Employee equity schemes are a fantastic way to align employees’ interests with the financial performance of a business and incentivise high performance levels. Employee share schemes come in a variety of forms including employee share schemes (ESS) which allow employees to purchase shares, or employee share option plans (ESOP), which involve employees being given the option to purchase shares at a later date or upon certain key performance indicators being achieved.
On 1 July 2015, the Government implemented a tax exemption for employees of start-up companies who are participating in a qualifying ESS. However, there are some limitations associated with the Government’s reforms. As a result, the Government’s start-up ESS will not meet the needs of all businesses. In particular, the start-up ESS only applies to defined start-up companies (explained below) and is generally not suitable for companies looking to incentivise a small group of employees.
The problem
The problem the Government was seeking to address was that currently under tax legislation, if an employee is offered securities at a discount, the discount is included in their assessable tax income. Suppose an employer wants to incentivise a senior employee and offers her the opportunity to purchase $100,000 worth of shares at a 30% discount. The employee pays $70,000 and receives her shares. At tax time, the employee must declare that she has notionally received $30,000 in taxable income. Assuming the employee is a high income earner she will need to find the cash to fund an additional $14,355 in tax liabilities, even though she may not have received any returns on her shares at this stage. Not a good outcome.
Start-up ESS
Under a qualifying start-up ESS, shares can be offered to employees at a discount of up to 15%, without any upfront tax liability for the employee. In the usual way, employees will be taxed on any capital gains generated upon the disposal of their shares.
Under a start-up ESS, an employee cannot acquire an equity interest in the company of more than 10% and participation in the ESS must be offered to 75% of all employees. Employers seeking to offer more generous discounts to employees, or offer participation in the plan to a small group of employees should consider an ESOP (discussed below).
In order for a company to take advantage of the start-up ESS tax exemption, it must meet the following requirements:
1. The company’s turnover must be less than $50 million;
2. The company must not be listed on a stock exchange;
3. The company must have been incorporated for less than 10 years;
4. The company must be an Australian resident tax payer;
5. The securities acquired under the ESS must be held for at least 3 years;
6. The shares must be ordinary voting shares.
If your company or proposed ESS does not comply with these requirements, then you should consider establishing an ESOP.
You can obtain free ATO approved standard ESS document at:
https://www.ato.gov.au/general/employee-share-schemes/in-detail/standard-documents-for-the-start-up-concession/
ESOP
As stated above, an ESOP allows employers to offer employees the option to purchase shares at a later date or upon certain key performance indicators being achieved. By using these strategies, the requirement to pay income tax can be deferred until when the right to exercise the options vest, which is usually followed by the employee purchasing the shares. For ESOPs where tax is paid upfront on the options, it is possible for employees to access an annual tax concession of $1,000.
$1,000 general exemption
Qualifying employees may be entitled to receive an annual tax concession of $1,000 off the discount received for any securities. However, this incentive only applies where the employee is a minority shareholder in the company (10% or less) and earns less than $180,000 per annum. In addition, the employee equity scheme must be offered to 75% of employees.
General advice disclaimer
The information contained in this article is general in nature. It should not be taken as a recommendation to implement any particular tax strategies. You should seek legal advice which takes into account your personal circumstances and objectives before you make any decisions.
Need help?
New Era Lawyers can assist you with establishing a tax effective employee equity scheme. Please contact us to arrange a time to schedule a no obligation meeting.
