Employee Profit Sharing Arrangements, Employee Share Schemes and Tax Consequences

Posted by Byron Cannon on April 13, 2012

Profit Sharing AgreementsProviding greater incentives to staff in a company may come with hidden consequences for both the company and the employee.

As a company grows, staff may be offered incentives such as shares in a company as well as profit sharing.  Payments of shares and profits may be made directly to an employee or into a Trust set up specifically for that purpose.

When entering into these arrangements, employers may or may not enter into written agreements with their staff as to how the shares and profits in a company will be distributed to the employee.

A distribution of company shares or profits in this way is likely to be viewed by the Australian Taxation Office as an employee share scheme, depending on the nature of the agreement.  The Australian Taxation Office has specific requirements for this.

For employees, some of the consequences of this arrangement may include the following:

  • The employee may be taxed when they receive the shares or profits in the company, when they leave the company, or when various triggering events occur. 
  • The tax payments could be significant and occur at a time which is not suitable for the employee.
  • The scheme may still be viewed as an employee share scheme even if the shares are held by a Trust.
  • Payments of income out of the trust to various beneficiaries may have further consequences for the employee in relation to their individual tax payments.
  • There will be compliance and administration costs associated with the running of the Trust.
  • The agreements may or may not cover who pays the tax and when it is to be paid.
  • Tax implications when the shares in the company are subsequently sold by the employee.

Employers wishing to enter into such transactions would need to be mindful of the following consequences:

  • Fringe Benefits Tax implications.
  • Issues surrounding how the company is to be valued, the proportion of profits to be paid and when they are to be paid.
  • The employees may have voting or other rights in the company which the employer may not have intended.

With the numerous tax and other consequences of providing employees with a share of the company and company profits, employers and employees need to very carefully consider their agreement and the consequences that follow.  Alternate, simple arrangements may also need to be considered.  Expert legal and accounting advice should also obtained.

If you have any questions regarding the above, or questions generally regarding employment agreements and taxation, please do not hesitate to contact me.

Business Succession Planning

Posted by Byron Cannon on March 20, 2012

Business StrategyBusiness Succession Planning can be a difficult and long process, however the rewards of a properly documented Business Succession Plan far outweigh the time and effort spent in preparing the plan.  Too often have I seen clients attend my office after an event such as death or retirement where a business is suffering.  Often problems could have been avoided with a properly documented Business Succession Plan.

What is Business Succession Planning?

In simple terms, Business Succession Planning is developing a strategy to transfer the ownership, management and financial responsibility of a business.

Who should be involved in the Business Succession Planning?

There are a number disciplines and professionals that should be engaged to ensure that the Business Succession Plan achieves all of your objectives.  Often I will meet with Accountants, insurance brokers, financiers and sometimes management consultants to ensure that all areas of expertise are involved.

What matters should be addressed in Business Succession Planning?

It is difficult to outline all matters that should be outlined because each business is different.  Depending on the business the following matters should be factored into the Business Succession Plan:

  • Retirement plan for key stakeholders in the business;
  • Management succession plan which deals with the timing of the handover of the management of the business;
  • Equity succession which deals with the actual transfer of ownership, and payment for this.
  • Once the succession plan has been finalised it will need to be incorporated into the estate plans of the current owners.

Process for Planning

It is very important a structured process to approach the Business Succession Plan.  The process will involve consultation with appropriate professionals and deal with all of the elements that need to be considered.  Part of the process also involves conducting a review and due diligence of the business.

This approach will include considering the following questions:

  1. Who could and would run the business for you if something was to happen;
  2. How do you propose to continue your income after your exit from the business;
  3. How did the other important stakeholders in the business view this;
  4. What is the business worth;
  5. What insurances do you have in place, both for the business and personally;
  6. Do you have legal documents such as Shareholder Agreements, Will, Power of Attorney, Buyer Solicitor, Business Will;
  7. Do you have a strategic plan for your business;
  8. Who are the key stakeholders in your business that will continue to be involved in the business after you exit;
  9. When would you like to exit the business.

It is very important that details consideration is given to any business succession plan, and professional advice sought from a number of disciplines.  Please do not hesitate to contact me if you would like to discuss this very important strategy for your business.

Capital Gains Tax and Life Insurance Policies in Business Wills

Posted by Byron Cannon on November 17, 2011

Life InsuranceI was recently asked to give a presentation for Business and Estate Planning Specialists. This company specialises in selling risk insurance for businesses and individuals. They had asked that I explain to their team the taxation implications for various forms of life insurance policies. 

One issue that was discussed is why it is so important to structure life insurance policies properly when preparing Business Wills or Buy/Sell Agreements.

Is Life insurance a Capital Gains Tax asset?

The Capital Gains Tax legislation treats insurance policies as a Capital Gains Tax asset, and the payment of the insurance proceeds as a disposal of the asset.

Capital Gains Tax asset a Chose-in-action

The definition of a Capital Gains Tax asset includes a “chose-in-action”. A chose-in-action is a contractual promise to do something or to pay something.  An insurance policy is a chose-in-action as it is a contractual promise by the insurer to pay the amount insured upon the occurrence of an event (ie. death). This asset will be disposed upon the performance of the contract (ie. the payment of the insurance proceeds). This results in the disposal of a Capital Gains Tax asset.

Now that it is established that an insurance policy is a Capital Gains Tax asset, careful consideration needs to be given as to whether any of the Capital Gains Tax exemptions apply.

Capital Gains Tax exemptions

Death benefits will only be exempt from Capital Gains Tax where the recipient is either:

(a)     The original beneficial owner - this can include two or more people such as the case when policies are owned by business partners over each other, and can also include a company or trust; or

(b)     Acquired the interest in the policy for nil consideration.

The term “original beneficial owner” has also been stated by the ATO to be the first person who:

(a)     At the time the policy is effected, holds the rights under the policy; and

(b)     Possesses all the normal incidents of beneficial ownership.

Ownership of policies by surviving business owners

It is very important that if insurance policies are owned by surviving business owners, there are no changes to the ownership of the business between the time that the policy was taken out, and the death of the deceased owner. 

The reason for this is that if new owners are introduced into the business, and those owners wish to take advantage of the insurance policy, the definition of “original beneficial owner” may not be met as:

(a) That person would not have been the original beneficial owner; and

(b) If money was paid to purchase the share in the business, and the interest in that life insurance policy, there would not have been an “acquisition in the interest of the policy for nil consideration”.

It is therefore essential that if new owners are introduced into the business, that the existing policies are terminated and new policies entered into.

Ownership by deceased estate

If insurance policies are owned by the deceased estate, the deceased estate would be the “original beneficial owner” and the estate would be exempt from Capital Gains Tax in relation to the life insurance proceeds. 

However, for Capital Gains Tax purposes, the estate would be deemed to have disposed of the interest in the business, at a deemed market value, and would have to pay Capital Gains Tax on the capital gain realised upon their disposal of the interest in the business.

Business Wills

It is essential that when drafting Business Wills, careful consideration is given to the ownership of life insurance policies so that unwanted Capital Gains Tax consequences are not brought about.  Please do not hesitate to contact me if you would like to discuss any aspect relating to Business Succession, Business Wills, Estate Planning, or the ownership of life insurance policies.

What is a Business Will? Here is the answer!

Posted by Byron Cannon on September 19, 2011

Business WillI recently met with a client and their Accountant to discuss some business succession issues.  One of the questions I asked was what happens to the business if one of the owners dies. This led to other questions like:

  1. Does the deceased spouse go into partnership with the other owners?
  2. How is the deceased paid out?
  3. How is the business valued?
  4. How is the debt of the business paid?

These simple but important questions demonstrate the need to discuss Business Succession Planning and the importance of a Business Will for each business.

Business Succession Planning

The key objectives for effective business succession planning include

  1. Ensuring the ongoing management and control of the business
  2. Ensuring the ongoing financial viability of the business
  3. Addressing the personal requirements of owners
  4. How will the transfer of ownership be funded?
  5. What are the Tax Considerations – CGT, GST, Stamp Duty
  6. How are business debts & personal guarantees dealt with
  7. Maintain the equity of continuing owners
  8. Ensuring a smooth transition for all – staff, family & investors

What is a Business Will?

A Business Will is an agreement that usually takes the form of a buy and sell option. It ensures the smooth transition of the ownership of a business on the event of a death, total and personal disablement or trauma of an owner.

Funding for a buy out in a Business Will is critical, and is commonly achieved by appropriately held insurance policies.  It is very important to ensure that expert advice is sought when taking out the policies, so that Capital Gains Tax is not triggered unnecessarily.

Advantages of a Business Will

A properly structured Business Will, will have the following attributes

  1. It can specify responsibilities, obligations, capital requirements, funding and management
  2. It will contain compulsory buy/sell provisions
  3. It avoids uncertainty for business & family as the process is structured and seamless
  4. It can contain restraint obligations, confidentiality etc
  5. It allows for a smooth transition of ownership
  6. Funding by life insurance relieves pressure on the business and continuing owners
  7. It deals with the event of a shortfall in funding
  8. It has an agreed formula to value the business on a trigger event
  9. It contains dispute resolution provisions

Implementation

Implementation is critical for the Business Will.  I recommend the following procedures:

  1. Conduct an Owner’s Meeting to reach agreement on critical terms like method of valuation, times for payment etc.
  2. Value the business to determine the level of insurance needed.
  3. Determine who will own the insurance policy and receive benefits upon death, TPD etc. To ensure the Business Will and the policies are tax effective
  4. Determine if other insurances are needed such as key person debt, revenue, income protection, business expense
  5. Inform families to make sure they understand the benefits, implications, procedure etc
  6. Obtain insurance policies
  7. Finalise and execute the agreement
  8. Review business owners existing Wills as they will more than likely need to be updated

Please contact me to discuss any questions relating to this important area.  If you would like to prepare a Business Will, please visit the Ferguson Cannon Lawyers Client Services Portal to start the process.