Attracting and retaining high performing employees can be key to ensuring the long-term success and growth of a business – a significant challenge for many Australian businesses navigating through COVID-19. Implementing an employee share scheme (ESS) or incentive plan can be an effective means by which businesses can attract, motivate, and retain valued employees. 

ESS provide employees with the ability to buy equity in a company through the acquisition of discounted shares, options, or rights. However, the complexity of the ESS provisions including qualifying requirements for tax deferral mean many businesses, particularly SMEs, opt for other (less tax effective) incentive schemes such as bonuses. The Australian Government has for many years tried to simplify the ESS rules and measures announced in the Federal Budget on 11 May 2021 have again attempted to address this.

A complex history of change

The ESS rules have been subject to various amendments. 12 years ago, in the 2009 Federal Budget the Government announced proposals to simplify the then ESS rules in Division 13A and section 26AAC of the Income Tax Assessment Act 1936. However, the resulting Division 83A that was introduced into the Income Tax Assessment Act 1997 to replace Division 13A and section 26AAC was dramatically different to the measures announced in the 2009 Budget.

Further amendments were made to Division 83A in 2015 for ESS interests bought from 1 July 2015. After the 2015 amendments, the key features of Division 83A are (at the date of this article):  

• a default position that taxpayers will be taxed upfront on the discount on ESS interests;

• taxpayers may be eligible for a tax concession of up to $1,000 on the upfront taxation;

• concessions are available for certain “start-up” companies;

• ESS interests are exempt from fringe benefits tax; and

• tax on ESS interests may be deferred to a later date where there is a real risk of forfeiture in relation to the ESS interest.

Proposed change – deferred taxation 

In the 2021 Federal Budget the Government announced further amendments to the ESS rules focusing, in particular, on the last point above – tax deferral.

Deferral of tax to a later income year is currently available for employees where:

• the ESS interests are at ‘real risk of forfeiture’; or

• the employee acquires the ESS interest at a 100% discount by salary sacrificing a maximum of $5,000.

Currently deferred taxation is the earliest of:

• the cessation of employment of the employee;

• in the case of shares, when there is no risk of forfeiture and no restrictions on disposal of the shares;

• in the case of options, when the employee exercises the option and there is no risk of forfeiting the resulting share and no restrictions on disposal of the share; or

• 15 years after the employee acquired the interest.

The 2021 Budget proposed the removal of cessation of employment as a taxing point. Cessation of employment as a taxing point creates significant obstacles for employees and businesses as:

• It is inconsistent with encouraging the long-term ownership of shares.

• Most employees cannot sell the ESS interests (or underlying shares) at the cessation of their employment to fund the tax liability triggered on their employment ending.

• The employees’ taxable amount is calculated by reference to the employer’s share price at the leaving date. If the share price falls after the employee leaves, the employee has paid tax on an amount greater than the value of shares eventually sold.

These changes will apply three months after Royal Assent of the enabling legislation. 

While the obstacles of cessation of employment as a taxing point can be structured around by employers issuing “indeterminate rights” (typically cash settleable) removing the taxing point and avoiding the need for complex structured schemes should result in increased participation (particularly for unlisted or smaller companies).

Proposed change - streamlined ESS reporting

In addition to the removal of cessation employment taxing point, the 2021 Budget also announced streamlined ESS reporting for:

• where employers do not charge or lend to the employees to whom they offer ESS; or

• where employers do charge or lend, for unlisted companies making ESS offers that are valued at up to $30,000 per employee per year.

These changes also will apply three months after Royal Assent of the enabling legislation and are particularly significant for unlisted companies where the current requirements are a disincentive to providing ESS interests to employees.  

Key Takeaways

The ESS rules are complex and parties need to carefully consider whether the ESS being proposed is in line with the expectations and aims of both the business and the employee. Whilst a promising move for simplifying the ESS rules, there is still substantial work to go.

As noted the proposed change to the deferred taxing point will only apply for ESS interests issued in the first income year after the amendments receive Royal Assent. Therefore, it will not apply to ESS interests currently issued. Businesses or employees considering entering in to an ESS arrangement should understand that these changes will not apply until after Royal Assent.

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Sladen Legal’s Business Law team is dedicated to working with clients to help develop employee share schemes or incentive plans that enable businesses to grow and prosper. Whether you are a small business, a privately held Australian enterprise, or a public entity, we will work closely with you to develop tailored schemes or plans that suit your needs, encourage your key staff to stay with the company and ultimately inspire the evolution and development of your business.

If you would like to discuss these or the proposed changes to the ESS as a result of the 2021 Federal Budget contact one of our team:

Laura Spencer
Senior Associate
M 0436 436 718 | T +61 3 9611 0110
E: lspencer@sladen.com.au

Neil Brydges
Principal Lawyer | Accredited Specialist in Tax Law
M +61 407 821 157 | T +61 3 9611 0176
E: nbrydges@sladen.com.au

Lucy Liang
Lawyer
T +61 9611 0131
E lliang@sladen.com.au