On 3 April, the Australian Government Treasury office released an Employee Share Schemes (ESS) Consultation Paper (Paper). The Paper called for submissions to be made in order to better assist small businesses and start-ups offering ESSs.

The Paper makes the point that legislative developments in this area will have widespread impacts. 99% of all businesses in Australia are small businesses, which employ 5.7 million Australians.

What is an ESS?

An ESS is an offer of shares by a business to its employees. The offer might take the form of options or other financial products which are built into the employee’s salary package, or added to it as a bonus.

Shares of this kind usually vest over time, creating an incentive for the employee to remain with the enterprise as it grows. The Paper refers specifically to this concept: the Government wants to ensure small businesses and start-ups are supported in attracting and retaining their employees. Tax concessions have applied to certain ESSs since 2015, reinforcing the message that the Government recognises that ESSs have a positive economic influence.

An ESS that offers options creates a right, but not an obligation, for the employee to purchase shares in the company. The share that is promised does not come into being until a later, specified date. The ESS nominates a price – known as the exercise or ‘strike’ price – to be paid in order to exercise the option.

Vesting refers to the length of time until the employee who holds the option is able to sell or otherwise deal with the shares. This may be tied to the employee’s length of service, and is typically set at three to five years.

An ESS promotes loyalty, as options will customarily lapse if the employee leaves before the vesting date.

The Tax Breaks

For an employee to benefit from the ATO’s tax breaks, the exercise price must be at least the fair market value of a share in the company, as at the date on which the start-up granted the option. Specific methodologies apply for establishing fair market value.

To qualify for tax breaks, the ESS offeror must be an Australian private company, incorporated for less than ten years and have an annual turnover of less than $50 million. The employee, for their part, must hold the shares for at least three years, and cannot hold more than 10% of the company’s capital.

When the employee invokes the option to purchases shares, they will often need to either enter a shareholder agreement with the employer, or sign a ‘deed of accession’, agreeing to be bound by the terms of any shareholder agreement. That agreement often provides for the terms of any disposal of the shares. Occasionally, such terms are also documented in the ESS plan itself.

What are the proposed changes to the ESS rules?

The Government aims to simplify the ESS scheme by suggesting a number of changes. Submissions were open until 30 April via the Treasury website, which called for parties to present further proposals and feedback on how the law in this area can be improved.

The Paper outlines concerns such as:

  • ASIC class order relief (being an instrument that exempts a person from certain provisions of the Corporations Act 2001 (Cth) (Act)) is widely considered too restrictive and has resulted in businesses having to seek individual relief from ASIC; and
  • there is a perception that disclosure obligations are a disincentive to small businesses using ESSs, as they may compel public release of commercially sensitive information (having in mind that some disclosure is always necessary for investor protection).

The key proposals and present regulatory framework are outlined in the table below.

It is unknown at this stage whether the upcoming Federal Election on 18 May will have an impact on the foregoing proposed changes. The Paper emphasises small business is a key contributor to the Australian economy. As a result, a degree of bipartisan support could be expected in regards to simplifying the ESS regime.

Clarendons view the Paper as a welcome opportunity to refine and simplify the rules in this area. ESSs offer benefits both to small businesses in attracting and retaining motivated staff and to workers who want to see their commitment reflected in a financial incentive.