June 2009
By David Hetherington
The expansion of share ownership amongst employees advances a number of important economic priorities identified by the Federal Government, and has the potential to give Australia a stronger and fairer economy.
Rewarding employees with increased ownership in the companies in which they work increases productivity, advances flexibility with fairness in the workplace and builds a national savings culture. However, to secure these benefits, it is critical that employee share ownership is extended widely to ordinary workers rather than concentrated at the top levels of management.
Employee share plans are frequently criticized for concentrating risk, for duplicating superannuation and for being regressive, but carefully designed policy can address each of these shortcomings.
Existing Australian policy towards employee share ownership lacks this careful design. This report compares the employee share policies of the UK, the United States and Australia. It finds that, despite the wider economic benefits of employee share plans, ordinary Australian workers have little or no incentive to participate in them.
Taxation arrangements mean that Australian workers can be penalized for participating in employee share schemes rather than making equivalent investments in the sharemarket. In Britain and America, on the other hand, tax structures favour employee share schemes over ordinary equity investments.
The paper models the results of a standardised A$10,000 investment in alternative employee share schemes held for 10 years compared against a benchmark investment returning 5.4% p.a. after tax. Under this framework, American schemes return 9.3%-10.2% p.a. and British schemes 9.7%-10.5% p.a. Australian schemes in contrast return 4.5%-5.8% p.a., which at the lower end is even less than the benchmark investment.
The report argues that share schemes should seek to incentivise investment in employee-owned companies and should certainly not penalize such investment as the Australian “deferred” scheme does.
The “deferred” scheme results in the employee paying an additional $7,141 in tax over and above the benchmark investment in ordinary equities.
In its recent Budget, the Rudd Government announced changes to employee share schemes that put a $60,000 means-test on the $1,000 tax-exemption for employee share grants, and remove the ability to defer tax until the employee actually sells the shares.
The changes seek to preserve tax revenues and make the schemes more accessible to lower-income workers, while maintaining the overall policy objective of supporting employee share ownership.
As it was completed before the announcement, this paper does not analyse the effects of these changes in detail. Yet the proposed changes leave low-income workers exactly where they were prior to the announcement. The changes are only more progressive in the relative sense that they remove employee share schemes altogether for higher-income workers.
They do have the effect of increasing Treasury revenue, but at least some of this could be recouped through tighter enforcement rather than a cut-back in the schemes themselves. In fact, research in this paper shows that Treasury can actually collect more tax from the abolished tax-deferred scheme than from ordinary investment in the sharemarket.
Since the Budget, the Government has agreed to a review of its proposed changes and a policy options paper is expected shortly. The Government should simplify the existing dual scheme structure into a single, simplified scheme where employees are offered a tax-exempt amount and given the ability to defer tax above this amount.
The concern about multi-millionaire executives using schemes to defer high levels of tax can be overcome by placing a cap, say $10,000, on the total value of shares (and options) that can be claimed under the scheme.
If Treasury must remove tax-deferral and means-test the scheme in order to boost tax revenue, the threshold should be raised to allow greater participation and the removal of the tax-deferral should be a temporary measure, to be lifted when the fiscal position improves.
The paper makes a number of policy recommendations as follows:
– Implement a single employee share scheme under which employees can take an increased exemption amount (in the range of $1,500 to $5,000) tax free with normal CGT on disposal, and any additional amount with both income tax and CGT (at the normal rate) deferred until disposal
– Remove the distortion under which capital growth under certain ESO-plans is effectively subject to twice the rate of tax relative to capital growth in ordinary listed equity holdings
– Remove the taxation of unrealized gains on employee share holdings
– Remove the taxation point at cessation of employment in the case of redundancy, retrenchment or retirement
– Offer smaller companies the ability to release a streamlined offer document, outlining top-level financial results, projections and risk factors, rather than a full prospectus
– Extend tax deductibility for an amount equal to the value of the shares and options granted to an employee upon which the employee will ultimately pay income tax up to a ceiling of $10,000 annually per employee
– Allow companies to pay up to 20% of SGC payments as employee share allocations into an ESO plan for participating employees. These allocations are taxed exactly the same as SGC payments, but can be accessed after 10 years rather than at retirement age
Per Capita believes these measures will extend employee share ownership beyond senior executives to ordinary workers with important benefits for the economy, contributing to a more prosperous and fairer Australia.
