Tax and regulatory changes to employee share schemes: exposure draft legislation released

By James Morvell, Anthony Bradica and Vanessa Murphy

Employers use employee incentive schemes (ESSs) to attract, retain and motivate staff by issuing interests – typically shares and options over shares – usually at a discount.

Following announcements in the 2021 Federal Budget, the exposure draft legislation proposing tax and regulatory changes that will allow ESSs to be implemented with greater ease has now been released. Submissions on the exposure drafts are due by 25 August 2021.

Current regulation of ESSs

The Corporations Act 2001 (Cth) already contains certain exemptions from regulatory obligations that apply to the offer or issue of securities where the offerees are employees (including the ‘senior managers’ disclosure exemption). There is also class order relief in place (Class Orders 14/1000 (listed bodies) and 14/1001 (unlisted bodies)) that provides listed and unlisted entities with relief from the disclosure obligations, advertising and hawking restrictions and Australian Financial Services Licence (AFSL) obligations in the context of ESSs. However, the conditions that need to be satisfied in order to take advantage of the class order relief are somewhat restrictive, and, in our experience, can prohibit an entity from structuring its ESS in a way that achieves the intended commercial objectives.

In particular, to rely on the current class order relief:

For unlisted entities:

• No more than a nominal amount can be paid by a participant as part of the ESS (except in the case of options or performance rights, where there may be payment upon vesting or exercise, subject to the satisfaction of other conditions).
• There is a $5,000 limit on the value of all offers to each participant in each 12 month period.
• The ESS cannot involve the employer group making a loan to the participant to fund the acquisition of the securities.
• The ESS cannot be a ‘contribution plan’ (being where the participant makes contributions pre or post tax wages or other monies).

For listed entities:

• The interests offered must have been traded for at least three months before the offer is made.
• The interests cannot have been suspended from trading for more than five days in the previous 12 months.

Proposed regulatory reforms

The proposed reforms to the Corporations Act would significantly reduce the conditions that currently apply to the operation of ESSs in reliance on regulatory relief. The reforms modify the Corporations Act in respect of offers of interests in both listed and unlisted companies, as well as listed managed investment schemes.

Under the proposed reforms:

• The following individuals may be eligible to participate in an ESS:
  • employees (full time, part time or casual, regardless of the number of hours worked) and directors (executive or non-executive) of the company or its associated bodies corporate (or the responsible entity in the case of a listed scheme);
  • independent contractors predominantly providing services to the entity or its associated bodies corporate; and
  • persons that are about to be in one of the above categories (ie to ensure that offers can be made when recruiting people into those roles).

The interests issued under the ESS do not necessarily have to be held by the eligible participant, but instead can be issued to an immediate family member, a company where the only members are the participants or their immediate family members, or the trustee of a self-managed superannuation fund.

• There are prescribed types of security that may be issued under the ESS, which include (among others) the more commonly issued ESS securities: fully paid shares, units and stapled securities, options and performance rights.
• ESSs that do not require any payment from employee or director participants would generally not be required to comply with the Corporations Act.
• For ESSs that require payment by employees or directors, or that are open to contractors, streamlined conditions and obligations need to be complied with (even if the ESS involves a loan or contribution plan). These include:
  • an ‘issue cap’ of 5% for listed entities and 20% for unlisted companies, being the maximum number of fully paid interests (as a proportion of the total interests on issue in the entity) that are covered by an ESS offer in the previous three years; and
  • in the case of unlisted companies, an ‘offer value cap’ of $30,000 on the value of all offers to each participant in each 12 month period (rather than $5,000).

Participants must also be provided with certain warnings and disclosures in an offer document (which is currently the case for ESS offer documents). The information that needs to be disclosed in respect of unlisted companies includes valuation and financial information, given that value and financial position can be more difficult for participants to assess where the entity is not listed.

• Loan-funded acquisitions would be permitted for unlisted companies, provided that the loan is:
  • interest-free and involves no fees; and
  • limited in recourse to only the interests acquired using the loan.
• Contribution plans would be permitted for unlisted companies, provided that:
  • the securities offered are fully paid shares or units (or options or rights to acquire fully paid shares or units);
  • contributions must be held in a trust account with an Australian ADI; and
  • participants can elect to discontinue the deductions or payments at any time (with any deductions made and not already used to acquire interests being repaid within 45 days).
• ASIC would have various intervention powers in relation to ESSs, including the power to make stop orders if there are deficiencies in the ESS offer documents.
• Offences would be introduced that capture certain misleading or deceptive conduct in connection with an ESS made under the Corporations Act regulatory exemptions (which apply to the body making the offer, as well as each of its directors and those involved in making the misleading or deceptive statements).

Proposed tax reforms

Currently, under a tax-deferred ESS, where certain criteria are met, employees may defer tax until a later tax year (the deferred taxing point). The deferred taxing point is the earliest of a number of events. Often, it is the time when the equity is received – for example, when an option is exercised and shares are issued – and there is no risk that the employee can lose or forfeit the equity and is free to dispose of it.

There may also be an earlier taxing point on cessation of employment. This can mean that an employee has a taxing point on termination of their employment. This will ordinarily mean an unfunded tax liability for that employee, potentially forcing them to sell their shares.

The Government will remove the ‘cessation of employment’ taxing point for tax-deferred ESSs that are available for all companies. This change will apply to ESS interests issued from the first income year after the date of Royal Assent of the enabling legislation. At the earliest, the change will apply to ESS interests issued from 1 July 2022.

This measure will remove the cessation of employment as an event that is a trigger for taxation.

Observations on proposed tax reforms

Existing Plans

Companies with existing plans (and employees with existing grants) do not need to change their arrangements or revisit them.

However, for new grants made from 1 July 2022, under an existing Plan, companies will need to revisit their Plan documents and ensure that any tax advice provided to employees and contractors is still correct.

New Plans

For grants made between now and 30 June 2022, the existing law is unchanged. The ending of employment, even if that occurs after 1 July 2022, will remain a taxing event.

However, for grants made after 30 June 2022, whether under an existing ESS or a new ESS, the ending of employment will no longer be a taxing event and any guidance provided to Plan participants should be checked to confirm that it reflects the proposed new law.