Recent amendments to the Income Tax Assessment Act 1997 mean that many companies can offer more tax effective incentives to their employees under an employee share scheme (ESS).

New rules

As a result of changes introduced with effect from 1 July 2015, many companies can now provide a tax effective incentive to employees with reduced administrative costs.

The new rules apply for companies that are:

  • unlisted;
  • have an annual turnover not exceeding $50 million; and
  • have been incorporated for less than 10 years.

If an employee is issued with shares in the company, no amount will need to be included in the employee’s assessable income as long as the discount on the purchase price of shares is no more than 15% of the market value of the shares.

If employees are issued with options to acquire shares at a later time, different rules apply. In this case, no amount will be included in an employee’s assessable income provided the exercise price of the option is equal to or greater than the market value of the shares at the time that the options are granted.

The new rules apply regardless of whether there is a risk of an employee forfeiting their shares or options and no longer need to be ‘non-discriminatory’, provided the ESS is broadly available to at least 75% of full time employees with at least three years’ service.

There are rules and conditions that must be satisfied to access these concessions and the ESS documents will need to comply with these, as well as obligations under the Corporations Act 2001, otherwise there could be significant consequences for both the employee and the company.

New safe harbour rules for market valuations

To make the start-up concession easier to set up, the amendments also introduced safe harbour provisions binding the ATO to accept a company’s valuation done using methods published by the ATO.

The ATO has published two approved methods. The first method appears to be based on a straight calculation of net tangible assets and most companies seeking to access the new concessions should be able to apply this method.

This valuation method should significantly reduce start-up and administration costs.

Key issues to consider

Clients who intend to establish an ESS under the new rules should get advice on the commercial and employment law aspects of any employee incentive arrangements, including on the following issues:

  • Will the terms of the ESS provide a real incentive for employees?
  • When will employees be able to cash out their shares and will the employer provide a guaranteed buy back option?
  • In what circumstances will employees be liable to forfeit their share entitlements?
  • The rules for the ESS must make it clear that the rights under the ESS are separate from the employment entitlements of participating employees and do not give rise to any claim on termination of employment.
  • Will the ESS have any Division 7A implications?
  • The ESS documents will need to comply with the fund raising requirements under the Corporations Act 2001.
  • Should the employees have a direct shareholding in the company or should the employee shares or options be held in a separate trust for all participating employees?