Approved valuation methods recently published by the Commissioner of Taxation will provide start-up companies with the opportunity to significantly reduce the cost and complexity of making employee equity offers.

First exercise of Commissioner’s new valuation powers 

The Tax and Superannuation Laws Amendment (Employee Share Schemes) Act 2015 (2015 ESS Amendment Act) amended the rules regarding the taxation of employee share scheme interests, with effect from 1 July 2015. Our Alert in relation to the key features of these amendments can be found here.

As part of these amendments, the Commissioner has been granted a new power to approve methods for determining the market value of assets or non-cash benefits generally. The scope of this power is not restricted to the valuation of ESS interests.

The Commissioner has now exercised this new power through the Income Tax Assessment (Methods for Valuing Unlisted Shares) Approval 2015 (Approval). 

Valuation methods stated to be of narrow application

The Approval is stated to apply narrowly to the new ESS concession for start-up companies contained in the 2015 ESS Amendment Act. 

The 2015 ESS Amendment Act introduced a specific concession targeted at eligible start-up companies (see details here). To qualify for the start-up company concession, one of the requirements is that the employee interests being issued must satisfy certain requirements in relation to (in the case of shares) their market value or (in the case of rights) the market value of ordinary shares in the start-up company (see section 83A-33(5) of the Income Tax Assessment Act 1997 (1997 Act)).

For these purposes only, the Approval sets out two approved valuation methods for working out the value of unlisted ordinary shares. 

What are the valuation methods?

The Approval sets out two alternative valuation methods:

  • Method 1: The first method is approved only for certain companies who are required to prepare financial reports in accordance with accounting standards under the Corporations Act 2001. The method broadly allows for the market value of ordinary shares to be determined by reference to the net tangible assets of the company and adjusted for preference share preferred returns.
  • Method 2: The second method is approved for broader application. It allows the chief financial officer of the company or a qualified valuer to value ordinary shares in the company, having regard to specified considerations such as assets, cashflows and comparables.  
  • The valuation must then be endorsed by the directors of the company.

Valuation methods establish minimum acceptable value

The valuation methods effectively establish a minimum value that will be acceptable to the Commissioner. 

The 2015 ESS Amendment Act provides that the approved valuation methods will bind the Commissioner. 

Whilst the Approval only prescribes two alternative methods, the Approval states that other valuation methods will also be taken to have been made under the Approval if they produce a value not less than the specified valuation methods.

Broader difficulties for unlisted companies remain

The general rules in relation to the taxation of employee share schemes contained in Division 83A of the 1997 Act contain a number of provisions which require issuing companies to work out the market value of employee equity interests. 

The Approval does not expressly provide relief to unlisted companies more generally. It remains to be seen whether the Commissioner of Taxation will provide any relief of broader application in this regard.

Meanwhile, unlisted companies that are not able to access the new start-up concession continue to face uncertainty in determining the value of the ‘discount’ for the purposes of Division 83A.