Briefing on the New Australian Employee Share Schemes
From July 1, 2015 the Australian Taxation Office brought in new rules for Employee Share Schemes (ESS). The reforms have brought Australia in line with other developed nations, and are especially great news for start-ups who want to reward or incentivise talented employees with a stake in the company.
What is an ESS?
Employee Share Schemes (ESS) are formal written policies. They allow employees to purchase shares in the company they work for at a discounted price, and/or the opportunity to buy shares in the company in the future (a right or option).
Note: Employee Share Option Plans (ESOP) is a term commonly used for these schemes, especially internationally. However, in the Australian legislation they are called "Employee Share Schemes".
Changes to the existing rules
There are a number of changes that will apply to all ESS interests – that is, shares, stapled securities and rights to acquire them.
The main changes are:
- Deferred taxing point for ESS interests (in certain tax-deferred schemes)
- Changes to the test for significant ownership or voting rights limitations
- A tax refund will now be possible if an employee does not exercise the rights they acquire
Start-up tax concessions
The main benefit for start-ups is a new tax concession. This is an exciting development that finally makes these plans usable for start-up companies.
Prior to these reforms, when you received equity "for free", the market value of that equity was taxable when you received it. Now it can be taxed when you sell that equity instead – a much more favourable tax treatment for start-ups, as long as certain conditions are met.
The term "start-up" is not defined in the legislation and it's not limited to any one particular type of business. However, in order to be an "eligible" start-up, there are strict requirements your company will need to meet.
The most notable thing about implementing an ESS, is that the tax concessions will not apply to someone who owns more than a 10% stake in the company. In other words, these are designed for new team members rather than company founders.
There are strict requirements that need to be met to qualify as a start-up company that is eligible for the concession:
- The company must be an Australian tax resident and not listed on a stock exchange
- The company (and all companies in a group) must have been incorporated for less than 10 years
- There must be an annual turnover of less than $50 million per annum in the year the securities are issued
- It must be a requirement of the ESS that the securities are held for at least three years, or until the holder is no longer employed by the company
- If the ESS grants shares as well as options, it needs to be available to at least 75% of employees that have been of service for three or more years
- Any options that the company is offering must have a value that is equal to, or higher, than the current market value of an ordinary share (these will still be considered as shares offered "at a discount" for tax purposes)
- Any shares that the company issues must have a discount of less than 15% of the market value
When the shares or options are exercised by the employees, and the resulting shares are sold by the company, any capital gains by the employees will be subject to capital gains tax (CGT).
This is where the discount for start-ups really helps out. For eligible start-ups, if the share has been held by the employee for more than 12 months (with other requirements) then they can get the 50% CGT relief – that is, they can potentially halve their effective tax rate.