Attracting and retaining high performing employees can be key to ensuring the long-term success and growth of a business, which many Australian business have found challenging as a result of COVID-19. Implementing an employee share scheme (ESS) or incentive plan can be an effective way that businesses can appeal to, encourage, and retain valued employees.
ESS provide employees with the ability to buy equity in a company through the acquisition of discounted shares, options, or rights. However, the ESS provisions are complex, which include qualifying requirements for tax deferrals. As a result, many businesses, particularly SMEs, opt for other (less tax effective) incentive schemes such as bonuses. The Australian Government has for many years tried to simplify the ESS rules and measures announced in the Federal Budget on 11 May 2021 have again attempted to address this.
A complex history of change
The ESS rules have been subject to various amendments. In the 2009 Federal Budget the Government announced proposals to simplify the then ESS rules in Division 13A and section 26AAC of the Income Tax Assessment Act 1936. However, the resulting Division 83A that was introduced into the Income Tax Assessment Act 1997 to replace Division 13A and section 26AAC was dramatically different to the measures announced in the 2009 Budget.
Further amendments were made to Division 83A in 2015 for ESS interests bought from 1 July 2015. After the 2015 amendments, the key features of Division 83A are (at the date of this article):
– a default position that taxpayers will be taxed upfront on the discount on ESS interests;
– taxpayers may be eligible for a tax concession of up to $1,000 on the upfront taxation;
– concessions are available for certain “start-up” companies;
– ESS interests are exempt from fringe benefits tax; and
– tax on ESS interests may be deferred to a later date where there is a real risk of forfeiture in relation to the ESS interest.
Proposed change – deferred taxation
In the 2021 Federal Budget the Government announced further amendments to the ESS rules. The amendments particularly focus on the final point above – tax deferral.
Deferral of tax to a later income year is currently available for employees where:
– the ESS interests are at ‘real risk of forfeiture’; or
– the employee acquires the ESS interest at a 100% discount by salary sacrificing a maximum of $5,000.
Currently deferred taxation is the earliest of:
– the cessation of employment of the employee;
– in the case of shares, when there is no risk of forfeiture and no restrictions on disposal of the shares;
– in the case of options, when the employee exercises the option and there is no risk of forfeiting the resulting share and no restrictions on disposal of the share; or
– 15 years after the employee acquired the interest.
The 2021 Budget proposed the removal of cessation of employment as a taxing point. Cessation of employment as a taxing point creates significant obstacles for employees and businesses as:
– It is inconsistent with encouraging the long-term ownership of shares.
– Most employees cannot sell the ESS interests (or underlying shares) at the cessation of their employment to fund the tax liability triggered on their employment ending.
– The employees’ taxable amount is calculated by reference to the employer’s share price at the leaving date. If the share price falls after the employee leaves, the employee has paid tax on an amount greater than the value of shares eventually sold.
These changes will apply three months after Royal Assent of the enabling legislation.
Although the obstacles regarding cessation of employment as a taxing point can be circumvented by employers issuing “indeterminate rights” (typically cash settleable), removing the taxing point and avoiding the need for complex schemes should result in increased participation (particularly for unlisted or smaller companies).
Proposed change – streamlined ESS reporting
In addition to the above, the 2021 Budget also announced streamlined ESS reporting for:
– where employers do not charge or lend to the employees to whom they offer ESS; or
– where employers do charge or lend, for unlisted companies making ESS offers that are valued at up to $30,000 per employee per year.
These changes also will apply three months after Royal Assent of the enabling legislation and are particularly significant for unlisted companies where the current requirements are a disincentive to providing ESS interests to employees.
The ESS rules are complex and parties need to consider whether the ESS being proposed is in line with the expectations and aims of both the business and the employee. Whilst these proposed changes are a promising move for simplifying the ESS rules, there is still a considerable amount of work to go.
As noted, the proposed change to the deferred taxing point will only apply for ESS interests issued in the first income year after the amendments receive Royal Assent. Therefore, it will not apply to ESS interests currently issued. Businesses or employees considering entering in to an ESS arrangement should understand that these changes will not apply until after Royal Assent.
For more information, please contact:
T: 03 5225 5231
T: 03 5226 8541
Principal - Harwood Andrews
Paul is a Principal at Harwood Andrews. He brings a commercial approach to the law from a broad set of experiences as a business owner, private legal advisor and in-house counsel, and having worked with management teams over many years. Paul is valued for distilling issues down to what is really important and being prepared to make a risk call based on judgement and experience.
Paul’s key areas of practice include:
- commercial contracts and advice;
- business and share capital structuring;
- sale and purchase of business;
- procurement and service arrangements;
- technology, intellectual property, data protection and start-ups;
- consumer law;
- corporate advisory, including , company secretarial and directors' duties, shareholder relations; and
- capital raising and financing requirements
Paul also manages Harwood Andrews’ corporate counsel advisory service, built on a decade of experience as a client and managing legal functions within one of Australia’s biggest corporations.
Paul believes that evolving how legal services are delivered can be a win-win for lawyers and their clients, particularly how on how technology impacts the legal profession, legal advice and the delivery of efficient legal services.
Paul’s professional commitments include:
- Member of the Law Institute of Victoria
- Member of the Law Institute of Victoria’s Technology and the Law Committee