares have a very low initial market value so the amount of capital at risk is low.

Because the new rules apply to any purchase of shares by an employee, not just to formal schemes, tech companies (and companies generally) are going to have to take considerable care when documenting share purchase arrangements when bringing new partners or senior-hires into the  business.

This will be particularly so for services companies, who in the past haven’t had to worry about the tax treatment of share buy back arrangements that apply when/if that partner or senior hire leaves the business.  Unfortunately, these new tax rules may force companies into market value buy out arrangements when buy-out at entry price or on some other formula would make more commercial sense.

The IRD’s initial consultation paper on these rules suggested that founder vesting arrangements would result in the taxation of gains made by founders up to the point of vesting.  However, the IRD appears to have has listened to our submissions on this issue and founder vesting will now fall outside of the definition of employee share schemes whether or not the founders are employed by the company.

what happens to existing share purchase schemes?

The Bill does not apply to shares issued to employees prior to 12 May 2016.  Also exempt from the new rules are shares issued after that date but not later than 6 months after the new Bill comes into force, as long as the share scheme taxing date is no later than 1 April 2022 (as long as the shares weren’t issued with the purpose of avoiding the new rules – although it is hard to know how this would be proved or disproved).

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