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An employee share scheme (ESS) is an arrangement between a company and its past, present or future employees (or their associates). The arrangement concerns the issuing of shares or options to acquire shares in connection with their employment. Employee share schemes are a great way to reward or remunerate your employees for their work. An ESS also incentivises employers to stay with your company for longer and share in its success. 

The rules surrounding ESSs are complex, particularly regarding their taxation. This article provides a broad overview of the basic definitions and rules relating to ESSs. Still, you should consult a commercial lawyer or tax advisor before deciding whether an ESS is appropriate for your business. 

ESS Benefits and Taxable Benefits

An ESS benefit arises when your employee purchases or is given shares for free or below market value. If your employee receives payment for transferring or cancelling their rights to shares, this is also an ESS benefit. No ESS benefit arises if your employee has to pay market value for their shares.

Regardless of how your employee receives the benefit, the amount of income accessible to them is the difference between what they paid and the market value of the shares on the share scheme taxing date – we discuss this below. Any payment they receive for transferring or cancelling their rights to shares is also taxable income. Your employee pays tax on their taxable benefit at their regular income tax rate.

As an employer, you can deduct tax from your employee’s ESS benefits to meet their tax obligations on this income. If you do not, your employee will have to pay tax on the benefits at the end of the year, unless the benefit is provided under an exempt ESS.

Share Scheme Taxing Date

The ‘share scheme taxing date’ is when your employee becomes liable for tax on their ESS benefit. The share scheme taxing date arises when:

  • there is no real risk that your employee’s entitlement to the shares will change or that they will have to be transferred or cancelled; 
  • the employee is not compensated for a fall in the value of the shares; and 
  • there is no real risk that there will be a change in terms of the shares affecting their value.

In other words, if there are any sorts of conditions attached to your employee’s ESS benefit, the share scheme taxing date is when they meet these conditions.

The share scheme taxing date will also arise if your employee’s ESS benefit is cancelled or transferred to a non-associate before they meet these conditions.

Example: ABC Construction transfers $20,000 worth of shares to a trustee. The trustee holds these shares for Nikau, one of the company’s top employees. If Nikau resigns or the employer terminates his contract at any point in the next four years, he loses his entitlement to the shares. Nikau remains with the company for four years, at which point the trustee transfers the shares to him. 

In this case, the share scheme taxing date is when the four years have elapsed. 

Employee Share Option Plans (ESOPs)

Regular ESSs that issue shares to employees have several disadvantages. These include:

  • tax treatment of ESS shares, as discussed above;
  • potential need to provide loans to your employees to fund their purchase of the shares;
  • potential need to set up a trust to hold your employees’ shares for them until they have earned them;
  • shareholder rights your employees will have upon becoming shareholders. For example, information, voting and dividend rights; and
  • the difficulty involved in buying back or cancelling shares if your employee leaves.

For these reasons, a popular alternative to issuing shares under an ESS is issuing options to acquire shares in the future through an Employee Share Option Plan (ESOP). Under an ESOP, your employee receives options at no upfront cost and with no upfront tax liability. 

The options will typically ‘vest’ over some time (usually three to four years). As long as the employee remains employed by the company, the options will continue to vest. Once the options have fully vested, the employee can then convert them into shares by paying the ‘exercise price’ or ‘strike price’.

The exercise price of an option is usually the market value of a share in the company at the time the option was granted. Once your employee exercises their option, they will be liable for income tax on the difference between the exercise price paid and the market value of the shares when exercised.

One of the key advantages of options over shares is that optionholders do not have shareholder rights. Furthermore, it is much easier to cancel options if an employee leaves. The alternative would be buying back shares, which can be an expensive and complicated process.

Tax-Exempt Employee Share Schemes

Whether you use an ESS or an ESOP, your employee must still pay for either their shares or the tax on the taxable benefit (or a combination of both). The tax treatment of the ESS benefit for your employee is essentially the same as if you simply paid them in cash. However, there are additional costs for you in implementing and managing the scheme.

Fortunately, it is possible to implement an ‘exempt employment share scheme’. Under an exempt scheme, your employee’s ESS benefit is tax free. While this is very beneficial for you and your employees, there are several strict eligibility criteria. The most essential criteria summarised are:

  • the maximum value of shares you can offer to each employee is $5,000 per year;
  • the maximum discount you can provide to each employee is $2,000 per year;
  • you must offer the scheme to at least 90% of your full-time employees;
  • if you offer the scheme to part-time employees, you must offer it to at least 90% of them;
  • if you require a minimum spend from your employees, this amount cannot be more than $1,000 per year; 
  • any minimum period of service required before the employee can participate must not exceed three years; and
  • if your employees must pay any amount for their shares, you must provide an interest-free loan for that amount, or let your employees pay in instalments.

If you plan to implement an exempt scheme, you will need to inform Inland Revenue by lodging an IR1211 form. You will also need to report the total value of shares granted to your employees at the end of each tax year using an IR1212 form.

ESS Exclusion to the New Zealand Disclosure Regime

You will need to include a prescribed warning statement in your ESS documents and provide access to certain information about the company. However, full disclosure under the Financial Markets Conduct Act is not required when offering shares or options under an ESS. These exclusions apply when:

  • you make an offer of shares or options as part of the remuneration arrangements for that employee; 
  • you did not make the offer for the primary purpose of raising funds for the company or employer; and
  • the total number of shares or options issued in any 12-month period does not exceed 10% of the company shares as at the start of that period.

Key Takeaways

Employee share schemes are a great way to reward your employees and incentivise them to stay with your company. As an employer, you can deduct tax from your employee’s ESS benefits to meet their tax obligations on this income. The share scheme taxing date is when your employee becomes liable for tax on their ESS benefit. Alternatively, you can also consider issuing future shares through an Employee Share Option Plan. An ESOP may be more attractive as it is much easier to cancel options if an employee leaves. If you are considering implementing an ESS for your business, contact LegalVision’s corporate lawyers on 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

What is an Employee Share Scheme (ESS) benefit?

An employee share scheme benefit arises when an employee purchases or is given shares for free or below market value. No ESS benefit arises if your employee has to pay market value for their shares.

What is the share scheme taxing date?

The share scheme taxing date is when an employee becomes liable for tax on their ESS benefit. There are a few circumstances where the taxing date arises. For example, there is no real risk that an employee’s entitlement to the shares will change or that they will have to be transferred or cancelled.

What is an Employee Share Option Plan (ESOP)?

An alternative to an ESS is issuing options to acquire future shares through an ESOP. Under an ESOP, your employee receives options at no upfront cost and with no upfront tax liability.  The options will typically ‘vest’ after three to four years.

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