What happened?
As you may be aware, many employer companies offer shares or options at a discount (i.e. issued for a cost lower than market value) to employees as part of an ESS.
Such a discount can either be taxed upfront (i.e. on issue) or when the option is exercised or for example when the share is sold or when there is no longer any real risk of forfeiture (i.e. deferred to a later time).
From 1 July 2015, there will be changes to certain aspects of the tax treatment of employee share schemes (ESS).
The main aim of these changes is to boost entrepreneurship by creating special concessions for small start-up companies that use such schemes to reward their employees through issuing non-cash incentives.
Other changes that will apply from 1 July 2015 include:
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All options acquired under an ESS can be taxed at a later time (i.e. taxation of the discount is deferred) even if these options schemes do not contain a real risk of forfeiture;
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An employee that never exercised his or her option acquired under an ESS (and where the discount was taxed upfront) will be entitled to a refund of income tax paid, provided the scheme was not structured to prevent the employee from downside market risk;
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The maximum deferral point for the taxation of the discount on both shares and options will be increased from 7 to 15 years;
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The significant ownership and voting options limitations will be relaxed from 5% to 10%, allowing employees to obtain a greater share of ownership in their employer;
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The ATO will work with industry to develop certain safe harbour market valuation methods and the Commissioner will have a new power to approve other valuation methods as he sees fit.
The Government hopes that through these changes, innovative Australian firms using employee share schemes will be able to attract and retain high-quality employees in the globally competitive labour market.
What does this mean for you?
Overview & deferred taxation of options
- All options are subject to deferred tax treatment
The problem with upfront taxation is that this may lead to cash- ow issues for the employee (i.e. no money to pay the tax) – as compared to if the employee is only taxed at a later stage when the share is sold or option exercised (i.e. proceeds of share sale can be used to pay the tax).
It is therefore refreshing to see that from 1 July 2015, all options acquired under an ESS can be taxed at a later time (i.e. taxation of discount deferred) even if these options schemes do not contain a real risk of forfeiture.
Small start-up concession
What is the concession?
- Small discount exempt from tax
In broad terms – provided the discount is small- employees of small Australian start-up companies that receive shares or options under an ESS will not have to include the discount in their assessable income, provided they hold the shares or options for at least 3 years.
Instead, any future increase in the value of the share will be taxed as a capital gain on the eventual disposal of the asset (thereby allowing CGT concessions).
The mechanism to effect this CGT treatment will work as follows:
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For shares acquired under an ESS – the discount will be exempt from tax and the acquired share will have a cost base reset at market value in the hands of the shareholder;
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For options acquired under an ESS – the discount will not be subject to upfront taxation and there will be no CGT on the exercise of the options and the resulting acquisition of shares. Furthermore, the resulting share once acquired will have a cost base equal to the employee’s cost of acquiring the option, and the time of acquisition for capital gains tax discount purposes will be the time at which the option (and not the share) was acquired.
Employees who qualify for the small start-up concession will not be able to access either the $1,000 up-front concession or the deferred tax concession.
Who can qualify for the concession?
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Unlisted company
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Less than 10 years in existence
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Maximum aggregated turnover of $50 million
Since the concession is aimed at small start-up companies that do not have easy access to capital and are difficult to value, the concession will only apply to unlisted companies that:
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Were incorporated less than 10 years at the end of the company’s most recent income tax year before the share / option was acquired;
- Have an aggregated turnover not exceeding $50 million for the income year prior to when the ESS was acquired (ignoring investments from deductible gift recipient tax exempt entities or venture capital entities).
Furthermore, the employing company (who may or may not issue the ESS interests) must be an Australian resident taxpayer.
How can Nexia help you?
Please contact your Nexia Advisor if you are involved with a company that has employee share schemes in place or are thinking of structuring employee share schemes and would like to know more about how these changes may affect you.
1 - Employee may qualify for a $1,000 discount under this option provided the employee earns less than $180,000 a year.
2 - There will be a real risk of forfeiture if a reasonable person would conclude that there is a real risk (not only a mere possibility) that the shares / options acquired under the ESS would be forfeited or lost other than by disposal (e.g. if an employee will forfeit the shares / options if a minimum term of employment is not completed).
3 - The Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015, received Royal Assent on 30 June 2015. Please see our Nexia tax alert of October 2014, January 2015 and March 2015 on the Nexia Australia website for a background to these changes.
4 - Previously, only shares/options that are subject to a real risk of forfeiture may be taxed at a later stage (i.e. subject to deferred taxation and not upfront taxation of the discount).
5 - Previously, the discount will not be taxed under the ESS provisions if after acquisition of the share/option, the employee holds a beneficial interest in more than 5% of the shares in the company or is able to control more than 5% of the votes.
6 - A small discount for a share would be a discount of less than 15% of the market value of the share when acquired. For options, there would be a small discount if the exercise / strike price is greater than or equal to the market value of an ordinary share in the issuing company at the time the option is acquired.
7 - Due to the availability of a CGT rollover.
8 - All companies in the corporate group also need to have been incorporated less than 10 years before the acquisition date.
9 - For example, another company in the corporate group may issue the ESS interests.
