Tax Office to stop businesses claiming deductions for employee trusts

Companies may no longer be able to claim tax deductions for contributions made to employee benefit trusts, unless the employees sell their shares within five years. 

A draft ruling by the Australian Taxation Office issued yesterday effectively put a timeline on how long companies have to claim deductions to employee remuneration trusts for the first time.

The decision by the ATO has been labelled a ‘u-turn’ by some tax experts, but Gary Fitton of Remuneration Strategies Group told SmartCompany the move is a change, but not a backflip.

“It’s not a u-turn, although there is certainly a loan change and as far as we’re concerned there is no legislative basis for the five year restriction,” he says.

“The issue of the five years is the only new element of the ruling.”

The ruling states the tax commissioner generally accepts a short period of time for the trustee of an employee remuneration trust to “diminish a contribution for the direct provision of remuneration to employees to be up to five years from the date the contribution was made by an employer to the trustee of an ERT”.

“One may question whether an employer has a primary purpose of providing remuneration to employees if the contribution is first intended to be accumulated for a longer period of time (for example, in excess of a five year period) before such remuneration is paid.”

In the past, employers have been able to claim deductions for contributions to ERTs for an unlimited amount of time.

Large companies and start-ups which utilise employee share scheme arrangements are the most likely to be impacted by the change.

The ruling has been criticised for being overly lengthy and complicated, without providing clarity for companies which have already been given rulings saying they can claim deductions.

Fitton says he’s pleased with the ruling.

“The ruling is essentially saying for contributions to be deductible the shares have to be sold within a five year period. As long as you fall within this period, the ruling is actually supportive of these employee benefit trusts,” he says.

After an employer makes a contribution to an ERT, the trustee administers the share plan and buys and allocates the shares to the employees, as nominated by the employer.

If the employee sells the shares after a 12 month period, they will have a reduced capital gains tax rate.

“Since the mid-80s these trusts have been commonly funded by tax deductible contributions from a company or as loans from a company. It’s quite common to have a tax deductible contribution to a share plan trust,” Fitton says.

“Under these arrangements employees can hold the shares over the period they’re employed. The employers want that so the employees are invested in the company indefinitely and want to work to maximise the value of the business.”

Also yesterday the ATO announced the formation of a new tax advisory group called the The Tax System Committee.

The group includes Deloitte senior tax partner Teresa Dyson and Hall and Wilcox partner Keith James and will meet quarterly to advise the government on any possible tax changes.