Understanding the ESS changes: Five things you need to know

Recently, changes to the tax rules surrounding employee share schemes (ESS) were made, with the intention of making it more attractive for employers and employees to participate in them.

The changes to the ESS rules came into effect from 1 July 2015 and effectively allow potentially longer deferral periods for taxing points. In addition, the changes introduce a new concession for startup companies.

Here are five things you must know about the changes.

1. Changes to the tax treatment of employee share schemes take effect on 1 July 2015

The 2015 changes apply to ESS interests issued on or after 1 July 2015. They apply to shares, stapled securities, rights and options to acquire shares or stapled securities.

2. Additional concessions are available for startup companies

Under the new rules, where shares are issued to employees in a startup company at a discount of up to 15 per cent (relative to market value), the discount is exempt from income tax. The shares will only be subject to capital gains tax on disposal.

The rules apply to startup companies from any industry, but they must be a company that has been incorporated for less than 10 years, have no equity interests listed on a stock exchange and aggregated turnover of less than $50 million.

For the concession to apply, the ESS must satisfy the following criteria:
  • For share interests issued under the ESS, a share must be provided at a discount that is no greater than 15 per cent of the market value.
  • For rights issued under the ESS, a right must have an exercise price (or strike price) that is equal to or greater than the market value of an ordinary share in the issuing company.
  • The ESS must require that employees hold ESS interests for at least three years.
3. In tax-deferred schemes, the taxing point may be deferred from vesting to the date of exercise

This change has the effect to, in some circumstances, postpone the occurrence of the first taxing point for rights. Under the new rules, the taxing point in tax-deferred schemes is the earlier of:

  • For rights, when the employee has exercised the rights and there is no risk of forfeiting the resulting share and no restriction on disposing of that share.
  • For all ESS interests, when there is no risk of forfeiting the interest and any restrictions on its sale are lifted.
  • The time when the employee ceases the relevant employment.
  • 15 years after the ESS interests were acquired (previously the deferral was only for 7 years).
4. The test for significant ownership or voting rights limitations has been eased

The limitation on shareholding and voting power has increased from 5 per cent to 10 per cent. However, previously only share ownership was considered in the significant ownership test, but now all interests in the company, including rights to acquire shares, are taken into account.

This effectively allows employees to own a greater share of the company, but takes unexercised options into account.

5. An income tax refund is possible where an employee acquires rights but does not exercise them

Where an employee chooses not to exercise his or her option to acquire shares under an ESS but was taxed on the discount upfront, the employee will be entitled to a refund of any income tax paid. However, the refund will only be available if the ESS was not structured to directly protect the employee from a fall in the market value of the shares (i.e. downside market risk).

The 1 July changes have been eagerly awaited by professionals in the tax, accounting and legal professions. Of them, Louise Boyce, of Squire Patton Boggs says, “[the changes] have been welcomed by employers. We have seen a rush of interest in establishing employee option schemes, particularly by companies who qualify for the startup concessions.”

The new standard

Along with the above changes, the Australian Tax Office (ATO) recently released standard share plan documents to help make ESS easier for startup companies to implement. Available on the ATO website, this library of templates includes a standard employee Option plan and letter of offer to kick off the proceedings for you.


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