• Employee Share Schemes (ESS) align the interests of employers and employees by offering shares or the option to acquire shares to employees. 
  • ESSs allow companies to be more competitive in recruiting and retaining talented employees. They can also result in more productive working relationships, higher productivity and reduced staff turnover.
  • There are some start-up tax concessions available. These allow eligible startups to issue options or shares at a discount. Likewise, employers can defer the tax treatment of that discount until disposal.

Employee Share Schemes

Employee Share Schemes are when employers provide their employees with shares, stapled securities or rights to acquire shares (known as ESS interests) about their employment. Such schemes attract talented employees in an international labour market and provide employees with a financial interest in their company.

The Income Tax Assessment Act 1977 regulates employee share schemes. The 2015 Federal Budget made significant changes to the scheme, listed below.

  • the legislation allows the Federal Commissioner of Tax to approve market valuation methodologies that taxpayers can use to comply more easily with the law; 
  • there are some taxation concessions available to employees of certain small startup companies. The employee must hold shares for at least three years. Discounts on shares may not be subject to income tax, and discounts on rights will be treated as capital and deferred until the sale of the resulting share; and
  • to access small startup concessions, start-ups must:
    • be incorporated for less than 10 years at the end of the most recent income year; 
    • must not be listed; 
    • have less than $50 million for the income year; and 
    • the employing company must be an Australian resident taxpayer.

Benefits of Employee Share Schemes

Employee share schemes offer employees a direct financial interest in the company they work for. These schemes also encourage positive working relationships and reduce staff turnover. For employers, ESSs can help to attract and retain talented employees. Additionally, they increase international competitiveness by supplementing employees’ salaries with equity in the company they work for.

Structuring Employee Share Schemes

There are a few ways ESSs can be structured. A company can choose to either give direct equity to the employee, have a vesting agreement in place, or give the employee options to purchase shares at a future date. 

Startups generally offer options to purchase shares to their employees. There are a few reasons why this is the preferred option:

  • offering employees options to buy shares instead of direct equity in the company is a way to retain key employees by incentivising them to buy shares over the time they remain employed; and
  • giving direct equity to an employee carries risk. This is because you are giving an employee a direct share in the company without any requirement to remain an employee or act in the company’s interests. 

The options generally vest over time if the employee remains employed by the business. The standard time frame for the vesting of options is between three to five years.

For example, if you offer an employee a 10% stake in the company, you can set this option to vest over four years. You can have the shares vest at a rate of 25% for each year they are employed. Hence, the employee will receive the full 10% after four years. They will have: 

  • 2.5% after one year;
  • 5% after two years;
  • 7.5% after three years; and
  • 10% after four years.

Impact on Startups and Small Businesses

Taxation

Employees issued with options under ESSs will be able to defer tax until they exercise the share option to convert and realise financial benefits. Employees have up to 15 years to defer their tax liability. The taxing point will take place at the earliest of one of the following times:

  • when the employee ceases the employment in respect of which they acquired the right;
  • 15 years after the employee acquired the right;
  • when there are no longer any genuine restrictions on the disposal of the right, and there is no real risk of the employee forfeiting the right; or
  • when the right is exercised, and there is no real risk of the employee forfeiting the resulting share, there is no genuine restriction on the disposal of the resulting share.

Concessions for Employees

Employees under ESSs can access an ESS tax concession so long as their maximum individual ownership is under 10%. Other concessions include allowing employees to receive options or shares at a small discount. To qualify for these concessions, startups must:

  • have been incorporated by less than ten years; 
  • be unlisted; and 
  • have a turnover of no more than $50 million per year. 

Additionally, employees can have access to concessions only if they earn less than $180,000 a year. The upfront tax concession is limited to $1,000.

Capital Gains Tax

Employees of ESSs can access a 50% Capital Gains Tax (CGT) discount, even when they hold the underlying shares for less than 12 months.

Maximum Ownership and Voting Right Limitations

Further, to access taxation concessions, employees must not hold more than 10% of a company. This encourages employees with small or no ownership in a company to take up an interest. This also prevents employees from misapplying the concession to buy a business or indirectly access company profits through ESS rules.

Frequently Asked Questions

What happens when an employee has already been taxed on a discount, but the interest is forfeited (e.g. the employee leaves the company)?

Employees will be able to receive a refund of income tax paid about discounted ESS interests. The forfeited ESS interest is treated as having never been acquired.

What is the small startup concession?

The startup concession provides that an employee does not include the grant of an ESS interest in their assessable income if the scheme meets certain conditions. For shares, the discount is not subject to income tax and the share. Once an employee acquires the share, it is then subject to the CGT system with a cost base reset at market value. Concerning rights, the discount is not subject to upfront taxation. Also, the right is subject to CGT with a cost base equal to the employee’s cost of acquiring the right.

Will there be CGT for the small start-up concession?

There will be no capital gains tax on the exercise of rights and the resulting acquisition of shares or options. However, upon exercise, the exercise price of the rights will form part of the cost base for the resulting CGT tax calculation.

Does the start-up concession apply to other ESS taxation rules?

Those eligible for the small start-up concession cannot access either the $1,000 up-front concession or the deferred taxation concession.

How can LegalVision help me?

LegalVision assists businesses and individuals with tailored online legal advice for a fixed-fee, including start-up advice and guidance on Employee Share Schemes. Call LegalVision today on 1300 544 755 or fill out the form on this page.

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