Employee share schemes: measures to ensure real risk of forfeiture of shares and options through minimum employment terms and good leaver provisions

There was widespread concern from employers last year when it was announced in the Federal Budget that the ability to defer tax on issues of options and shares had been abolished.

Under the new rules, all options and shares issued after 1 July 2009, under qualifying and non-qualifying schemes (including existing schemes) were taxable up front on the discount (the difference between market value and the amount paid).

“Real risk of forfeiture” concession
The share scheme legislation which passed in December 2009 contains provisions allowing taxpayers to defer the taxing point on their shares and options issued under employee share schemes where a “real risk of forfeiture” exists. 

The ATO has recently issued ATO ID 2010/61 which outlines a situation in which rights acquired under an employee share scheme satisfy the “real risk of forfeiture” requirement for deferral of tax on any discount.

The scheme outlined in ATO ID 2010/61 satisfies the “real risk of forfeiture” requirements because it contains minimum employment terms and good leaver provisions.

Minimum term of employment
ATO ID 2010/61 refers to a scheme which requires employees to serve a minimum period of employment before their rights vest. 

Under this scheme, where the employee ceases employment prior to the vesting of the rights, the rights are forfeited, unless the employment ceases because of death, invalidity, bona fide redundancy or retirement and the employee has been employed for a least six months.

The vesting of the rights occurs as follows:

• 1/3 of the rights vest one year from the date of grant of the rights
• 1/3 of the rights vest two years from the date of the grant of the rights, and
• 1/3 of the rights vest three years from the date of the grant of the rights
  

ATO ID 2010/61 indicates that such conditions in a scheme allow it to align the interests of the employer and employee and do result in the employee’s interests being at real risk of forfeiture.

Good leaver conditions
Under this scheme, the ability of an employee to access their rights where they cease employment prior to the end of the minimum term of employment is subject to them being a “good leaver”.  In this case, a good leaver is one who ceased employment as a result of either death, invalidity, retirement or as a result of a bona fide redundancy.

In ATO ID 2010/61, the Commissioner states that where such good leaver provisions are part of an employee share scheme, they do not prevent the rights issued as part of the scheme from being at real risk of forfeiture.

Deferral of tax
In ATO ID 2010/61, the Commissioner indicates that where an employee share scheme has the features as described above, it will satisfy the “real risk of forfeiture” requirement of subsection 83A-105(3) of the Income Tax Assessment Act 1997 and consequently, employees will be able to defer tax on any discount on rights they receive until the deferred taxing point, usually when the interests vest.

This is good news for both employers and employees, as it allows them to continue participating in many existing schemes without the risk of being taxed up front and provides an opportunity for new schemes to be structured in a manner which avoids immediate taxation.

For more information on the ATO's position on employee share schemes, contact your usual Grant Thornton advisor or the author of this article.

Author, Peter Godber, April 2010

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