As part of its Industry Innovation and Competitiveness Agenda released yesterday, the Government has announced changes to the income tax treatment of employee share schemes (ESS).

Broadly, the proposed changes to the ESS tax regime are as follows:

  • Reversal of the changes made in 2009 to the deferred taxing point for ESS options. This is proposed to apply to all companies and would mean that discounted options are generally subject to tax when they are exercised (converted to shares), rather than when the employee receives the options, i.e. when the real risk of forfeiture over the options is lifted.
  • Update to the 'safe harbour' valuation tables, which are used by companies to value their options, so they reflect current market conditions.
  • For eligible start-up companies, the following concessions:
    • ESS options or shares that are provided at a small discount will not be subject to up-front taxation, provided the shares or options are held by the employee for at least three years;
    • rather, ESS options will have taxation deferred until sale (under certain conditions) and shares issued at a small discount will have that discount exempt from tax; and
    • the maximum time for tax deferral will be extended from 7 years to 15 years.

Companies that have an aggregate turnover of not more than $50 million, is unlisted and has been incorporated for less than 10 years are eligible start-up companies and qualify for this concessional treatment.

The integrity provisions introduced in 2009 and the existing $1,000 up-front tax concession for employees (who broadly earn less than $180,000 per year) will be retained.

The Government is expected to consult with industry on draft legislation, with legislation proposed to come into effect on 1 July 2015.

The announcement is generally well-received by the private sector at large. The reversal of the changes and updating the ‘safe harbour’ valuation tables is in line with commercial practicality and the proposed tax concessions for start-ups may assist making Australia more competitive in the market for investor capital in this industry.