The Federal Government has released exposure draft legislation to amend the Employee Share Scheme (ESS) rules as foreshadowed in their October 2014 announcement, see our earlier update.
When enacted, the changes will take effect for shares and options granted on or after 1 July 2015. The changes do not apply to existing ESS interests that are unvested at that time.
In short, the proposed changes will:
- Reverse the law changes that were made in 2009 to the tax treatment of options;
- introduce new concessions for employees of start-up companies;
- provide updated tables to value options for tax purposes; and
- permit the ATO to work with industry to develop safe harbour valuation methods supported by standardised documentation.
Options and shares generally – changes for all companies
Tax on exercise, not vesting for options
The main impact of the changes for non-start-up companies is on options (or ‘rights to acquire shares’). Currently, employees may be subject to tax on their options once they vest which may be at a time well before they are exercised, leaving employees to find a way to fund the tax liability on the options.
For options granted on or after 1 July 2015, employees will only be taxed once they actually exercise their options and are not subject to any sale restrictions on the shares acquired on exercise.
Changes to tax deferral conditions
Importantly, for tax deferral, a real risk of losing the option will no longer be required to defer tax.
The rules will also be amended to allow a tax deferral of up to 15 years from the date of acquisition of shares or options (up from the existing 7 year deferral).
Currently, employees who hold more than 5% of the company are not entitled to tax deferral. From 1 July 2015, that threshold will increase to 10%, although the rules will require employees to also count any shares that may be acquired on exercise of options that are granted in that 10% threshold.
Refunds on tax where options lapse
Finally, in a case where options have not been exercised, but an employee triggers a taxing point by leaving employment, and subsequently chooses not to exercise the option because it is ‘underwater’ (the exercise price is more than the market value of the share that can be acquired on exercise), the rules allow the employee to apply for a refund of the tax previously paid when they left the employer. Under the current rules, employees are not entitled to a refund of tax simply because they choose to allow an option to lapse because it is underwater.
Options and shares – start-up companies
Who is a ‘start-up’?
The new concessions are available to employees of start-up companies that are unlisted, have been incorporated for less than 10 years and have ‘aggregated turnover’ of less than A$50 million. The tests need to be applied on a group basis and include holding companies that own at least 50% in the start-up.
Conditions for Plan to qualify
In order to qualify for the start-up concession, the Plan must have certain conditions, being:
- If shares are offered, they can only be offered at a discount of less than 15% of their market value;
- in the case of options, the exercise price must be at least equal to the market value of the share at the time the option is granted; andn the case of options, the exercise price must be at least equal to the market value of the share at the time the option is granted; and
- the options or shares must be subject to a three year holding period that can only be broken if employment ends before the three year period.
The concession for employees
If the conditions are met, the employee is subject to tax under the CGT rules (for which the CGT may be available) and will only pay tax on disposal of the shares.
The proposed amendments are largely consistent with the Government announcement made late last year and are to be applauded. While the ESS rules intended to provide a statutory regime for the taxation of ESS interests, good policy dictated that they should not hamper or restrict the offer of such interests to employees which has been the case for many corporates.
Nonetheless, and while the draft is subject to further consultation, corporates and their advisers should consider the following:
- whether the concessions give rise to any better tax treatment for employees than other alternatives, such as loan funded share plan arrangements (CGT treatment and tax only on disposal), will require some further comparison between these alternative scheme types;
- some corporates may not be able to meet the definition of a ‘start-up’ (including listed companies) and should consider whether they should wait for 1 July or implement a loan share plan now in order to reward and ‘lock-in’ their key employees;
- the grouping and aggregation rules are complex and may require companies to do detailed analysis to confirm whether they qualify as a ‘start-up’; and
- even though shares and options are more tax efficient post-30 June 2015, companies need to remember that there are various Corporations Act requirements regarding licensing, fundraising and disclosure documents that still need to be considered as part of any grant of equity to employees.