The Federal Government has released exposure draft legislation that proposes to amend the tax rules relating to employee share schemes (Proposed Amendments) (available here). The Proposed Amendments were announced in October last year (see our previous alert), and are intended to encourage share ownership by employees.
The Proposed Amendments seek to reverse and improve some of the tax concessions introduced in 2009 which are applicable to all companies implementing employee share schemes (ESSs), improve the regime for the valuation of ESS interests and provide additional concessions for employees of certain start-up companies. The Proposed Amendments are welcome and provide a clear indication that the Government is committed to encouraging share ownership by employees, particularly for start-ups.
Changes to deferred taxation
Under the Proposed Amendments, an ESS interest which is a “right” (which may include an option, a performance right or other right to acquire shares in a company) may qualify for tax deferral even if the plan does not provide for a real risk of forfeiture with respect to the right. Tax deferral should be available for such an ESS interest where the scheme rules genuinely restrict immediate disposal of the right and expressly state that the right issued under the ESS is subject to deferred taxation.
The Proposed Amendments also extend the time at which both shares and rights issued under an ESS which qualify for deferred taxation will be taxed. In particular:
- the maximum time deferral is extended from 7 years to 15 years (with this extension to apply to both shares and rights issued under an ESS); and
- in relation to rights, a deferred taxing point is extended from when the right becomes exercisable under the scheme rules to when it is actually exercised by employee (provided certain other requirements are satisfied).
Contrary to earlier expectations, the Proposed Amendments do not return to the pre-2009 position in former Division 13A of the Income Tax Assessment Act 1936 (Cth), where the recipient of a share or right under an ESS could elect to be taxed either on an upfront basis or on a deferred basis.
The Proposed Amendments also:
- introduce changes to the refund provisions so that an employee who chooses not to exercise a right (for example, because it is out of the money) may be entitled to a refund of any income tax previously paid in respect of acquiring the right; and
- extend the significant ownership and voting rights limits that apply to the availability of ESS concessions from 5% to 10% of the interests (and rights to acquire interests) in the employer.
Safe harbour valuation methods and update to valuation tables
The Proposed Amendments introduce a power for the Commissioner of Taxation (Commissioner) to approve methods for the calculation of the value of assets or non-cash benefits. Once approved, the methodologies will be binding on the Commissioner, although the taxpayer will not be bound to adopt such methodologies. The Australian Taxation Office will consult with stakeholders to identify appropriate safe harbour methodologies and develop standardised documentation (details of this consultation are available here).
As previously announced, the valuation tables which are used by companies to value employee options are also proposed to be updated in the relevant regulations to reflect current market conditions.
Additional concessions applying to start-up companies
Additional tax concessions will apply to ESS interests that are provided by an eligible start-up company, if certain general requirements are satisfied. An eligible start-up company is generally defined in the exposure draft legislation as a company that has an aggregate turnover of not more than $50 million for the income year prior to the year in which the ESS interests are issued, is unlisted and has been incorporated for less than 10 years before the time the ESS interests are issued (Eligible Start-Up). The employing company (which may or may not be the company which issues the ESS interest) is also required to be an Australian resident for tax purposes.
The additional start-up concessions are as follows:
- shares issued at a discount of less than 15% (calculated as at the time the share is acquired) will be exempt from income tax; and
- rights that have an exercise price that is greater than or equal to the market value of an ordinary share in the Eligible Start-Up at the time the right is acquired will not be subject to income tax upfront. The right, and the share acquired upon exercise of the right, is instead taxed under the capital gains tax rules with a cost base equal to the employee’s cost of acquiring the right.
To access the above start-up concessions, the shares or rights must satisfy the general conditions which apply to all ESS concessions and also the following further conditions:
- the shares must be held by the employee for at least three years; and
- the scheme must meet a broad availability condition.
When will the changes come into effect?
The Proposed Amendments are intended to apply to employee share scheme interests acquired on or after 1 July 2015.
Submissions on the draft legislation may be made here. Submissions close on Friday, 6 February 2015.