The Federal Government’s planned changes to employee share schemes continue to be attacked by business leaders, lobby groups and unions, desperate to protect the tax benefits received by their staff and members under the equity grants. The Financial Review continued its campaign against the changes, noting the views of NAB Chairman, Michael Chaney, who dubbed the move “inexplicable … counterproductive … and totally unfair.” (The timing of Chaney’s comments and his defence of executive share schemes is ironic, given The Age’s revelation today that between 50 and 100 senior NAB executives are currently enjoying a secret shareholder-funded junket in San Francisco).
Some critics of the proposed laws suggest valid points. Crikey received several excellent comments in relation to yesterday’s commentary regarding changes to the taxation of employee share schemes. The general theme was that while tax evasion by executives in relation to non-reporting of equity instruments can be solved by other means (such as withholding tax or mandatory employer reporting) and that the Government’s initiatives go to far in requiring upfront payment of tax on not-yet vested instruments.
Andrew Carter noted yesterday that:
Taxing the share or option at grant is more generous than the existing system, the problem the business community has with the change is that it is completely impractical.
It imposes a tax liability on an employee that can’t be funded because the share or option is wrapped up in, typically, a [three] year vesting period. It can’t be sold to fund the tax bill, and this is the fundamental problem with the new rules (not only can’t it be sold, the option may never be earned if performance hurdles aren’t met).
In a practical sense, Carter’s points are completely valid — some employees would be unable to participate in share schemes due to their personal financial position precluding them from funding the tax payable immediately. (Admittedly, this problem would not be universal, given that tax is paid at the taxpayers’ marginal rate on a steeply discounted accounting value”. Also, the tax paid can be re-claimed should the option never vest).
Leaving aside the mechanics of the planned changes — the overarching (and seemingly ignored) issue is whether employee equity scheme are actually beneficial to the economy (and to the companies operating them). They are certainly a good thing for the employees who receive the shares who are able to benefit from concessional tax treatment.
Importantly, such share schemes are only available for employees who work at public companies. Therefore, certain workers are able to receive concessional tax treatment (in the form of deferred taxation and later discounted taxation) at the expense of all other taxpayers (such as employees at private companies, small business owners, partnerships or not-for-profit organisations). Why should one worker be able to defer tax while another not simply because they happy to work at a public company as opposed to an accounting partnership or small business? There is nothing to stop an employee using their disposable income to purchase shares in their employer, the only reason most people don’t is because there are no tax benefits to such actions.
Moreover, there are significant doubts whether the granting of equity incentives to employees actually provide any benefit to the company itself. For non-executive staff, the notion of handing a middle-manager a couple of thousand dollars worth of shares will alter their performance is bizarre. Most employees would consider receiving equity grant as a kicker to their income and a handy way to defer tax. For example, it would be difficult to believe that employees of Visy would be less motivated than employees of Amcor. Judging by their relative performance, one would suspect the contrary is the case. (Some may even argue that the main reason companies continue to operate share schemes is because executives benefit from them and human resources staff who have a job because of them).
As far as executives go, while they have a greater degree of control over their company’s fortunes than lower-level employees, it is doubtful that providing equity instruments to executives reduces the spectre of agency costs. The theoretical reason for granting executives equity in the first place (in the form of options, shares or performance rights) is to align their interests with those of shareholders. In reality instead of minimising agency costs, granting equity may actually have the opposite effect.
For example, by providing an executive with options containing an EPS or market-based performance hurdle, executives would benefit from a short-term spike in earnings by say, reducing capital expenditure or by undertaking risky lending or trading. While such actions would likely lead to lower long-term returns, they would increase the chances of executives’ seeing their options vest.
By the time investors realised that the profit were only temporary (and most likely, damaging to the company’s long term prospects), the now-wealthy executive would be long gone. (In other cases, executives don’t bother to goose short-term earnings, rather the equity instrument will re-testing performance hurdles constantly while other companies will simply backdate the terms of equity instruments to ensure that executives are paid regardless of actual company performance).
Equity schemes are an unfair burden on the majority of the community and in most cases, are of little or no benefit to anyone except the executives and employees receiving the grant. If the Federal Government’s proposed laws lead to petulant companies cancelling share schemes due to taxation implications, that may very well be a good thing for shareholders and taxpayers.