The Commonwealth Government has released draft legislation to amend the taxation arrangements of Employee Share Schemes (ESS).

By unwinding the restrictive rules introduced by the former Government in 2009, the legislation introduces wider tax concessions for share and option schemes, which aim to make the schemes more internationally competitive and supportive of start-ups in Australia.

The proposed changes are a welcome relief to the cumbersome tax rules currently in place, and we envisage that a much bigger update of option schemes, particularly by the start-up sector, will follow. This article summarises some of the key changes and their implications for the uptake of options schemes.

Background

ESS play an important role in increasing employee attraction rates, talent retention and employee motivation. This is particularly true for start-ups that may not have the capital to reward and retain talented staff.

In 2009, changes to the ESS rules meant that, as a default position, employees were usually taxed at the point that shares were issued, or an option was granted. This means that employees are usually taxed before any gain or benefit is realised, despite, in many cases (especially in the case of start-ups), the facts that no financial gain or benefit will ever be realised and the shares are unable to be traded. Additionally, to the extent that the taxing point is able to be deferred, the taxing point is the vesting date, rather than the date of exercise.

This has had a significant impact on the uptake of ESS. Research has shown that since 2009, the number of Australian companies offering ESS has dropped dramatically, with one of the principal reasons cited being the complex administrative burdens and unfavourable tax treatment. The draft legislation aims to address this.

Draft legislation – what are the key changes?

The draft legislation can be broken into two parts. The first deals with start-ups, while the second deals with all companies.

Key amendments under the draft legislation include that:

  • the taxing point of an ESS interest, which is a "right" (for example, an option, a performance right or other right to acquire shares), may be deferred even if the ESS does not provide for a "real risk of forfeiture" in respect of the right
  • a deferred taxing point of ESS rights is extended from when the right becomes exercisable under the ESS, to when it is actually exercised by the employee (provided certain other requirements are satisfied)
  • the maximum deferral period (for both shares and rights) is increased from seven to 15 years
  • the significant ownership and voting rights limitation will be relaxed from five to 10 per cent of the effective ownership or maximum voting rights of the employer
  • the Commissioner may approve safe harbour valuation methodologies that are binding on the Commissioner, and
  • a further tax concession is introduced for employees of certain start-up companies so that:
    • for shares issued at a discount of less than 15%, the discount on issue is exempt from income tax, or
    • for rights that have an exercise price that is greater than or equal to the market value of an ordinary share in the company at the time the right is acquired, the discount is deferred until exercise or sale under capital gains tax rules.

To access the concessions, shares or rights must satisfy the general conditions that apply to all ESS concessions. The ESS must also operate so that all employees hold the ESS interest for at least three years. Additionally, for the tax concession to apply the company must:

  • have an aggregate turnover of less than $50 million
  • be unlisted, and
  • have been incorporated for less than 10 years.

What does this mean?

The changes are a welcome relief to the cumbersome rules currently in place and we envisage that a much bigger update of option schemes, particularly by the start-up sector, will follow. However, loan plans, which have been the scheme of choice for private companies since 2009, will still remain popular due to the ability for the employee to hold his/her shares on capital account from the date of grant (assuming the shares are issued at market price).

Next steps

The closing date for written submissions about the draft legislation is Friday 6 February 2015. It is proposed that the legislation will apply to ESOP interests acquired on or after 1 July 2015.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.