Equity ownership through an employee share or option scheme (ESS) is a valuable tool for Australian businesses. An ESS is an arrangement put in place by a business to reward people who contribute to the business, namely directors, employees, and service providers – with shares or other equity-like interests in the business. The function of an ESS is of particular advantage to smaller businesses, startups and cash-poor businesses, when those business would otherwise be unable to compete with the salary and wages offered by larger, more established businesses.
In 2015, the tax legislation was amended to introduce new concessions for employees of ‘startup’ companies. These changes have made ESS arrangements very tax effective for employees, directors and other service providers to the startup company. Together with pro forma documents being made available through the ATO website and valuation concessions, ESS arrangements have generated considerable interest in the startup community.
As it currently stands, the regulatory framework surrounding the operation of an ESS makes it challenging for many smaller businesses to offer an ESS as part of their remuneration packages. While early stage companies will often rely on the ‘small scale offering’ exemption (often referred to as the ‘20 in 12’ rule) or the ‘senior manager’ exemption, these exemptions require close ongoing monitoring of the company’s fundraising position, and may often be of limited benefit for ESS offerings if the participant group is large or if the company wants to provide meaningful equity to its employees.
However, in March 2022, the Federal Government passed the Treasury Laws Amendment (Cost of Living and Other Measures) Bill 2022 (Bill), which amends the Corporations Act 2001 (Cth) (the Act) to significantly remove red tape for businesses to operate an ESS. The relevant amendments will come into effect on 1 October 2022.
As outlined in the Explanatory Memorandum to the Bill:
- if an ESS falls within the relief provided under the Bill, the usual regulatory requirements for businesses offering shares and financial products to retail clients under the Act will not apply in connection with the ESS. This will mean:
- an ESS can be operated without an Australian financial services licence;
- general financial advice can be provided in relation to the ESS without an Australian financial services licence;
- the restrictions on advertising and hawking securities and financial products in the Corporations Act do not apply to the ESS;
- the design and distribution obligations do not apply to the issued, sale or transfer of interests under the ESS; and
- the existing disclosure requirements under the Corporations Act do not apply to offers under the ESS. No disclosure requirements apply to an ESS that does not require payment to participate and a streamlined set of disclosure requirements apply to an ESS that requires payment to participate.
- an ESS will fall within the relief if:
- the interests issued, sold or transferred to participants under the ESS fall within certain eligible categories of interests (such as shares or options);
- the participants in the ESS are directors, employees, or service providers; and
- if the ESS requires payment to participate:
- certain disclosure documents are provided with the offer (this is a streamlined set of disclosure requirements, however, it is more extensive for unlisted entities);
- if the ESS has an associated contribution plan, loan or trust, the contribution plan, loan or trust meet certain requirements;
- the total numbers of products issued under the ESS over the previous three years does not exceed the specified percentage of the body’s issued capital (5% for listed bodies or 20% for unlisted body corporates, unless otherwise specified by the constitution); and
- for an unlisted body corporate, all participants are generally limited to outlay a monetary cap of $30,000 per year (which can be accrued for unexercised options over a 5-year period, up to a maximum of $150,000), plus 70% of dividends and 70% of cash bonuses.
In addition, offers under an ESS using the pre-existing disclosure relief – such as an offer to senior managers and directors under section 708(12) of the Corporations Act – may also receive the benefit of this relief, provided that such offers are stated to be made under the relevant division. For offers made in reliance on the small-scale offerings exemption in section 708(1) of the Corporations Act, it will also be necessary to comply with the trust, loan and contribution plan requirements (if they are offered under the ESS) in order to rely on the relief.
The materially reduced compliance requirements are welcome changes which will go a long way in helping smaller businesses and startups compete with more established businesses in attracting and retaining talent by virtue of being able to more easily offer an ESS to its employees, directors and service providers.