Generally speaking, Employee share schemes (ESS) have the potential to be an integral operational asset to all companies, but particularly to start-up companies who are unable to offer employees a significant cash remuneration package. However due to the tax implications associated with ESS, since 2009 many employers and employees alike have eschewed the utility of ESS. This was seen as putting Australia at a competitive disadvantage compared to particularly, the UK and the US.
As many clients may have not used ESS in recent years, it should be remembered that the benefit of ESS is taxed to the employee, and is not subject to Fringe Benefits Tax at the level of the employer (which is usually the case with non-cash benefits provided by an employer).
On 14 October 2014, the Government announced that the laws surrounding ESS tax liabilities will be amended from 1 July 2015 to incorporate changes which may encourage the use of ESS, essentially by reversing some of the 2009 amendments.
The proposed general amendments
Since 2009, the tax regime surrounding ESS has required that an employee pay tax up-front on any shares or options issued at a discount by the company as part of a remuneration package, unless there was a real risk for forfeiture.
The amendments which will affect all companies, relate to the payment of tax upon the exercise of an option under an ESS, as opposed to the issue of an option, subject to a time limitation on the exercise. However, it is not yet clear whether this is only so, provided the exercise price is not less than the market value of the shares at the time of issue, or whether there will be any absolute limit on the value of the benefit thereby conferred.
The tax deferral in relation to options under an ESS will increase from requiring options to be exercised within 7 years from the date of issue, to a maximum deferral of 15 years from the date of issue.
The integrity provisions introduced in 2009, as well as the $1,000 up front tax concession for employees who earn less than $180,000 per year, will be retained.
Eligible start-up companies
Further concessions will be provided to eligible start-ups.
Eligible start-ups are unlisted companies, which have an annual turnover of less than $50 million and have been incorporated for less than 10 years.
These eligible start-up companies will also be allowed to issue shares to employees at a discount of up to 15%, as long as the shares are held for at least 3 years, without a tax liability.
Under the new regime, no up-front tax will be payable on such shares. The tax event will now occur on the date on which of the shares are sold (or the date employment is terminated if the shares have not been sold).
The gain made on the sale of the shares issued at a discount of no more than 15% will generally be taxed as a capital gain, and the CGT 50% discount will likely apply, presuming that the shares have been held for 12 months from the date of issue (if employment is not terminated beforehand).
Where options are issued with an exercise price no less than the market value of the shares on the day of issue, the imputed discount value of the option is not assessable on the date of issue, but the value is taxed as a capital gain on the sale of the share received as a result of exercise of the option.
Where options are issued with an exercise price less than the market value of the shares on the day of issue, the imputed discount value of the option is only assessable on the date of exercise of the option, and not on its issue (if employment is not terminated beforehand) .
So in summary
This move away from up front tax will likely be welcomed by employers and employees alike, but particularly for start-ups, as the proposed regime does not require that the employee pay tax on the shares on their issue at a discount of up to 15%, or on the issue of an option, making ESS a more tax friendly regime, allowing cash to be re-invested in the company rather than paid out as salaries, and at the same time, incentivising employees.
The tables valuing unlisted options will also be softened. It is said that the government and regulatory bodies will together develop standard documentation which will assist in creating and administering the new regime ESS.
Potential issues
Many details relating to the new ESS regime are not yet known. For instance, whether there will be an absolute limit on the value of shares that may be issued by an eligible start-up, at a 15% discount.
For instance, other issues include, where the employee receives a second tranche of shares at a 15% discount, from a private company with accumulated profits, there may be the provision of a benefit to an existing shareholder, that is currently subject to deemed dividend treatment under Div 7A. Further, if the private company loans the employee the purchase price of the second tranche of shares interest free (being 85% of their market value), if the employee ends up with more than 5% of the company, the benefit of the exemption of the interest free loan from Div 7A would under existing rules, be lost. It is not known if these issues are to be addressed.
How can we help?
ESS have the potential to be a powerful tool for eligible start-ups.
Pointon Partners has considerable experience with ESS, and once further details of the new regime are to hand, we will be in a position to advise on, and implement a suitable plan for your business.
If you have any queries in relation to an ESS please contact Anthony Pointon or Robert Gordon of our office on (03) 9614 7707.