Tax law structuring options for employee share schemes are generally not attractive to medium-sized businesses and their accounting advisers in Perth. The ATO-endorsed employee share scheme incentives are good on scale, but the tax-free discount of $30k ($1,000 for others) for start-ups is ordinarily too small compared to the accounting advice and valuations needed for an effective employee share scheme.
This is where employee-funded share loans can help.
This blog will discuss the tax benefits of loan-funded share plans (LFSP) as an alternative to employee share acquisition schemes.
What is a Loan Funded Share Plan
A loan-funded share plan is a straightforward concept. It involves the trading company providing an interest-free loan to the employee, who then uses it to purchase shares in the company at market value. The company pays dividends to the employee, which are used to repay the loan.
The loan to the employee can also be limited recourse. So, the company’s ability to call upon the unpaid loan is limited to the value of paid-up dividends declared by the company.
What is the tax implication of a loan-funded share plan
If the employer issues shares to the employee and the process is followed, no tax implications will occur to the employee or the employer.
The biggest tax risk for Perth businesses and their tax accountants advising the transaction is that the shares subject to the LFSP are not issued to the employee at their market value. Getting a solid valuation from an independent valuer is important to support the tax position. If the shares are issued below their market value, the employee receives taxable income, and the shortfall of the share issued by the employer is subject to payroll tax.
The fringe benefits tax impact of loan funded share plans
The loan to the employee must happen before the employee purchases the shares. If the loan happens before the employee becomes a shareholder, the Fringe Benefits Tax Act will apply to the loan. If the loan happens after the share issue Division 7a of the Tax Act will take precedence.
So, when the loan is to the employee, the otherwise deductible rule of the FBT Act will apply to reduce the taxable value of the loan to nil. This only occurs when the employee loan-funded share plan loan is used to purchase shares in the employer.
If the loan by the trading company is made to somebody other than the employee, the FBT otherwise deductible rule will not apply to that loan. The otherwise deductible rule can only apply when the interest on the loan, if charged, would have otherwise been tax-deductible to the employee. This is not the case if the loan is to an employee’s associate.
Importantly the otherwise deductible rule is not a set and forget concession. The employee must sign an annual fringe benefits tax declaration that the interest on the loan, if charged, would otherwise be tax deductible to the employee who received the loan funded share plan.
If the shares under the loan funded share plan are placed in an entity other than the employee it can be difficult, if not impossible, to show how the loan is tax deductible.
A loan subject to a loan-funded share plan will ordinarily have vesting conditions. This could include a special class of shares with reduced voting rights, reduced sale rights or trigger events connected to the employee in the event of death.
If the company performs poorly, there is a fringe benefits tax risk. If the loan is non-recourse and the value of the shares falls below their purchase price so that they are handed back to the family business, a debt waiver fringe benefit can apply to the LFSP.
What are the reporting obligations of LFSP’s?
If your LFSP has the correct tax and structuring advice from your Perth tax accountant, it has significantly reduced reporting requirements. In particular, the reporting rules for Employee Share Schemes do not apply to loan-funded share plans.
How are LFSP’s shares taxed on vesting?
If you have repaid your loan under the loan-funded share plan, the shares normally become yours with full title. This is classically your acquisition date to determine your entitlement to the 50% CGT capital gains tax discount.
The moment when the shares vest to you under a loan-funded share plan does not trigger a taxing point.
Can I buy more shares under a LFSP?
Once you purchase shares under an LFSP, you are now a shareholder. So, any new loans by the commercial family business to help you, as an employee, to buy shares are no longer effective. The tax laws regarding private company shareholder loans (Division 7a) takes priority.
Can a company lend its shareholders money to buy shares?
If a company can lend money to help shareholders if:
- The loan does not affect the interest of creditors;
- The other shareholders agree to the loan.
Getting good advice for this area of law is important.
Structuring for succession
A loan funded share plan can work remarkably well in some instances. And a loan funded share plan is not the only option in a tax advisors kit bag. Getting great tax advice is critical to ensure succession of a family owned, private business, is well thought out and executed.
This is where Westcourt is a natural choice. Our proven track record of tax advice and our tax leadership in the profession, coupled with our independent advice, sole focus on family-owned businesses and our global depth clearly makes us a natural choice for taxation and succession advice – so why not call us today?
