Australia: New law gives a much needed boost to employee share schemes

Last Updated: 28 September 2015
Article by Michael Phillips


An employee share scheme (ESS) is a scheme under which shares or rights to acquire shares (options) in a company are provided to an employee or their associates.


An ESS is a way of attracting, retaining and motivating staff because they align employees' interests with shareholders' interests. Employees benefit financially if the company performs well. Phrased neatly by Malcolm Fulton, investment director at Starfish Ventures, share plans are "... key currency that people employ to keep highly talented people on board while conserving cash."

This is all the more the case with start-up companies, particularly those in the technology sector, where cash is sparse and talent expensive. The problem, however, for the Australian start-up sector before July this year was that complex rules and adverse tax consequences rendered such plans, all but useless leaving the Australian start-up sector languishing behind jurisdictions such as the US, EU and elsewhere.


In essence, employees who were granted options or shares under an ESS would incur a tax liability, in the case of options, when the option vested even if the employee chose not to exercise the option and, in the case of shares, when the shares were no longer subject to claw back. If the shares were issued at a discount, the tax liability of the shareholder would be further compounded. The amount assessed would be the market value of the ESS interest at the deferred taxing point, reduced by the cost base of the interest.

On taking government, the Coalition elected to redress the above and a number of other problems associated with share plans, which had left them largely ignored, particularly by the Australian start up sector.


The key changes are:

  • for rights (options) --- the taxing point will not be when the right can be exercised but will be deferred to the point at which the right is exercised and will be further deferred until the shares issued upon the exercise of the options are actually sold;
  • for shares--- provided they remain subject to genuine restrictions on sale for at least three years (in other words, they are not able to be disposed of) the taxing point will be deferred until the shares are actually sold.

Significantly, at the time of sale, Capital Gains Tax will generally apply.

In the case of shares, assuming they are issued at a discount (which can be no more than 15%) the discount will never be taxed, as the gain for CGT purposes will be the sale price less the market value of the shares when acquired.

In respect of options, the discount is not subject to upfront tax but 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.

Furthermore, employees will be entitled to receive 50% CGT relief if they have held the options and shares collectively for at least 12 months, even when the shares they received on exercise have been sold by them within 12 months of exercise of their options.


To be eligible to access these tax concessions, the following requirements must be met:

  • unlisted: the grantor company must be unlisted
  • 10-year incorporation: the grantor (and any other companies in the corporate group) must be incorporated for less than 10 years before the ESS interest is granted
  • $50 million turn over limit: the grantor must not have an aggregated turnover of more than $50 million for the prior income year
  • no share trading: the grantor company's business must not involve share trading
  • ordinary shares: all shares that may be acquired under the ESS must be ordinary shares
  • Australian resident: the employing company (which may or may not be the grantor/issuer) must be an Australian resident taxpayer
  • 10% limit: no employee may hold more than 10% of the shares in the company (including the shares that could be acquired by exercising options/rights held by that employee)
  • salary sacrifice: the shares or rights acquired under the ESS via a salary sacrifice arrangement (if applicable) must not exceed more than $5,000 worth of shares per income year under those arrangements
  • discount: in the case of shares, the discount provided must be no more than 15% of the market value of the shares at the date of purchase---for options, they must have an exercise price (or strike price) equal to, or greater than, the current market value of the ordinary shares (in other words, issued at market value or out of the money) in the issuing company at the time the right is acquired
  • minimum holding of 3 years: every acquirer of an interest under the ESS must be obliged to hold its interest for a minimum of 3 years from the date of acquiring the option or the shares
  • 75% availability: in respect of share schemes, at least 75% of Australian resident "permanent employees" (with at least three years' service) must be entitled to acquire ESS interests in the employer (or holding company).

These concessions are clearly a much needed boost for the start-up sector and those who have dismissed or placed on hold plans to introduce an ESS should now re-consider their position. The process is not complicated and the benefits associated with aligning the interests of key staff with those of the shareholders is something not to be underestimated.

For further information, please contact:

Michael Phillips, Partner
Phone: +61 2 9233 5544

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.

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