ESS Tax Concessions

In Short

• Eligible Employee Share Schemes (ESS) allow employees to defer tax payments until they sell their shares, rather than at the time of receiving them.
• Employees may access a 50% Capital Gains Tax (CGT) discount if they hold the shares for at least 12 months after acquisition.
• Startups can use the ‘net tangible assets’ test to determine company valuation, potentially reducing the purchase price for shares or options issued to employees.

Tips for Businesses

Implementing an ESS can be a tax-effective strategy to attract and retain talent. Ensure your company meets eligibility criteria, such as being unlisted, incorporated for less than 10 years, and having an aggregated turnover under $50 million. Utilising safe harbour valuation methods can make share offerings more affordable for employees.

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Table of Contents

• Tax Concessions
• ESS Eligibility
• ESS Ineligibility and Further Options
• Key Takeaways
• Frequently Asked Questions

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. This effectively grants employees participating in the ESS considerable tax concessions. These changes include:

To incentivise your employees, you may consider giving them discounted shares in your startup. However, if they pay less than the market value for the shares, they will be taxed upfront on the discount. This is because the discount will form part of their taxable income. Instead, if eligible, you could take advantage of the tax concessions under an Employee Share Scheme (ESS) and provide an outcome more beneficial to employees.

In this article, we look at the eligibility requirements and tax concessions available under an ESS.

Tax Concessions

If eligible for the ESS startup concession (discussed further below), your employees can benefit from two tax consequences.

1. No Upfront Taxation

Under non-concession share or option schemes, there is a risk that there may be upfront taxation for the employees at various points before they make any money from those shares or options. For example, when your company issues the equity or when the shares vest. However, under an eligible ESS, the employee does not incur any tax liability upon receipt of the shares or options. Likewise, employees only incur tax when they make a capital gains from selling shares. This gives your employees the ability to forecast their tax liability.

The share sale also generally creates a Capital Gains Tax (CGT) event meaning a 50% CGT discount may apply if the shares are sold at least 12 months after the share issue or the grant of the options. 

2. Safe Harbour Valuation

Another benefit of the ESS startup concession regime is that you may be able to reduce the purchase price payable for the shares or options you issue to employees by determining the value of your company’s equity using a safe harbour valuation method – the most popular being the ‘net tangible assets’ test.

Generally, the market value of shares is calculated as the amount for which the shares can be sold on the valuation date. However, using the net tangible assets test, a startup’s valuation can be calculated using the following formula:

(A – B) / C  = Valuation

where:

• A means the company’s net tangible assets at that time;
• B means the return on any preference shares on issue at that time if the shares were redeemed, cancelled or brought back; and
• C means the total number of outstanding shares in the company.

ESS Eligibility

To be eligible for the startup tax concessions under the ESS, you must meet the following criteria:

Valuation Test Eligibility

You must also meet the criteria below if your startup wants to utilise the net tangible assets test under the safe harbour valuation rules: 

ESS Ineligibility and Further Options

Even if your company is ineligible for the ESS, you may still issue employees with shares by issuing them upfront. This may be the case if you issue shares early enough for their value to be low or nil so that the discount itself is low or nil. 

Alternatively, you could consider using a deferral tax regime, recourse loan or premium-priced option plan if:

• the taxable discount income could create a significant tax expense; or
• where the parties prefer to avoid paying market value for the share upfront.

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Key Takeaways

Employee Share Schemes can be an affordable, tax-effective way of rewarding employees and granting them a real ownership stake in the business. If your startup meets the eligibility criteria for the ESS startup concessions, your employees will be taxed only when they make a financial gain regarding their ESS interest.

If you need help setting up your ESS, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions