The Government has published exposure draft legislation to lessen the taxation of Australian employee share and share option plans. If implemented, tax changes introduced in 2009, that effectively put a stop to the use of employee share option plans in Australia, will be reversed, and wider tax concessions for share and option plans will also be introduced.
This draft legislation follows an announcement made in October of last year (see our previous update in October 2014). The changes are proposed to apply to shares and options acquired on and from 1 July 2015.
2 Options to be taxed on exercise rather than vesting
Currently, options that qualify for tax deferral are taxed at the earliest to occur of the following:
- when the option is no longer subject to risk of forfeiture (i.e. on vesting) and any disposal restrictions have been lifted;
- cessation of employment; and
- 7 years from the date of grant of the option.
It is proposed that options that qualify for tax deferral will be taxed at the earliest to occur of the following:
- at the time when the option is no longer subject to risk of forfeiture (i.e. on vesting) and any disposal restrictions have been lifted (i.e. if you can transfer/sell your option, a taxing point will be triggered post-vesting, but prior to exercise);
- when the option is exercised (unless a risk of forfeiture or disposal restriction exists in relation to the share received on exercise of the option, in which case the taxing point is further delayed until these restrictions have been lifted);
- cessation of employment; and
- 15 years from the date of grant of the option.
The increase in the maximum tax deferral period, from 7 to 15 years, will apply to share plans as well as option plans.
3 Relaxation of the "real risk of forfeiture" and 5% holding conditions
Currently, deferred taxation is only available for employee share and share option plans where there is a real risk that the employee will forfeit the share or option – normally this is satisfied by a minimum term of employment forfeiture condition. It is proposed that the risk of forfeiture will no longer be a condition of option plans, provided there is a restriction on disposal of the options.
Currently, a condition of qualifying for the tax concessions is that the employee must not have more than 5% of the shares or voting rights in the employer immediately after the grant of the shares or options. This limit is to be increased to 10%. However rights/options held by the employee will need to be taken into account when assessing this threshold, as must interests of any associates of the employee. It is not clear at this stage whether it is only vested rights/option that must be included when assessing the threshold or whether rights/options held by other persons may be included.
4 New concession for small start-ups
If introduced, companies that qualify for this new concession will be able to issue certain shares or options to employees with no tax payable up front.
Shares must be issued at a discount of less than 15% to market value to qualify for this concession.
Options must have an exercise price equal to or greater than the current market value of a share to qualify.
The employee will then hold the shares or options as a CGT asset, paying tax only on an eventual disposal of the shares. (There will also be no taxing point when options are exercised and shares are obtained). In the case of options, it appears that an employee will only benefit from the 50% CGT discount on that disposal, where the shares received on exercise are held for at least 12 months before disposal. This is likely to be problematic, given that most unlisted companies generally prefer not to allow exercise of options until a liquidity event, at which time the employee's shares will be dragged along in the sale (most likely within 12 months). It may be that the benefit of this concession is somewhat limited unless the Federal Government can be convinced to amend the exposure draft legislation.
The start-up company must:
- be unlisted;
- be incorporated less than 10 years before the share or option is granted, and not be part of a corporate group, in which any other company has been incorporated for more than 10 years;
- have an aggregated turnover in the previous tax year of A$50 million or less, and
- be Australian resident.
The greatest difficulty with this proposal - establishing the market value of shares in start-up companies - remains largely unaddressed at this stage. The exposure draft legislation does include a facility for the Commissioner of Taxation to implement safe harbour valuation methods in future by regulation, and the Government has indicated they will continue consultation with industry in this area.
Other conditions, broadly matching those which apply to the current up-front and tax deferral concessions, will also apply:
- The plan must relate to ordinary shares;
- There is an integrity rule denying the tax concession in certain circumstances where the employer is a share trading company;
- The plan must require that the shares, or options and shares acquired on exercise of options, are held by the employee for at least 3 years;
- There is a limitation (as discussed above) on the employee holding more than 10% of the shares or voting rights in the employer; and
- Shares or options under the plan must be available to at least 75% of all employees who are Australian residents and have completed at least 3 years' service with the employer.
There is no risk of forfeiture requirement for this concession.
With shares, the upfront discount will never be taxed, as the gain for CGT purposes will be the sale price less the market value of the shares when issued. In the case of options, tax on the discount is effectively deferred until the options are exercised and the resulting shares disposed of, at which time the gain for CGT purposes will be the sale price less the aggregate of the amount paid by the employee to acquire the option and the exercise price.
5 Availability of refunds for options left to lapse
Currently, where an employee pays tax on the discount on an option (e.g. at vesting) but the option is never exercised and lapses (e.g. because it was never in-the-money), the employee is not entitled to a refund of the tax, but rather a capital loss.
Under the proposed changes, it appears that a refund of tax will now be available in these circumstances.