Australian Panel Calls For Executive Pay Tax Changes

by Mary Swire, Tax-News.com, Hong Kong

06 January 2010

Australia’s Productivity Commission has issued its report on executive remuneration, in which it recommends that the government should make legislative changes to remove the cessation of employment trigger for the taxation of equity and options, that would otherwise qualify for tax deferral.

In its report, the Commission notes that the Australian tax system does not specifically target executive remuneration structures, as in other jurisdictions. This has meant that, in Australia, additional taxes have not been imposed on components of executive remuneration, nor access to concessions disallowed.

It says, in fact, that using the tax system to constrain particular components of executive remuneration can have perverse consequences, including consequential increases in other components of executive remuneration and the use of tax ‘gross-ups,’ which may increase total remuneration and raise costs to the company.

The report observes, however, that equity-based payments are an increasingly significant component of executive remuneration. Taxation of equity-based payments can be complex, as different amounts may be variously taxed as salary or substitutes for salary, fringe benefits, or capital gains. Consequently, there are several points in time at which tax can apply, and the value of future, or contingent, equity rights can be very difficult to determine.

Currently, in Australia, income tax on equity-based payments is generally payable at termination of employment, irrespective of whether performance conditions or holding requirements still apply. The Commission’s view is that, from an executive’s perspective, this creates a disincentive to deferring equity over the longer term, and thus could work counter to approaches that seek to improve managerial alignment with shareholder interests.

While there may be some costs to revenue from extending tax deferral beyond the termination of employment, the Commission thinks that the broader economic costs of not changing this policy are more important.

It therefore recommends that equity-based payments to employees of a company, such as in employee share schemes, should be taxed at the point at which ownership of, and free title to, the shares or rights is transferred to the employee, or seven years after the employee acquires the shares, whichever is the earlier.

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