By Daniel Butler, Director, DBA Lawyers
Acquiring shares via an employee share scheme (‘ESS’) in an self managed superannuation fund (‘SMSF’) can appear attractive but SMSF trustees have to be careful of the in house asset and the related party acquisition rules.
Broadly, a company can via an ESS provide employees the opportunity to acquire its shares or options. Generally the upside is that employees are able to obtain more favourable terms or prices and lower transaction costs compared to other investors. However, the usual caveat is that interests acquired under an ESS are typically subject to restrictions on vesting and sale.
In addition, from a tax viewpoint, a person who acquires ESS interests may be eligible for special tax concessions, such as the ability to defer the taxing point for a period of time. Generally the ability to defer the taxing point applies where there are certain conditions in relation to the disposal of the ESS interests that are reflected in the ESS documents.
Can an SMSF trustee acquire ESS shares from an employee?
The first hurdle with SMSF’s acquiring an ESS interest is to ensure the SMSF is in a position to acquire such an interest without contravening the Superannuation Industry (Supervision) Act 1993 (Cth) (‘SISA’).Under some ESS arrangements, the employee can elect to have an associate (eg, a spouse, family company, family trust or SMSF trustee) take up their ESS interests. This may result in, under certain ESS plans, the employee foregoing their entitlement to an ESS interest to allow an associate to take it up.
Furthermore, under some ESS arrangements, if the employee elects that their SMSF acquire shares in relation to an ESS offer to an employee, from a legal perspective, the SMSF trustee may be on a technical analysis be acquiring those shares indirectly from the employee. For superannuation law, the employee is invariably a related party of the SMSF. Unfortunately, SMSFs are broadly prohibited from acquiring assets from members and related parties, unless:
- the ESS interest (eg, shares) qualify as a listed security acquired at market value under s 66 of the SISA; or
- the ESS interest is an in-house asset and the value of all of that fund’s in-house assets is less than 5% of the total market value of the SMSF’s assets.
ESS interest acquired by SMSF trustee at less than market value or for no consideration
If ESS shares are acquired by an SMSF trustee at less than market value or for no consideration, the ATO will treat the discount as a personal contribution to the SMSF by the employee (ie, generally a non-concessional, in-specie contribution). The ATO’s website addresses the following situation:
If the scheme says the member can nominate their SMSF to receive shares or options and the trustee of the SMSF pays no consideration or less than the market value consideration for the shares or share options, the acquisitions by the SMSF result in super contributions if the contributions are made for the purpose of benefitting one or more particular members of the fund, or all of the members in general.
Further, the ATO, in TR 2010/1, state that where the capital of the fund increases and the purpose is to benefit a member or members then a contribution arises.
Consider the following example:
Rufus is an employee of SHINRA LTD. SHINRA has an ESS for its employees. SHINRA offers the ESS shares at a 25% discount and no brokerage fee. Due to his performance, SHINRA offers Rufus 100 shares. Rufus takes up the offer and nominates his SMSF’s trustee to receive the 100 shares.
SHINRA shares on the date of transfer have a market value of $2.
When the shares are contributed to Rufus’ SMSF, for superannuation purposes the shares are treated as being acquired at $2 each ($2 x 100 shares, in total $200), ie, the market value of the shares.
Assuming the shares are taxed up-front on grant under Subdivision 83A-B, Rufus would include $50 (discount of $0.50 x 100 shares) in his assessable income for the year in which the shares are acquired. Whereas, for superannuation purposes Rufus’ SMSF trustee would record the contribution of his ESS interest (worth $200) as a non-concessional contribution.
Acquiring an ESS interest at market value is crucial since an acquisition of an asset below market value can result in any dividends or capital gain in respect of the shares being taxed as non-arm’s length income (‘NALI’). The tax rate in respect of non-arm’s length income is currently 45% .
The ATO applies a strict view on what dividends from private companies or distributions from other business structures such as unit trusts constitute NALI rather than concessionally taxed income to an SMSF. In recent years the ATO have issued a number of taxpayer alerts which reflect a concern that SMSFs are increasingly being used as an investor of choice in business structures due to their concessional tax treatment (refer, for instance, to TA 2015/1 and TA 2016/6).
We recommend that before an SMSF participates in an ESS offer or invests in a business in which the employee is involved, that expert advice from an SMSF lawyer with tax expertise be obtained.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).
Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.
15 December 2017 (as revised on 27-August-2018)