At its core, employee share schemes (“ESS”) are designed to align the interests of employees with those of the employer. When that is achieved, the benefits extend to the economy at large due through encouragement of innovation and entrepreneurial behaviour.
However, the utilisation of ESS in Australia has been hobbled by complex tax rules and excessive regulatory requirements. This is particularly the case for private businesses. Despite some changes, most notably the introduction of the “Startup Concession” in 2015, usage of ESS in Australia is still well behind the US, UK and other OECD countries.
On 23 August 2021, the House of Representatives Standing Committee on Tax and Revenue (“the Committee”) released its report on the tax treatment of ESS, along with various recommendations to improve the operation and administration of the ESS provisions. In its report, the Committee recommended two alternative roadmaps.
Either of these roadmaps would represent a fundamental change to Australia’s existing ESS rules and would make ESS arrangements significantly more feasible for Australian private companies to utilise.
The first roadmap is simple and would represent a complete overhaul of the current ESS tax provisions – being that all ESS interests issued under an employee share scheme be treated as capital for tax purposes. This would effectively mean:
- no tax liability upon issue of the ESS interests to the employee.
- no tax liability upon vesting, exercise or other “deferred taxing events” besides a once-only taxing event for the employee upon disposal of the ESS interests, with the sales proceeds taxed under the Capital Gains Tax regime, and
- the 50% general CGT discount being available for ESS interests held for at least 12 months.
This measure would completely do away with the current ESS provisions – no more upfront taxation or deferred taxing points prior to disposal, which in turn makes concepts such as real risk of forfeiture, disposal restrictions and minimum option exercise price redundant as far as tax is concerned.
Undoubtedly, this first roadmap would be welcome news for employers and employees alike. However, in our opinion this recommendation seems far too concessional for it to have a realistic chance of being passed into law without some significant limitations being put in place. It would turn the tax treatment of ESS into an outlier when compared with other types of employment-related remuneration and benefits.
Further, a one-size-fits-all approach would result in outcomes that would be a hard-sell politically. For example, the optics of highly paid executives of large banks receiving a significant tax cut on their share-based payments would be politically unpalatable even if the measure would similarly help employees of small entrepreneurial businesses.
The second roadmap represents a less dramatic albeit still ambitious reform to the ESS tax provisions, comprising of 18 specific recommendations including:
- Changes to the Startup Concession:
- Extending the definition of a “startup” to include listed companies that otherwise meet the relevant eligibility requirements.
- Removing the requirement for a maximum 15% discount for shares, and
- Partially easing the “aggregated turnover” limit.
- Extending the “safe harbour” valuation (i.e. the Net Tangible Assets calculation) to all small and medium unlisted companies that have a turnover of less than $50 million but do not otherwise satisfy the definition of a startup.
- Increasing the $1,000 reduction in taxable value for certain taxed upfront schemes to $50,000.
- To create parity in tax deferral conditions for share and options schemes:
- Removing the requirement for share schemes to be issued to at least 75% of permanent employees, and
- Removing the real risk of forfeiture requirement.
- Expanding the role of the Tax Office in assisting businesses to set up ESS (although we continue to see major benefits of having legal documents prepared by a lawyer instead of adopting ATO templates which do not consider company-specific circumstances and tend to leave key commercial parameters unaddressed).
Each of these recommendations is targeting a specific area of the tax system that is hindering the widespread adoption of ESS. These recommendations should be strongly welcomed by companies, employees and advisors alike.
Easing of non-tax regulatory requirements
The Committee also made recommendations to ease the regulatory burden for companies in implementing ESS by requiring them to comply with the various Corporations Act disclosure requirements only if employees are being asked to contribute financially to acquire any ESS interests. In our opinion these measures should be adopted given the excessive cost of complying with these disclosure requirements.
The Committee’s recommendations represent a genuine game-changer for ESS in Australia but it will likely be a number of years before any meaningful changes are implemented.
In the meantime, Australian businesses will still need to navigate the complexities of the existing tax laws to design a share plan that achieves the commercial objectives of the business without creating a prohibitive tax cost for the employee.
The Startup concessions can be an effective approach for newer private businesses. For more established private businesses, it is still feasible to design an effective ESS but the best arrangements tend to be “purpose built” for the business and so require a greater investment of time and resources. However, in an increasingly competitive labour market, an ESS or other target benefit arrangements could be key in helping your business attract and retain high quality people.
Contact your William Buck Tax Adviser now if you would like to discuss how to set up a tax-effective employee share scheme for your business.