Changes to Employee Share Scheme tax rules

The Government has released its “Industry Innovation and Competitiveness Agenda” containing initiatives to boost business competitiveness. Among the initiatives are reforms to the tax rules for Employee Share Schemes (ESS).

The reforms will enhance the attractiveness of options issued to employees as an incentive tool. Significant new concessions will also be introduced for eligible ‘start-up’ companies.

Changes to tax treatment of options – for all companies

Deferred taxing point

Under the changes, options that are issued at a discount will generally only be taxed when they are exercised and converted to shares. An employee can then sell the shares to fund any tax liability.

Currently, options can be taxed when they vest, which can often be before exercise. This could result in employees being subject to tax before they receive cash to pay their income tax liability. This has been a significant factor in the dearth of options being granted to employees in recent times.

Tax will still be payable on the discount element of the options at marginal tax rates and CGT may be payable if the shares acquired on exercise of the options are subsequently sold at a profit.

Extension of maximum deferral

To take advantage of the later taxing point, the options need to be issued under a scheme that qualifies for tax deferral, for instance because the options are subject to a vesting schedule. Under the current law, tax could be deferred for up to 7 years.

The Government is proposing to increase the maximum deferral period to 15 years.  This will allow more time for start-up companies to succeed.

Updated valuation tables

The safe harbour valuation tables that are used by many companies to value their options will be updated to reflect current market conditions.

New concessions for ‘start-up’ companies

Who is a ‘start-up’?

Eligible start-ups will be defined as companies that:

  • Have turnover of less than $50m;
  • Are unlisted; and
  • Have been incorporated for less than 10 years.

It would seem that all three criteria need to be met in order to qualify as an eligible ‘start-up’.

What are the concessions?

The concessions to be provided to start-ups are generous and, if the Plan is structured appropriately, can give rise to a pure CGT outcome for employees. In short:

  • Options and shares provided at a small discount of less than 15% to market value, which must be held for at least three years, are not subject to upfront tax;
  • Any discount on shares granted will be exempt from tax and the shares only taxed on sale;
  • Certain options will have their taxing point deferred until sale of the underlying shares; and
  • Tax will only be payable on sale of the shares under the CGT rules.

When do the new rules apply?

The Treasurer will consult with industry to ensure that the draft legislation delivers the intended outcomes.  However, the proposed changes are only intended to come into effect for shares and options granted after 1 July 2015.

Issues to consider if you are about to implement an ESS

The proposed reforms of the ESS rules are welcome and will make ESS arrangements more tax effective for employees.  Implicitly, this will enable ESS to become a more powerful tool in attracting and retaining employees. However, some issues remain.  In particular:

  • The new rules won’t be effective until 1 July 2015. In the interim, companies will still need to consider whether they should implement some form of incentive arrangement.  Loan funded shares plans are still tax effective and compare favourably with options, even under the proposals;
  • Although tax is a major consideration in designing and implementing an ESS, the issue of equity (whether shares or options) is also subject to the disclosure and fund raising provisions of the Corporations Law.  We eagerly await whether concessions in the Corporations Law will also be provided for start-ups.
  • Improved valuation tables are welcome, but ultimately, the tables require some form of company valuation before the tables can be used.  Independent valuations are costly, while internal valuations can be more susceptible to ATO challenge.  It is hoped that the draft legislation will also contain some form of safe harbour that can be used for company valuations for ESS purposes.


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