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Dear Malvernmoe,
Since you have specifically encouraged level-headed responses to outline anyerrors in your post, I will respectfully do so.
Firstly, I disclose that I work with remuneration issues regularly and amfamiliar with Employee Loan Funded Share Plans. If you are not familiar with these schemes, I suggest a good place to start is to google "Employee Loan Funded SharePlans". You will find a number of good sources that explain how theseplans work (Guerdon have a good summary below). I have always been surprised theseplans are not used more widely as they have a number of advantages forexecutives and for the company. Perhaps your views on the plan explain why they are not more widely employed - they are complex and seem to be misunderstood.
Loan funded share plans have been used byASX-listed companies and large private companies (especially private equityportfolio companies) for a long time.
A loan funded share plan has the followingfeatures:
·A loan is grantedto an employee for the sole purpose of purchasing company shares
·The shares arepurchased at market value – so the structure is not captured by the employeeshare scheme rules in Division 83A of the Income Tax Assessment Act 1997
·The loan is limitedin recourse to the lower of the value of the shares and the loan value at thedate of repayment
·The loan may beinterest-free or at interest
·As the structurehas the economic effect of an option with an exercise price, it is accountedfor as an option under AASB2 – the grant date fair value is amortised over theservice period.
·For the individualexecutive, the shares are held as a capital asset and, on disposal, subject tocapital gains tax (CGT) rather than ordinary income tax like the typicalemployee share scheme structures
This structure more closely aligns employeeinterests with investor interests – as the employee owns the shares any increasein share price will be a net gain to the employee after repayment of the loan,along with dividends. It is also tax-effective for the employee.
Loans are limited recourse to the value of theunderlying shares with the maximum amount to be repaid limited to the initialloan value. Since the shares are acquired at the time of issue ratherthan at vesting, any increase in share price will be treated as a capital gainrather than an income gain. As such, an employee can benefit from theconcessional CGT discount of 50%.
Another benefit of the shares being acquired at thepoint of issue, is that dividends will be paid from that point. It is betteraligned with shareholder interests than an option plan, which only rewards forshare price growth. A loan funded plan ensures employees consider the 2elements of total shareholder return – share price growth and dividends. Theemployee can also receive the benefit of the dividends
As I hope you can see from the above, you have mischaracterized the intentionsand outcome.
Effectively the shares are like an option with an exercise price. This is certainly how the Australian Taxation Office treat them.
It is not correct to describe the plan shares as "free".In fact the executive has subscribed for these shares at the price, in thiscase, of 23c. This is the amount the company will receive for issuing theseshares. They are not free. If you continue to be confused on this pointconsider a leased vehicle. The car may be for sale for $50,000. If thepurchaser acquires the car and signs a sale contract and then subsequently afinance contract or a lease contract to fully fund the purchase (or is vendorfinanced the vehicle by his employer at a discounted coupon!) he has bought thecar, he has not disbursed any of his or her cash to buy the car, but allthe same it is not accurate to say they have received a car for free. They havejust financed the purchase. To describe the as a "free car" wouldimply the person has been given a car or won it in the lottery which isobviously not the case. The asset value of the car is offset by the liabilityof the finance contract and its obligations. It is undoubtedly convenient toacquire a car this way (as you do not require any cash), but it is certainlynot a free car. The asset value of the car will only be of value to thepurchaser if the car is worth more than the finance. In the case of an EmployeeLoan Funded Share Scheme this exactly the motivation - to increase the shareprice above the original price. This way the Executive is motivated to increasethe company's valuation and increase shareholder value.
I hope this has helped
(20min delay)