The new Australian share plan legislation received Royal Assent on June 30, 2015 and applies to all equity awards granted on or after July 1, 2015. Under the new tax regime, stock options are generally taxed at exercise only (not at vesting).
In this post, we explore the practical implications of the new legislation for most companies and examine the exceptions to the rule.
Grant Document Changes
Under the old tax regime that was in effect from July 1, 2009 until June 30, 2015, options generally were taxed at vesting which obviously was not a good result for companies nor for employees. As a result, many companies stopped granting options in Australia altogether. The companies that persevered (often private companies with no alternatives, such as RSUs, available to them) usually imposed special terms designed to avoid a taxable event prior to a liquidity event or at a time when options were underwater. To achieve this, they restricted exercisability of the options until a liquidity event occurred and/or until the option was in the money.
For options granted prior to July 1, 2015, these restrictions should continue to be enforced because the old tax regime continues to apply to these grants. However, for options granted on or after July 1, 2015, these restrictions are no longer needed. This means companies should revise their award documents and delete these restrictions (usually contained in the Australia appendix to the award agreement).
Exceptions, Exceptions, Exceptions……
As mentioned, under the new tax rules, tax is generally is due only at exercise of options, but of course there are exceptions (this being Australia). Three exceptions may be relevant to companies:
- First, tax could be further deferred (past exercise) in case the shares acquired at exercise are subject to genuine restrictions on sale/transfer. For publicly traded companies, this will typically be the case only if the employee is subject to insider trading restrictions which prevent the employee from selling/transferring the shares acquired at exercise. If an employee exercises the option during a black-out period imposed by an insider trading policy, tax is deferred until the black-out period expires.
Shares of privately-held companies are often subject to restrictions prior to a liquidity event, such as a right of first refusal, a right of repurchase or, in some cases, an absolute transfer restriction. Unlike an absolute transfer restriction, a right of first refusal and a right of repurchase typically do not qualify as a genuine restriction on transfer, because neither prevents an employee from selling the shares. By contrast, a market stand-off restriction which prevents an employee from selling shares during a certain period of time after an IPO can represent a genuine restriction for Australian tax purposes, but only if the exercise occurs during the stand-off period. In all of these case (where the employee acquires shares at exercise that are subject to genuine restrictions on sale), tax is deferred until the restrictions lapse. The taxable amount would be equal to the fair market value of the shares at the time the restrictions lapse (as determined according to Australian tax law) minus the exercise price.
- Second, tax can be deferred past exercise if the shares acquired upon exercise are sold within 30 days of exercise. In this case, the taxable amount is the difference (or spread) between the sale proceeds and the exercise price. This rule is helpful in clarifying the tax treatment of a cashless sell-all exercise, but can be more difficult to administer if an employee uses a cash exercise method to exercise the option but then subsequently sells the shares within 30 days of exercise. In this case, the company would typically not know that the employee has sold the shares. Thankfully, the Australian tax authorities have recognized this problem and allow companies to still report the exercise date as the taxable event (in the annual return to be provided to the tax authorities and in the annual statement to be provided to employees) and the spread at exercise as the taxable amount. It is the employee’s responsibility to report the sale as the actual taxable event and the gain realized at sale as the actual taxable amount, and pay tax accordingly.
- Finally, termination continues to be considered a taxable event, unless the option is forfeited upon termination. This means that:
- If an employee terminates employment with vested options (that do not forfeit upon termination but only after the expiration of a post-termination exercisability period), the employee will be taxed at termination, not exercise.
- If the employee does not exercise the option and the option expires, the employee is able to claim a refund for any tax paid at termination (or, more likely, never has to pay the tax to begin with assuming termination and expiration of the option occur in the same tax year).
- If the employee exercises the option before it expires (e.g., 15 days after termination) and holds the shares, the taxable event would be at termination and not at exercise. In this case, the taxable amount would be the market value of the option at the time of termination (usually determined according to a statutory formula). However, if the employee goes on to sell the shares within 30 days of the termination date (e.g., if the employee uses a cashless sell-all exercise method 15 days after termination), the sale date will be considered the taxable event (pursuant to the exception described above).
Although the new tax legislation certainly improved the tax treatment of options in Australia, the details remain challenging. And while there is still no tax withholding obligation in Australia (unless an employee has not provided his/her tax ID number which would be very unusual), the employer has to report the taxable events. Therefore, understanding the tax rules (and exemptions) is crucial. Similarly, if companies provide tax information regarding equity awards to employees, the information must be carefully tailored to reflect possible exemptions from the general tax rule.