Not only did we see significant falling commodity prices in 2015, but a World Bank analysis expected 37 out of 46 commodities to drop further in price in 2016 1 . Prices did rise during 2016, but if they slump again, the value of the shares in your Executive Share Scheme (ESS) may drop dramatically. Over the last 12 months you may have been concerned about how the fall in value in your share scheme almost left you with a tax bill larger than the value of your shares. How is this possible, and how can you protect yourself and is it worth considering selling some shares now?
Two of the most common triggers for the taxing point of ESS shares are:
- the shares vest; and or
- you are made redundant.
What would happen if either of these events collided with falling commodity prices and you had no downside protection in place?
In countries such as Canada and the United Kingdom, vesting withholding tax is levied by the respective tax authority. This requires the employer to sell enough of your vested shares to fund your tax liability. In Australia, there is no such requirement and hence the tax liability sits with you, the employee. This can create a significant risk for you.
Case Study 1 – Vested shares
- 10,000 of your shares vest in September each year (after being granted 3 years ago 2)
- Last year you saw them fall from $25.00 ($250,000) to as low as $12.00 ($120,000)
- A tax liability was incurred in the 2015/2016 tax year when 10,000 shares vested at $25.00 in September 2015, so the total taxable ESS value for your 10,000 vested shares was $250,000.
- Due to to falling commodity prices in 2015 and earlier this year, you saw the value of those shares more than half and you realise this could have left you in a position where the tax payable would have been more than the value of your shares. If this happens again next year you don’t want to be in the same position when you have to pay your tax bill ($122,500) in April 2017.
Your tax may be payable in or around April 2017, following completion of your tax return, but your taxing point was when the shares vested, that is September 2015.
Case Study 2 – Redundancy
- Your shares which were due to vest in September 2015, prior to your redundancy they did vest.
- You were made redundant in late September 2015.
- Your 11,000 shares, due to vest in the following year, became taxable, due to redundancy, even if a performance condition was yet to be met. Any shares or options cancelled on redundancy are generally not taxable.
- Each share was worth $25.00 at the vesting date in early September, so the total ESS value for your 10,000 vested shares was $250,000.
- At the redundancy date in late September, the shares which vested on redundancy were worth $24.00, so the total ESS value for your further 11,000 shares was $264,000.
- Due to falling commodity prices in April 2016, the value of your shares more than halved to $12.00 each, leaving you with a total ESS value of $132,000.
- This left you with a tax liability from the ESS of $251,860 while the total value of your ESS shares was only $252,000.
Case Study 1 and 2 show that if your shares devalue by more than 50%, your tax bill may be higher than the actual value of your ESS portfolio. With the recent recovery in share prices we have discussed multiple strategies around ‘de-risking’ portfolios providing for tax liabilities or an extraction of some value from the vested shares in the employee share scheme.
Please note that these case studies are merely an illustration based upon our understanding of Australian taxation laws as they currently stand. The illustration is not provided to determine exact taxation consequences but the consequences of share price variation. These laws may change and it is advisable that you confirm any taxation consequences in relation to Executive Share Schemes with a suitably qualified taxation adviser.
There are ways to protect yourself with downside protection insurance. Given the complexity of ESS and the risks and the vulnerabilities of this asset, it is strongly advised that you seek professional advice. With 16 years of expertise in this area, Brett Cribb is ideally placed to assist you. Read more about Brett.
Please contact me by calling 07 3007 2007 or emailing email@example.com to discuss strategies that aim to protect your ESS so that it remains an asset, rather than a liability that causes you financial and emotional stress.
For further information about executive remuneration strategies, please download our strategy paper: Mining Executive Remuneration Packing and Complex Tax Issues.
2 Note the date of grant is important. New legislation applies to shares granted from 1/7/15 onward.
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Stratus Financial Group and its advisers are Authorised Representatives of Fortnum Private Wealth Ltd ABN 54 139 889 535 AFSL 357306. This information does not consider your personal circumstances and is of a general nature only. You should not act on it without first obtaining professional financial advice specific to your circumstances.