Be careful of Australian employee incentive scheme rules

Generally, the benefit to an employee of any discount on the market value of shares in their employer’s company or subsidiary is taxed upfront (i.e. the value of the discount is included in the employee’s assessable income at the time of granting the shares or options). However, employees will be able to defer the taxing point when the EIS interest acquired under an EIS is at a real risk of forfeiture.

Broadly, a real risk of forfeiture occurs where there is a high risk that, under the conditions of the scheme, the employee will forfeit or lose their EIS interest. There are a number of other requirements that must be satisfied to qualify for this concessional tax treatment in order to defer the taxing point to the earlier of when there is no longer a real risk of forfeiture, or 15 years from the date of acquisition of the shares. These Australian EIS rules also apply to foreign resident companies issuing shares to their Australian employees or to employees who come to Australia having interests in their foreign EIS.

The rules for employees coming to Australia can be difficult to apply. Where a foreign resident employee who participated in an EIS scheme becomes an Australian resident whilst subject to ongoing vesting conditions such as continued employment, being an Australian resident at the deferred taxing point results in the benefits received under the EIS being fully taxable in Australia, despite the employee initially having earned the rights while a non-resident. 

This situation can be distinguished from an employee who is a temporary resident of Australia. When such employees acquire EIS interests for their employment before or after coming to Australia, the discount for employment services performed in Australia is taxed in accordance with EIS rules, while the part of the discount relating to the employment performed offshore is not taxed. This is irrespective of whether or not the discount is taxed on acquisition of the EIS interests when the employee becomes employed in Australia, or at a later date.

Accordingly, it is important to review the implications to employees of any foreign schemes that have not considered the Australian rules prior to offering the EIS to local employees or to employees with rights under an EIS who move to Australia. Otherwise employees may be surprised to learn they have a tax liability on the benefits they receive under the EIS, and may struggle to fund payment of the tax liability when they are unable to sell any shares under the scheme.

Tony Nunes has over 25 years’ experience in providing tax advice to clients, especially on issues affecting cross-border transactions, acquisitions and restructures, and on all aspects of structuring the ownership and financing of corporations and their operations.

Isabella Chin is a qualified CA, CTA and tax lawyer. She commenced her tax career with one of the “Big 4” accounting firms. She works with a diverse range of clients. Her areas of tax expertise include small business tax concessions, restructures, capital gains tax, and tax residency.