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Some companies encourage employees to participate in employee share schemes by offering them discounted shares or rights (including options) to acquire shares. Employee share scheme income tax rules (ESS tax rules) apply to this discount.
From 1 July 2006, the ESS tax rules apply to certain stapled securities (and rights to acquire them) acquired under employee share schemes. The ESS tax rules are limited to certain stapled securities and rights to acquire them that include an ordinary share and are listed for quotation in the official list of ASX Ltd. For more information, see Employee share schemes - answers to frequently asked questions by employees, available on our website.
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If the employee acquires 'qualifying shares or rights' (those that satisfy certain ESS tax rules), the employee can choose when they include the discount given on the shares or rights in their assessable income.
The employee includes the discount in their assessable income:
- in the income year they acquire shares or rights, if the employee makes an election under the ESS tax rules. The discount is calculated at the date the shares or rights were acquired, or
- in the income year that 'cessation time' of the shares or rights occurs. For shares, the cessation time is usually the earlier of employment ceasing or when the disposal restrictions cease and forfeiture conditions expire on the shares. For rights, the cessation time is usually the earlier of employment ceasing or the exercise of the rights to acquire the shares. The discount is calculated at the date of cessation time.
If the employee acquires shares or rights that are not qualifying shares or rights, the employee includes the discount, calculated at the date they were acquired, in their assessable income for the income year in which they acquired them.
The first element of the cost base of the shares or rights is their market value as determined under the ESS tax rules at the date the discount was calculated. If a CGT event happens to, or in relation to, the shares or rights, the capital gain or capital loss is calculated under the rules that apply to that event.
If an arm's length CGT event A1 (sale or disposal of a CGT asset), C2 (cancellation, surrender or similar ending), E1 (creating a trust over a CGT asset), E2 (transferring a CGT asset to a trust) or E5 (beneficiary becoming entitled to a trust asset) happens to the qualifying shares or rights (or any shares acquired as a result of exercise of the rights) within 30 days of cessation time, the capital gain or capital loss is disregarded.
If an employee makes an election under the ESS tax rules, special rules apply if the employee acquires a beneficial interest in the qualifying shares or rights - that is, the shares or rights were acquired on their behalf by the trustee of an employee share trust but, due to restrictions, the trustee is unable to dispose of them on behalf of the employee.
If the employee acquired their beneficial interest before 5.00pm (by legal time in the ACT) on 27 February 2001, the cost base of the shares or rights is either:
- their market value at the date the employee became absolutely entitled to the shares or rights (the date the disposal restrictions are lifted and the trustee can sell them on behalf of, or transfer them to, the employee), or
- if the employee chooses, their market value at the date the employee acquired the beneficial interest.
However, the 12-month ownership requirement for the 50% CGT discount commences from the date the employee acquired absolute entitlement in the shares or rights.
If the employee acquired the beneficial interest after 5.00pm (by legal time in the ACT) on 27 February 2001, the cost base of the shares or rights is their market value at the date the employee acquired the beneficial interest. The 12-month ownership requirement for the 50% CGT discount commences from the date the employee acquired the beneficial interest in the shares or rights.
For cost base purposes, the market value of the shares or rights is established under the ESS tax rules.
Elections under the ESS tax rules must be made by the employee in writing and should be kept with their tax return for the relevant income year.
If a liquidator or administrator declares that rights acquired under an employee share scheme are worthless, no capital loss is available. For employee shares that are declared worthless, a capital loss is only available in certain circumstances - see Shares in a company in liquidation or administration.
CGT implications for employee shares and rights under a corporate restructure
If employee shares or rights are exchanged for replacement shares or rights in a new company under a corporate restructure that happened on or after 1 July 2004, a rollover may be available so that there is no taxing point under the ESS tax rules. Corporate restructures affected include mergers, demergers (in limited circumstances) and 100% takeovers. Any capital gain or capital loss made on the employee shares or rights because of the restructure will be disregarded where this rollover applies.
Changing residence or working in multiple countries
There are specific CGT rules relating to ESS shares or rights held by employees who become, or cease to be, Australian residents. There are also specific rules for temporary residents.
Last modified: 06 Oct 2009QC 27893