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In March 2022, the government announced reforms to make it easier for businesses to utilise employee share schemes (‘ESS’) and reduce the red tape so that employees at all levels can directly share in the business growth they help to generate. These changes include:

  • amending the disclosure rules, allowing unlisted companies to offer an unlimited number of shares, of an unlimited value, as long as the employee is not charged more than $30,000 a year for them (up from a $5,000 a year cap). Employees will also be able to accrue up to $150,000 over a five year period; and

  • for employee share schemes where there is no payment to participate, independent contractors will receive the same treatment and receive the same regulatory relief as employees and directors who are participants in the scheme.

An Employee Share Scheme (ESS) rewards employees by giving them shares in the company or options to purchase those shares at a later date. An ESS is becoming an increasingly common tool for companies who want to attract and retain talented employees. A large reason for this is because, in July 2015, the Australian Tax Office changed the taxation rules that apply to ESSs, making them more employee-friendly.

Unfortunately, not all companies will meet the eligibility criteria for these tax concessions. This might be the case if the company wanting to implement an ESS:

  • has been incorporated for over 10 years;
  • has an aggregated turnover exceeding $50 million; or 
  • plans to issue an employee with more than 10% share ownership.

However, there are alternative arrangements that you can put in place that similarly reward employees, which this article will outline.

This article is Part 1 of Alternatives to Startup ESS Tax Concessions. You can read Part 2 here.

Startup ESS Tax Concessions Explained

Employees under startup ESSs only have to pay tax on shares or options that they acquire when they receive a financial benefit. This financial benefit happens when selling shares, rather than when employees:

  • receive the shares:
  • vest the shares; or
  • exercise options.

Further, capital gains tax (CGT) discount entitlements are measured from the day employees receive the shares or options, rather than when they exercise them. 

They receive this discount if the employee participates in the ESS personally, rather than through an associated entity. Otherwise, they must exercise the option and hold the underlying share for at least 12 months to receive the 50% CGT discount.

If Your Company is Not a Startup

Just because your company is not a startup does not mean that it cannot incentivise employees with a similar effect. You might consider the following ESS arrangements as suitable alternatives.

A Premium Priced Option Plan

A Premium Priced Option Plan (PPOP) involves issuing options whose exercise price is sufficiently above the current market value of the underlying shares. This provides the options with a nil value for tax purposes. 

The downside of this is that employees need to exercise options as soon as possible. In turn, this will ‘start-the-clock’ on the 12-month holding period rule for a CGT discount.

One of the key considerations before setting up a PPOP is whether it is a commercially viable arrangement for employees. This will depend on the market value of the underlying shares and the eventual premium price that employees will have to pay.

A Free Share Plan

A Free Share Plan (FSP) is a broad-based share plan where shares are issued up to the value of $1,000. Then, employees receive a $1,000 reduction in the amount they would otherwise have to include in their income. This reduces the relevant discount to nil, and there is no tax payable.

Importantly, employees must have income under $180,000 to be eligible for an FSP. Additionally, you must offer the FSP on a non-discriminatory basis to at least 75% of the company’s permanent employees residing in Australia with at least three years’ service.

A Phantom Share Scheme

A Phantom Share Scheme gives employees a right to be paid a certain amount of money that is indexed to the performance of the company’s shares. It essentially gives an employee the right to a cash bonus in the future and does not involve the issuing of any shares or options.

Compared to other alternatives ESSs, a Phantom Share Scheme is easy to set up and implement, whether: 

  • through a standalone contract; or
  • as part of an employment agreement.

However, this approach does not qualify for a CGT discount and has a cash cost for companies.

Providing Shares vs Providing Options

Prior to deciding on any incentivisation arrangement, it is important to consider whether this incentive will be through the issuance of shares or options. From a company perspective, issuing options is often simpler than shares. This is because when an employee receives shares, they have a right to attend and vote in the company’s governance.

Contrastingly, issuing options does not grant the same voting entitlements, and the company will be able to limit the number of shareholders that must approve of important decisions.

However, from an employee perspective, shares are often superior to options. This is because they grant voting rights and involvement from day one. They also allow the employee to more quickly qualify for a CGT discount.

Key Takeaways

ESSs are a great way to attract top talent and incentivise lasting commitment of employees to your company. While the ATO has made tax rules that apply to startups more favourable for employees, there are a number of options available to your company if you are not a startup. If you would like assistance in deciding how best to incentivise your employees with an ESS, contact LegalVision’s startup lawyers on 1300 544 755 or fill out the form on this page.


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