A Week in Review
ESS employer deductions – were you confused?
Just in case you were a little confused, IR has issued QB 21/04 to provide an answer to the question – when an employer is party to an employee share scheme, when does an employer’s expenditure or loss under section DV 27(6) or income under section DV 27(9) arise?
The potential for confusion has arisen, due to the existence of two relevant dates for both the employer and the employee, when the employee is deemed to have derived a benefit under an employee share scheme, which triggers now (since 29th September 2018) what is referred to as the ‘share scheme taxing date’.
This date is defined as the earlier of:
- The first date when the shares are held by or for the benefit of an ESS employee (or associate) and, after which, under the provisions of the ESS, there is:
– No material risk that beneficial ownership may change or that a right or requirement in relation to the transfer or cancellation of the shares may operate;
– No benefit accruing to the ESS employee (or associate) in relation to a fall in value of the shares; and
– No material risk that there will be a change in the terms of the shares affecting the value of the shares. - The date when the shares or related rights of an ESS employee (or associate) are cancelled or are transferred to a person who is not associated with an ESS employee.
The new regime was introduced to ensure neutral tax treatment of ESS benefits as compared with other forms of employee remuneration. That is, to the extent possible, the tax position of both the employer and the employee should be the same whether remuneration for labour is paid in cash or shares. Consequently, on the share scheme taxing date, usually an amount of income (although it can be expenditure if the share value has decreased) is calculated for the employee, and an equivalent deduction amount arises for the employer.
‘Income recognition’ and ‘expenditure incurred’ principles then come into play, because for the employee, if the employer has an employee benefit reporting obligation (most likely), then the applicable date for income derivation purposes for the employee, is 20 days post the share scheme taxing date – known as the ESS deferral date.
From an expenditure incurred perspective therefore, confusion surrounded whether the deduction entitlement arose on the share scheme taxing date (because arguably the benefit was calculated on this date, so the ‘cost obligation’ was then known by the employer) or on the later ESS deferral date.
Now clearly you are going to be saying to yourself, that the issue really only has relevance should the share scheme taxing date fall within 19 days of the end of an income year, because only then is there the potential for the deduction not to be claimable by the employer in the same income year that the share scheme taxing date falls, if the deduction entitlement does not arise for the employer until the ESS deferral date – and you’d be right!
However, for the sake of clarity (and because Murphy’s law will dictate that as soon as I dismiss the issue as being somewhat immaterial, a client will have a material issue!), QB 21/04 determines that the employers deduction entitlement arises on the ESS deferral date – because it is only via application of section DV 27 that the employer’s obligation for the expenditure or loss under the ESS is created, and this obligation is deferred to a date 20 days post the share scheme taxing date where the employer has an employee benefit reporting obligation.
Finally, just to avoid any confusion, if there is no employee benefit reporting obligation (most likely where the person is a former employee when the ESS benefit is deemed to arise), then the employer’s deduction entitlement will be triggered on the share scheme taxing date.
‘Continuity of business activities’ interpretation statement
One positive which arose as a consequence of the Covid pandemic, was the amendment to the loss carry-forward rules for companies, to introduce a ‘business continuity’ test – an effective safe-haven for a company that needed to restructure its shareholding ownership by more than 51% (perhaps to source new capital to help it survive the pandemic), but in essence carried on the same business activities post the change. Historically, the failure of the company to maintain a 49% shareholder continuity test from the income year in which tax losses arose through until the income year in which those losses were utilised, resulted in a complete forfeiture of the losses.
Effective from the commencement of the 2020/21 income year, a company that fails to satisfy the ownership continuity requirements, may still be able to carry forward unused tax losses under a new test in subpart IB (the business continuity test).
The legislation to introduce the new test (effective for most from 1st April 2020) was only passed just prior to the end of the income year to which it was to first apply. With March 2021 income tax return preparation already underway, IR has now released draft interpretation statement PUB00376 – Loss carry-forward – continuity of business activities. The prime focus of the IS is to explain in what circumstances a company is likely to satisfy the business continuity test.
Importantly, while a company needs to show that it has satisfied the business continuity test, it must also continue to do so for what will be referred to as the ‘business continuity period’, which is defined in the document as typically the period starting immediately before the ownership continuity breach and ending on the earlier of:
- The last day of the income year in which the tax loss component in question is used.
- The last day of the income year in which the fifth anniversary of the ownership continuity breach falls.
However, broadly, for a company where 50% or more of its tax losses eligible for carry-forward arose from bad debt deductions. The business continuity period will end on the last day of the income year in which the tax loss component in question is used. In other words, the five-year cap on the test will not apply.
So, some take-aways from the draft IS for you:
- ‘Business activities’ are any action taken in pursuit of one or more businesses that may be carried on by the company for income tax purposes. ‘Nature’ is defined as the ‘basic or inherent features, qualities, or character of a person or thing’, so the test is concerned with the basic or inherent features, qualities, or character of the company’s business activities.
- The nature of a company’s business activities should be described by referring to the type (or category) of product or service that the company produces or provides, and not to particular products or services.
- Determining whether there has been a major change in the nature of a company’s business activities requires both a qualitative and a quantitative assessment, taking into account changes in assets and any other potentially relevant factors.
- If there has been a major change in the business activities carried on by a company, the business continuity test may still be satisfied if the major change is a permitted major change (s IB 3(5)).
There are four permitted major changes, broadly, changes:
– made to increase the efficiency of a business activity;
– made to keep up to date with advances in technology;
– caused by an increase in the scale of a business activity; and,
– caused by a change in the type of products or services produced or provided.
- A tax loss cannot be carried forward if before the beginning of the business continuity period the business activities carried on by the company have ceased and have not been revived, or if the company ceases to carry on business activities during the business continuity period. In this regard, a temporary cessation will not constitute a cessation of business activities. In contrast, cessation with the possibility of recommencement will constitute a cessation.
Note that only those tax losses incurred in 2013/14 and later income years will be eligible for carry-forward under the business continuity test.
Finally, if you can’t see yourself wading through 42 pages of analysis on the issue, you can cheat and go straight to the Flow Chart on page 35 and see if that helps to answer your question.
Feedback on PUB00376 is requested no later than 28th June 2021.
Budget 2021 highlights?
Well, for those of us in the tax world, Budget 2021 was effectively a non-event, particularly post the March 2021 circus and associated hype of the Government’s property tax related announcements. A part of me was thinking that there may have been more to come in Budget 2021, considering that while the Powers-That-Be were seemingly unfazed by the panic they created for your typical mum and dad property investors in relation to the proposed new interest deduction limitation rules, there had been nothing further to date in the form of a consultancy document to perhaps help alleviate some of those concerns, by explaining some of the terminology used in the March announcements.
However, clearly not so, and therefore one continues to wait with eager anticipation for the chance to have ones say on the proposals, although equally with some concern that time is fast running out if the Government actually wants to run a legitimate consultation progress, considering they want the legislation in place to take effect from October 1st.
The single ‘tax related’ action that did stem from Budget 2021, which was introduced into Parliament under urgency on 20 May 2021, passing through all stages by the following day and now awaiting the Royal assent, was the announced increases to the Minimum Family Tax Credit threshold from $30,576 to $31,096 on 1 July 2021 – a tax credit aimed at providing financial support to low-income working families not receiving a main benefit.
Oh well, there’s always Budget 2022 to look forward to!