Overview
We often get enquiries about how to treat an SMSF acquiring shares from a related party in relation to Employee Share Schemes (ESS). Therefore, it is worthwhile having a quick look at the basics when it comes to SMSFs and ESS.
Employee Share Scheme (ESS) options and acquisition of shares by SMSFs
An ESS is a scheme where shares, stapled securities, or rights (including options) to acquire shares and stapled securities in a company are provided to employees in relation to their employment. Usually shares or rights acquired under an ESS are acquired at less than market value (and often for no consideration).
Trustees of SMSFs cannot intentionally acquire assets from a related party of the fund. A related party of an SMSF includes, but is not limited to, each member of the SMSF, their relatives, business partners and any standard employer sponsor of the SMSF. One exception to the prohibition on acquisition of assets from a related party is listed securities acquired at market value.
If listed shares are acquired by an SMSF for no consideration, or less than market value, the ATO considers the difference between the market value and consideration paid as a contribution. The ATO has provided information on determining the market value of shares, stapled securities or rights acquired by an associate of the employee (such as an SMSF) where the shares have been acquired for less than market value.
In most instances, if the SMSF receives shares or options to acquire shares for less than market value via an ESS, the ensuing contribution will be considered a personal contribution to the SMSF. This is because it is the employee who is granted the personal rights to receive the shares or share options at a discount to the market value under the ESS. Furthermore, the employee then:
- Surrenders those rights so that the SMSF receives the shares or share options, or
- Exercises those rights but nominates their SMSF to receive the shares or share options.
Such a contribution could be a concessional (personal deductible) or non-concessional contribution and would be subject to the relevant caps (see below).
What about shares in an unlisted company?
Often individuals in management positions in unlisted companies are given the option to acquire shares, and such shares can be very lucrative at this stage in the business cycle, given future potential capital growth in the company (and potential Initial Public Offering). One strategy is to have the SMSF receive the shares rather than the individual, given the concessionally-taxed superannuation environment.
So then question then becomes – can my SMSF acquire the shares in the unrelated company via an ESS?
The short answer is no. The longer answer is still no, as an SMSF cannot acquire ESS shares in an unrelated private company from a related party (the member). The right to acquire the shares resides with the member, as they are the one who has the nexus to the company via the employment arrangement (it is highly unlikely an unrelated company would issue shares to an unknown SMSF).
What if the company is a related party? Can the shares be acquired by the SMSF in the related company via an ESS?
The short answer is yes. The longer answer is an SMSF can acquire shares in a related company from a related party, as the SMSF is a Part 8 Associate of the company (i.e. a related party).
However, unless that related company complies with Regulation 13.22C of the SIS Regs, the entity will be considered an in-house asset and the fund’s investment will be limited to a maximum of 5% of the total fund’s assets.
For example, Ashley wishes his SMSF to take up his shares through an ESS in a related party company Little Buddy Pty Ltd. If the SMSF’s total fund assets are $1.2 million, the maximum the fund could invest in the company could be no more than $60,000.
Other considerations
Without going into too much detail, the contribution caps must be considered with ESS. If the member wishes to make a personal deductible contribution, they need to be mindful that Superannuation Guarantee and other contributions such as salary sacrifice count against the concessional cap of $30,000. The bring-forward provisions may apply, but it is important to understand the various Total Super Balance (TSB) caps. The member’s TSB may also determine the fund’s eligibility to receive the shares as a non-concessional contribution.
Another issue for contemplation is the arm’s length rules. The superannuation rules state where parties are not dealing at arm’s length and the terms are more favourable to the SMSF, there will be no breach of s109 of the SIS Act.
However, the Non-Arm’s Length Income (NALI) provisions then apply, which remove the fund’s tax concessions where the SMSF and other parties are not dealing at arm’s length in relation to a scheme.
Where income is deemed to be NALI, all the income generated from that asset will be taxed at the top marginal tax rate of 45% (plus Medicare Levy), even if the member is in the pension phase.
Conclusion
The above is not an exhaustive list of factors to examine regarding ESS options. Like most things involving superannuation, the rules regarding ESS are complex, and specialist advice should be sought.
What does Neo Super provide?
We are an innovative end-to-end SMSF service provider specialising in:
- SMSF administration and compliance.
- Documentation services, including fund establishment, borrowing arrangements and pension documentation.
- White label documentation and services for Intermediaries such as accountants and financial planners.
- SMSF technical support, education, and training.
Further Information
For other service requirements, please contact our office at neo@neo-super.com.au or 1300 083 428.
