The Government has moved to reverse certain tax changes made in 2009 that effectively put a stop to the use of employee share option plans in Australia. This is good news for foreign companies that have already entered, or are looking to enter, the Australian market and we expect that for those companies, option plans will make a strong return once the proposed changes take effect.
The Government has announced the following changes to the employee share scheme tax regime:
- The changes made in 2009 to the taxing point for options will be reversed for all companies. This means that the taxing point for options that qualify for tax deferral (i.e. options that are subject to a "real risk of forfeiture" – normally satisfied by a minimum term of employment forfeiture condition) will revert to exercise as opposed to vesting.
- Some special rules will apply to "eligible start-ups". The qualification criteria will include turnover of not more than A$50m, being unlisted and being incorporated for less than 10 years. Clearly, further detail will be needed around these criteria to deal with avoidance activity but the criteria seem reasonable.
- The maximum period of tax deferral for eligible start-ups will be extended from 7 years to 15 years. It is not clear whether this will extend beyond eligible start-ups to other companies.
- A concession will be provided for options issued by eligible start-ups where:
- the employee must hold the options for a minimum of 3 years; and
- the options are "out-of-the-money" on grant (i.e. exercise price is above the current market value of a share).
Under this concession, tax is deferred until sale of the shares received on exercise of the options. Further, the "discount" on the options (normally being their market value on issue) will not be subject to income tax (at personal marginal rates of tax), rather the gain made on sale of the shares (the sale price less the exercise price) will be subject to capital gains tax (CGT). It is assumed that employees will be entitled to access the 50% CGT discount concession to reduce the tax payable on their capital gain. However, exercise of the options will refresh the 12 month holding period that must be satisfied to access this concession, meaning that employees may be exposed to a level of market risk (drop in the value of their shares received on exercise of their options) if they are to access the 50% CGT discount concession.
- A concession will also be provided for shares granted by eligible start-ups where:
- the employee must hold the shares for a minimum of 3 years; and
- the shares are offered to employees at a discount to market value of 15% or less.
Under this concession, tax is deferred until sale of the shares. Further, the discount will not be subject to tax, the cost base of the shares for CGT purposes will be the market value of the shares on grant, and the gain made on the sale of the shares (the sale price less the market value of the shares on grant) will be subject to CGT.
- The safe harbour valuation tables used to value unlisted options will be revised to more appropriately align with market value.
The changes will come into effect for shares or options provided by companies to employees on and from 1 July 2015.
The proposed changes announced by the Government are a much welcomed development, particularly returning the taxing point for options back to exercise from vesting and the more favourable treatment for start-ups who are typically more dependent on equity incentives.
Many foreign companies with operations across the globe prefer to adopt a consistent approach to employee incentives. Companies that use options around the rest of the world will now be able to use options in Australia on broadly the same terms as their home plans.
The biggest difficulty we foresee with the share and option concessions for eligible start-ups is that of valuation and establishing qualification for the concessions, i.e. determining the market value of a share in the company to establish that options have not been issued "in-the-money" or that shares have not been issued at more than a 15% discount.
We would also encourage:
- the Government to look at the complexity that taxing employees on cessation of employment adds to share and option plans; and
- ASIC to consider the relief it is prepared to give to facilitate employee share and option plans, particularly as the share plan concession for eligible start-ups would be difficult to implement under the existing relief.
We expect that some foreign companies that have adopted loan plans since 2009 as a solution to the option problem may stick with those plans now that they (and their employees) are familiar with their operation and the significant tax benefits associated with such plans.