Large listed companies are increasingly imposing minimum shareholding requirements on non-executive directors. Encouraging share ownership by non-executive directors through non-executive director share rights plans is set to increase following a recent ATO class ruling. Managing Associate Shaun Cartoon and Partner Robert Pick consider the key points.
How does it affect you?
- Market commentators have been encouraging non-executive directors (NEDs) to own shares in the companies they represent in order to align their interests with those of other shareholders.
- Additionally, the ASX Corporate Governance Council's Corporate Governance Principles and Recommendations specifically recognises that it is generally acceptable for NEDs to receive securities as part of their remuneration, to align their interests with the interests of other security holders.
- To encourage NED share ownership, large listed companies are increasingly imposing minimum shareholding requirements on their NEDs. For example, most of the ASX 20 companies now require their NEDs to have a shareholding in the company equal in value to at least one year of a NED's base fee. NEDs are generally given up to a five-year period in which to attain the requisite shareholding level.
- Since 1 July 2015, companies have been able to operate NED share rights plans that facilitate the acquisition of shares by NEDs on a pre-tax basis (with the taxing point generally being deferred to the first day on which the disposal restrictions are lifted or the NED leaves the company, if earlier).
- The ATO has recently issued a class ruling that, for the first time, confirms the expected tax treatment of a NED rights plan. Consequently, we expect an increased interest in NED rights plans as a way of accelerating NED share ownership at a faster rate than a post-tax share plan would otherwise enable.
The 2015 Australian tax changes
As a result of tax changes that were enacted in 2015 (which we last reported here), rights to acquire shares granted on or after 1 July 2015 are now eligible for deferred tax treatment, even where there is no 'real risk of forfeiture' on grant (subject to certain conditions being satisfied). On the basis that any tax-deferred equity awards form part of a NED's fixed remuneration, by definition there would be no real risk of forfeiture.
When is tax payable?
Under a NED rights plan, the shares do not generally become taxable until the first day on which the NED can dispose of the shares. Once this happens, tax becomes payable (at individual marginal rates) on the market value of the shares at the time when they become unrestricted. If a NED retires before the shares become unrestricted, the taxing point will generally be the leaving date (and the disposal restrictions will generally be lifted at this time).
The disposal restriction period applies from when the rights are granted under a NED rights plan. A NED could be given the choice of applying a fixed period (eg the earlier of three years from grant and leaving the Board), or the disposal restrictions continuing to apply for so long as they remain on the Board (but no more than 15 years from the date of grant of the rights).
A NED rights plan is in contrast to a pre-tax NED share plan, where the shares would generally be taxable at market value on acquisition (as there would be no real risk of forfeiting the shares under the conditions of the relevant scheme).
Australian corporate regulatory considerations
From a general governance perspective, NEDs can receive part of their fees as equity. Indeed, the ASX Corporate Governance Council's Corporate Governance Principles and Recommendations specifically recognises that it is generally acceptable for NEDs to receive securities as part of their remuneration, to align their interests with the interests of other security holders.
When implementing a NED rights plan, it is important that the company's constitution and the ASX Listing Rules (in addition to various other regulatory requirements) permit it.
Some of the key corporate regulatory considerations to be considered in implementing a NED rights plan are as follows:
- A NED rights plan, and the grant of rights under such a plan, must be structured in such a way as to ensure it is consistent with the NED remuneration fee cap that applies under a company's constitution and the ASX Listing Rules.
- The ASX Corporate Governance Council's Corporate Governance Principles and Recommendations recommend that NED remuneration should not be performance-based. Accordingly, to comply with this recommendation, any rights granted under a NED rights plan should not be subject to performance conditions.
- Under the ASX Listing Rules, shareholder approval will be required for the grant of the rights to NEDs if they are structured so that new shares are to be, or are able to be at the company's discretion, issued and delivered on exercise of the rights. If the rights entitle the NEDs to receive shares that are only acquired on-market, no shareholder approval will be required under the ASX Listing Rules.
- The Remuneration Report of the company will need to disclose the operation of the NED rights plan, and the rights and shares acquired pursuant to such a plan. In addition, on the grant and exercise of rights, disclosure will be required via the lodgement of an Appendix 3Y for each participating NED.
- As with other employee equity schemes (particularly those that include senior executives as participants and/or the delivery of shares acquired on-market), insider trading issues and the interaction between a NED rights plan and a company's securities dealing policy also need to be considered.
On 15 August 2018, the ATO published class ruling CR 2018/35 (the Ruling), which considers the operation of a NED rights plan by CSL Limited (the Plan). The Ruling is significant because it is the first public guidance that the ATO has released on the operation of a NED rights plan.
In the Ruling, the Commissioner confirms that the rights granted to the NEDs under the Plan qualify for tax deferral and that the taxing point of the rights will generally be at the earlier of when the NED leaves the company and the date on which the disposal restrictions on the shares are lifted.
In the Ruling, the Commissioner also considered the extent to which a disposal restriction will be considered 'genuine' for the purpose of deferring the taxing point. In this regard, the Commissioner confirmed that the nominated restriction period and any genuine trading restrictions caused by the terms of the company's Securities Dealing Policy would all constitute genuine disposal restrictions.