Australian Share Plan Reporting Goes Digital

The Australian tax year just ended (on June 30, 2016) and the deadlines for Australian Share Plan Reports are just around the corner! This year, to make things more complicated, the Australian Tax Office (ATO) has made a number of changes to the reporting requirements for both the Employee Share Scheme (ESS) Statements and Annual Reports.

In addition to a new online reporting system, the ATO is requesting additional data for both the ESS Annual Report and Statement, including specific information relevant to mobile employees and start-ups.

Background

The Australian financial year runs from July 1 to June 30 and the ATO runs a tight ship. Just two weeks after close of the year (i.e., by July 14), the ATO requires providers (i.e., the issuer / parent company) to distribute ESS Statements to all employees. The ESS Annual Report is due to the ATO one month later (i.e., typically by August 14, but this year, by August 15, since August 14 falls on a Sunday).

The ESS statements and Annual Report are required if a taxable event related to a share plan has occurred during the prior financial year. What exactly needs to be reported depends on the award type, the date of grant and the specific award terms. Very generally speaking, you can assume the taxable event occurs:

  • RSUs = Vesting date
  • Options =

    • Granted before July 1, 2009 or after July 1, 2015 = Exercise

    • Granted between July 1, 2009 - June 30, 2015 = Vesting date

  • ESPP = Purchase date

But please beware, because many exceptions apply. In particular, a taxable event can occur at termination if the employee does not forfeit the award upon termination, or, the taxable event can be moved to sale if the employee sells the shares within 30 days of the original taxing point.

So What Has Changed?

The most dramatic change is that the ATO will no longer accept a submission of the ESS Annual Report by paper or by using the bulk load excel spreadsheet. Instead, the ATO is slated to release a new online submission form. Unfortunately, the form can be used only by companies that have 50 or less employees with taxable events during the financial year. In addition, non-Australian companies without an Australian Business Number (ABN) cannot use the online form, regardless of the number of employees. These companies will need to utilize filing software that meets the ATO's Electronic Reporting Specifications by either developing the software in-house, or by hiring a third-party provider that has developed the software and can make the submission on behalf of the issuer.

It is important to note that it is no longer possible for an Australian subsidiary of a non-Australian issuer to submit the ESS Annual Return using its own ABN. Therefore, effectively, non-Australian issuers are not able to use the online submission form, but will need to use the special software to submit the ESS Annual Return. However, one benefit of using the software is that it generally also automatically produces the ESS Statements, unlike the online submission form.

There are additional differences to prior years for the preparation of the ESS Annual Return and Statement, which you can find summarized in an alert from our Sydney office. Please note, however, that the ATO recently confirmed that it is NOT necessary to include the acquisition date (typically the grant date) for any awards with taxable events during the tax year (contrary to what the ATO originally announced and reported in the alert).

Our Sydney office has developed the special software needed to make the submission of the ESS Annual Report (and which can generate the ESS Statements), and can assist with the submission. Please see our fee proposals for the submission here.

For more information on the Australian share plan reporting process, listen to our complimentary webinar.

What To Do When Your Board Goes Global
We are seeing an accelerating trend among U.S. companies to add non-U.S. residents to their Board of Directors. This makes sense: as more and more companies "go global" and expand in ever more countries, their Boards should reflect the global nature of the company.

What takes many companies by surprise, however, is that the tax treatment of cash compensation paid and equity awards granted to the non-U.S. directors can be quite complex. In addition, for the equity awards, companies will need to consider regulatory restrictions such as securities law requirements and ensure that the grants can fall under an exemption.

U.S. Tax Obligations for the Company

On the tax side, most companies are aware that compensation paid to non-U.S. directors (including equity awards) is usually subject to a flat U.S. withholding tax of 30%.

However, companies will first need to verify that the director is not a U.S. tax resident before withholding tax. This means he or she cannot be a U.S. citizen or permanent resident (green card holder) or spend 183 days or more in the U.S. in any tax year (or as determined under a special three-year look-back formula).

Furthermore, companies will need to check if an exemption from U.S. tax withholding exists under a tax treaty with the director's country of residence. Most tax treaties no longer include such an exemption, but there are notable exceptions, such as the U.S.-Canada Tax Treaty, which provides for an exemption from U.S. taxation unless the director has a fixed base or other permanent establishment (e.g., a physical office) in the U.S. If the exemption applies (because the director does not have a fixed base in the U.S.), the director will need to complete a Form 8233 on an annual basis to claim the treaty exemption and the company will need to file a copy of the form with the IRS.

Assuming the director is not a U.S. tax resident and no treaty exemption applies, U.S. federal tax withholding at a flat rate of 30% is required on any U.S.-source compensation paid to the non-U.S. director. U.S.-source compensation is compensation that is earned based on services provided in the U.S. If all of the Board meetings take place in the U.S., it is common for companies to take the position that all compensation is U.S.-source income and, accordingly, withhold U.S. tax on the full amount of the compensation. If, however, some Board meetings are held outside the U.S. or if the company believes it is reasonable to assume that the director prepared for the Board meetings while being outside the U.S., pro-ration of the compensation can be appropriate. Companies should develop a clear policy in this regard and apply it consistently.

If U.S. tax withholding is required, companies will also have to report the income paid to the director on an annual basis on Form 1042-S and file a tax return on Form 1042. A copy of the Form 1042-S has to be provided to the director. The forms have to be filed by March 15 of the year following the year in which the compensation was paid. Furthermore, to avoid that companies are subject to a back-up withholding obligation with regard to the compensation, they should obtain a Form W-8BEN from the director every three years. (There are situations where a Form W-8BEN may not be required to avoid back-up withholding, but we believe it is easier and safer to request the form from the director.)

Aside from the U.S. federal tax obligations, companies will also need to assess if they have any state tax obligations in the states in which the director provides services (i.e., typically the state(s) in which Board meetings are held). As an example, in California, companies arguably are not required to withhold California tax on compensation paid to a nonresident director. However, reporting is required, but it should be acceptable to take the position that the federal reporting (i.e., on Form 1042) will satisfy the reporting obligation in California, such that no additional tax report will need to be filed for California.

Lastly, but perhaps most surprisingly, companies may have tax withholding and/or reporting obligations in the director's country of residence. In many countries, because the director is not an employee of the U.S. parent or any of its subsidiaries, no such obligations will exist. However, there are several exceptions to this rule. In Canada, for example, the director will be viewed as an employee and the U.S. company will be required to withhold tax from the director's compensation and report it annually to the Canada Revenue Agency. This means that the U.S. company will in most cases need to obtain a Canadian Business Number to be able to discharge these obligations.

Director’s Tax Obligations

Of course, companies should firstly be concerned about their tax obligations, but many will also want to provide at least some information to the director regarding his or her personal tax treatment. Companies should be careful in this regard because conflicts of interest can ensue between the tax position the company may want to take and the director's tax position. Therefore, it usually is a better idea to advise the director to engage a U.S. and local tax advisor to determine his or her personal tax obligations with regard to the compensation paid by the company.

In general terms, however, it is likely that the director will be required to file a personal tax return in the U.S. (on Form 1040-NR). The 30% tax withheld by the company can be applied against the director's personal federal tax liability, but in certain cases, the director may owe additional tax and may be required to make estimated tax payments on a quarterly basis. Similarly, if services are provided in states with state income tax, the director may be subject to state income tax on the director's compensation and required to file a personal tax return at the state level.

In addition, the director usually will be subject to tax in his or her country of residence, which leads to double taxation. Tax treaties can provide relief from such double taxation and the director generally should be able to claim a foreign tax credit for the U.S. tax withheld.

Special Considerations for Equity Awards

When granting equity awards to a non-U.S. director, much like for grants to employees, companies will need to assess any regulatory issues in the director's country of residence. Depending on the type of award, exemptions may be available. However, just because the company grants the same type of award to employees in the respective country and can rely on an exemption, it should not assume that the exemption is also available for the grant to a director, because some exemptions are limited to employees (e.g., in the United Kingdom). Therefore, additional exemption filings may be required or, in extreme cases, stock-settled awards may not be a granted.

Finally, on the tax side, we see that many companies allow directors to defer the receipt of the shares (and/or their cash compensation). If properly structured under Section 409A of the Internal Revenue Code, U.S. directors can defer taxation accordingly. However, outside the U.S., this will not always be the case for voluntary deferrals. Consequently, companies should review the tax consequences for deferred awards in the director's country of residence to decide whether offering such an award makes sense from a tax perspective.

Conclusion

Non-U.S. directors are becoming a reality for many U.S. companies. Because of the heightened visibility of such individuals, companies are well-advised to thoroughly vet the tax and regulatory issues for compensation paid to such directors, both in the U.S. and in the director's country of residence. This analysis should be reviewed on a regular basis (e.g., annually).

If you are looking for more detailed information, I can highly recommend an article on this topic written by my colleague Sinead Kelly.

Are Arbitration Clauses in Award Agreements Arbitrary?
Most equity plans include a governing law provision that provides that the plan and the awards granted under the plan are governed by the law of the jurisdiction in which the issuer is incorporated. In addition, we typically recommend that companies include a venue provision in their award agreements providing that any dispute related to the plan or awards has to be litigated in a forum chosen by the issuer. For US-based issuers, this will usually be a federal or state court in the United States, where courts are more likely to enforce the provisions of the award agreements (which typically favor the issuer). The hope is that, by including such governing law and venue provisions, companies can defeat lawsuits brought by award recipients outside the United States on the basis that foreign courts (which are more likely to apply employee-friendly local employment laws) do not have jurisdiction. It is questionable if this argument always works (in fact, a UK court recently ruled that UK courts had jurisdiction despite a Massachusetts governing law and venue provision in the award agreement), but such venue provisions may at least have a deterrent effect in some cases.

A related question which comes up from time to time is whether arbitration clauses are a better way for companies to deal with employee disputes. In the U.S., this often will be the case, both to cut down on the costs related to lawsuits and the time it takes to resolve such disputes.

However, outside the U.S., it is doubtful that a typical "U.S.-style" arbitration clause will be enforceable. In the employer-employee context, arbitration clauses are rarely enforced outside the U.S. because most courts will view them as unconscionable given the balance of power in an employment relationship. That said, the equity award agreement is not entered into between the employer and employer but between the foreign parent company and a local employee. This and the fact that the equity awards are not necessarily a central part of the employment relationship could allow us to argue that the relationship is more of a commercial nature, in which case a court may be more inclined to respect an arbitration clause. However, this will differ from country to country and it remains unlikely that arbitration clauses will be enforceable in all countries in which a company grants equity awards.

Since most companies will not be prepared to analyze the enforceability of an arbitration clause on a country-by-country basis, companies should consider proceeding with including the arbitration clause and reviewing whether or not it may be enforceable only in case a dispute with an employee arises. Of course, companies would be losing the venue provision by including the arbitration clause (which necessarily has to replace the venue provision), but the enforceability of the venue provision is just as uncertain as the enforceability of the arbitration clause, so it is unlikely that companies are giving up any significant advantage by dropping the venue provision.

If U.S. companies wish to include an arbitration clause, the following suggestions may improve the chances of enforceability:

  • Use the International Centre for Dispute Resolution (ICDR), the international arm of the American Arbitration Association (AAA), as the arbitrator for non-U.S. employees, rather than the AAA. Non-U.S. courts likely will view the AAA as a U.S.-centric institution that will be biased towards the U.S. party which could affect enforceability. Using the ICDR may mitigate these concerns.
  • Use a well-drafted arbitration clause that is less likely to be viewed as unconscionable by foreign courts.
  • Separate the arbitration clause from the governing law provision in the award agreement. This way, if the arbitration clause is deemed unenforceable, it should not affect the governing law provision, provided a severability clause is included in the agreement.

As with a venue provision, it is very uncertain if a non-U.S. court would in fact decline to hear an employee's claim because of an arbitration clause. However, there also is no real downside to including such clauses, and companies may prefer to have consistency in the way they treat their U.S. and non-U.S. employees.