Thursday, 27 June 2013

Employee share plans: Make sure you calculate your tax properly

This post will be relevant only to Australian tax payers as it will have to do with a quirk in the tax system which means that you need to take special care about how you calculate your capital gain and tax payable on the income you make from the sale of your employee share plan shares.  Keep in mind that these rules keep changing and this is accurate for the 2013 financial year.

I have recently encouraged everyone to look at their portfolio and perhaps do some trades to avoid having to pay capital gains tax at the end of the financial year.  If you are not careful you could actually end up over or under estimating your actual capital gain and then trade needlessly

A recap of the basics

I posted more than a year ago about the basics of employee share plans and how you can make some money out of them.  They basically have some similar characteristics which include:

  1. They are issued at a discount to the market price
  2. You can sell them as soon as they are issued to you (they do not come with hold periods)
  3. When it comes to maximising your profit you have the choice of selling them straight away and making the discount in a risk free manner or you can hold onto them in the hope that they will appreciate more and sell them later in which case you can make more or less of a profit
The discount causes a tax quirk for Australian tax payers

Normally when you buy and sell shares you just look at the price which you paid for the shares and then look at the price which you sold them at including things like exchange rate movements and accounting for your transaction costs etc.

However if you look at the tax rulings given by the ATO (there is a whole section on shares issued to employees under employee share schemes) there are a few things that you need to keep in mind:
  1. The discount on the shares counts as part of your assessable income (and is counted as income and not capital gains)
  2. The discount is included in your assessable income the year in which you are able to sell them or 10 years after acquisition
This means that if you get (for example) a 10% discount on the shares at the date they are issued to you and then you sell them straight away then you are liable to pay income tax on that 10% discount however you have actually made no capital gain so will not have to pay capital gains tax.

This is important because if you are looking to trade shares before tax time to avoid a capital gains tax bill you need to make sure that you have not included the discount you received as part of your capital gain.

A brief worked example

The facts
  • I contribute $5,000 to my employee share plan 
  • The shares in the company I work for (AA Corp.) trade for $100
  • I get issued the shares at a 10% discount to the current traded price $90
    • I therefore get $5000/90 = 55.5556 shares
  • I hold onto the shares for a month or two and sell them at $110
The tax implications
  • The discount I got on purchase is $10 x 55.55556 shares = $555.55 of income which I have to pay income tax on
  • My cost base for CGT purposes is $100 so I made a $10 profit on each share when I sold them for tax purposes (not the actual $20) so I made $555.55 of capital gains which I have to pay CGT on
Do not forget that you can only offset capital gains with capital losses and vice versa so make sure you are calculating your capital gain correctly.  Your capital gain is NOT the difference between the $90 issue price and the $110 sale price

Read the rules yourself and if you don't understand them get an accountant to explain them to you.  This site doesn't give financial advice - it just reminds you of things you should be thinking about!

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