While it is generally accepted that business owners are the most driven to see their business succeed, the same sort of vested interest can also give staff a sense of participation and a solid reason to see the company become profitable. Having a real stake in a company through owning shares in it is an incentive that some companies, particularly those listed on the stock exchange, have utilised.

Employee share schemes (ESSs) are a way to give staff a financial share of a company’s potential success, and as such have long been recognised as being a valuable tool to help companies attract and retain high-quality staff.  Proposed changes to the law will make it more beneficial for start-up companies to remunerate staff in this manner.

2009 changes to ESS rules for tax purposes

Under an ESS, a company can offer its employees, as a form of remuneration and incentive, shares in the company or alternatively, an option/right to acquire such shares.

Since changes were made to the employee share scheme regime in 2009, fledgling enterprises and start-up businesses have been avoiding making ESSs available to staff due to the complex nature of the arrangements. Due to this, the changes have made ESSs less appealing for start-ups and smaller businesses.

The main reason is that the 2009 reforms taxed employees at the point of issue of the shares or options.  In other words, the employee is taxed upfront unless special rules for deferral at the time of issue apply.

The drawback of this is that employees can become liable for significant tax based on the value of the shares or options for the income year in which they are issued, even if they are not earning any income or before this value is realised by selling. One online retailing executive described the present structure as being “like paying tax on the winnings of the lotto ticket before you win the lotto”.

Proposed ESS changes

To enhance the system, the government is going to amend the ESS rules.  This  is planned to come into operation for shares and rights that are granted on or after July 1, 2015.   At this stage the proposed changes are still in draft legislation and it is yet to be introduced into Federal Parliament.

Under the revised ESS regime, some key amendments include:

• Taxation of rights at exercise: Companies will be able to give employees discounted rights or options to acquire shares, which will be taxed when they are exercised rather than when they are received. This means that those in receipt of such options will only have to take care of tax liabilities when they actually receive value.  Other conditions may apply however.
• Concessions for start-ups:  Start-ups will also be given some concessions under the ESS rules in an attempt to bolster the Australian innovation sector. This will apply to companies that have an aggregate turnover of less than $50 million, are unlisted and have been incorporated for less than 10 years.  It is also necessary that the shares or rights are held for at least 3 years.
  Specifically, for eligible start-ups:
  • For shares: An income tax exemption will be allowed for the issue of shares to employees which have a small discount (the rules propose discounts of up to 15%).
  • For options: The discount on the issue of options will not be taxed upfront but rather will be subject to the capital gains tax regime at the time that the share acquired from the exercise of the option is disposed of.
• Changes for deferred-taxing arrangements: The government has also proposed that the maximum time for tax deferral for the receipt of such options or shares be extended from seven to 15 years.

It is worth noting however that where an employee is subject to the discount up-front under an ESS, the concession that exempts from income tax the first $1,000 of share scheme interests given to an employee who earns less than $180,000 a year, will still be retained. The government had introduced this measure in 2009 to prevent highly paid executives from benefiting from a reduction to their tax liability if they were to be remunerated with shares or options.