On 14 October 2014, the Australian government introduced significant changes to the employee share scheme rules to apply to shares or options provided from July 2015. The existing tax rules introduced in 2009 by the former Labor government have been harshly criticised as inhibiting the ability to attract and retain employees by offering ownership interests in a company. The 2009 rules taxed employees either when shares or options were granted, or when the shares or options “vested”. This meant that employees were often taxed at a time when they were not able to sell the shares in order to pay the tax.
The government has announced significant concessions for employees of start-up companies, as well as some other changes to the rules to assist employees of all companies.
Concessions for Start-up Concessions
Companies Which are Eligible for Start-up Concessions
In order for employees to benefit from the start-up concessions:
- The shares or options must be held for at least three years
- The company must have an aggregated turnover of less than AU$50 million
- The company must be unlisted
- The company must have been incorporated for less than ten years
Start-up Concessions Where Shares are Provided
A significant concession will be given where shares are provided to start-up employees at a discount of up to 15% from the market value of the share. If the discount is less than 15%, that discount will be completely exempt from tax to the employee. The capital gains tax cost base will be based on the full market value of the shares (rather than the discounted price the employee paid), meaning the employee will not pay capital gains tax on the “discount” amount. It appears that the current proposal is that if the discount is more than 15% the start-up concessions will not be available at all.
Start-up Concessions Where Options are Provided
Tax concessions will be available where options are issued which are “out of the money”. The announcement explains that an option will be “in the money” where the exercise price is less than the market value of the shares. Commonly, employee option plans provide that the exercise price is equal to the market value of the shares. It will be important to clarify in the final legislation whether such arrangements will qualify as “out of the money” for the purposes of this concession.
The concession allows tax to be deferred until the shares are actually sold. The “vesting”, “exercise” or “termination of employment” taxing points would not seem to apply, but it appears from the announcement that the 15 year taxing point might apply.
The gain will not be taxed as ordinary income, but instead the difference between the exercise price and the sale proceeds will be taxed as a capital gain. The CGT concession may be available if the shares are held for more than 12 months post exercise.
This will result in a significant concession for employees of start-up companies.
Concessions for Other Companies
Where Shares are Issued
Based on the announced changes, there will be few differences in the tax rules applying to shares issued to employees (where the company does not qualify for start-up concessions). However, for schemes under which there is a genuine risk of forfeiture and restrictions on sale of the shares, the maximum deferral period may be increased from seven years to 15 years (although this is not entirely clear from the announcement). All companies may benefit from the proposed “standard documentation” which is to be developed and approved by ATO, ASIC and industry.
Where Options are Issued
The government intends to update the safe harbour valuation tables (currently in the Regulations) for valuing unlisted rights, to ensure they reflect current market conditions. However, the most significant change is the proposal to move the taxing point for options under deferral schemes until the option is actually exercised. While it appears that “vesting” will no longer be a taxing point, the other events which trigger an earlier taxing point (such as termination of employment) may continue to apply. Another significant change applying to options is the increase in the maximum deferral period from seven years to 15 years for tax deferred schemes. The deferral of the taxing point until exercise may have the result that the employee in fact pays more tax at their marginal tax rate where the share price has increased between vesting and exercise.
