Tax Rules for Employee Share Schemes: Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015

On 15 June 2015, the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 (the Bill) passed into the Senate, after passing through the House of Representatives on 27 May 2015. The Bill is significant in that it proposes significant changes to the taxation of employee share schemes (ESS).

Background to the Bill

The Bill is part of the income tax amendments in the Government's Industry Innovation and Competitiveness Agenda. Broadly, the new Bill would reverse a number of unpopular changes which were made to the ESS tax laws with effect from 1 July 2009, particularly in respect of rights (e.g. options), make other improvements to the taxation of ESS interests, introduce additional tax concessions for employees of eligible ‘start-up’ companies and allow for the Commissioner of Taxation (Commissioner) to approve different methodologies for valuing ESS interests.

According to the Government, these changes would improve the tax treatment of employee shares schemes, making them more accessible and attractive to business in order to facilitate the alignment of interests between employers and their employees, and stimulate the growth of innovative start-ups in Australia by helping small unlisted companies be more competitive in the labour market.

Employee Share Schemes (ESS)

An ESS (sometimes referred to as an employee share option plan) is a scheme under which shares, stapled securities, or rights to acquire them in a company (so called ‘sweat equity’) are provided to an employee (or  their associate) in relation to their employment, as a way of incentivising their involvement with the company. ESSs can be divided into two categories:

• broad based: where participation is open to at least 75 per cent of company employees and
• narrow based: which only allow a smaller group of certain employees (usually executives) to participate.

Whilst the precise ‘nature and economic value’ and extent of ESSs in Australia is difficult to determine (due to the relative lack of detailed data), the available evidence and recent studies nonetheless suggest that suggests that EESs ‘are increasingly prevalent and significant to the Australian economy’. Further, it also appears that whilst the incidence of employee participation in ESSs in Australia is lower than in the United Kingdom and the United States, it is increasing. Research also indicates that anywhere between four and ten per cent of Australian businesses have some form of ESS, and this appears to be increasing over time.

Provisions of the Bill

The proposed changes to apply from 1 July 2015 include: 

1. deferred taxation of all options acquired under an ESS even if there is no real risk of forfeiture;
2. where the discount was taxed upfront and the employee has never exercised the option acquired under an ESS, the employee will be entitled to a refund of income tax paid;
3. deferral for the taxation of the discount for both shares and options has been increased from 7 to 15 years;
4. an increase from 5% to 10% of share ownership in the employer company; and
5. the introduction of certain safe harbour market valuation methods.

The proposed concessions allow start-ups to issue shares to employees at a discount of up to 15% to the market value. Further, employees who receive shares or options under an ESS can defer payment of tax on the discount until they dispose of the shares or options, whereby it will be taxed as a capital gain.

To qualify for these concessions, the employer company must:

• be unlisted, with group aggregate turnover not exceeding $50 million;
• have been in existence for less than 10 years; and
• be an Australian resident taxpayer.

The Related Regulations

The Income Tax Assessment Amendment (Employee Share Schemes) Regulation 2015 (No. 63 of 2015) were registered on 1 May 2015 and will start to apply from 1 July 2015.

This regulation amends the Income Tax Assessment Regulations 1997 by updating the option valuation tables, also called the safe harbour valuation tables which are used to value unlisted rights, to ensure they reflect current market conditions.

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Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 and Associated Regulation as reproduced in TimeBase LawOne

Treasury Draft Legislation Website