The start of a financial year is a good time to consider whether to implement an employee incentive arrangement or make new grants under your current employee share option plan (ESOP).

For startups, one benefit is that you can use the company’s balance sheet at the most recent 30 June to establish your net tangible assets per share and set the exercise price for options issued under an option plan (or the subscription price for shares issued under a share plan).

The tax concessions for employees of startups are quite generous. In short, employees pay no tax until an exit event (sale or disposal are most common) and only pay tax on half the gain under the CGT rules (provided the equity has been held for at least 12 months before the disposal). Our previous article, ‘Now’s a good time for startups looking at Employee Share Schemes’, explains the tax concessions in more detail.

In the seven years since the new rules for startups were introduced, we’ve designed and implemented ESOPs for many startups. In this article, we’ll offer some tips for startup companies with an existing plan who are looking to make new offers in the coming year.

Our top seven tips for new grants under existing ESOPs are as follows.

Check that you can still use the net tangible asset per share concession (the NTA concession)

  • The tax concessions require that the option exercise price is set at the current market value of a share. To avoid the expense of an independent valuation, the ATO accepts that a company can use its NTA per share as a proxy for market value. However, a condition for the use of the NTA concession is that the company is making offers within seven years of its incorporation (or you qualify as a 'small business entity') so, even if you’re a startup with less than 10 years under your belt, you may no longer be able to use the NTA concession.
  • Another condition for the NTA concession is that the company must not have raised more than $10 million in the past 12 months. If you’ve raised more than $10 million in a previous year, though, the NTA concession may be available for this year’s grants if that $10 million threshold has not been breached in the past 12 months and the company otherwise qualifies for the NTA concession. Any US dollar raising needs to be converted to Australian dollars as the threshold for the NTA concession is based on Australian dollars.

Check that you still qualify as a ‘start up’ for tax purposes

  • Every year, you need to assess whether you meet the conditions for being a startup (less than 10 years old, aggregated turnover less than $50 million). Remember that the conditions work on a group or aggregated basis and, in some cases, you might need to include the turnover of your significant (more than 40%) shareholders.

Re-read your plan rules

  • Once you’ve got a set of plan rules, it’s easy to put it into the top drawer and forget about it until there’s someone who’s leaving or an impending exit event. As you grow and your business develops, it’s worth reviewing the plan rules.

For example, many companies have plans without vesting clauses or they might have provisions that deal with leavers that were settled several years ago. It’s worth having a quick re-read and having a think about whether the plan rules still suit your business and commercial needs.

Don’t forget the company law aspects…

  • When options or shares are granted, the fundraising provisions of the Corporations Act need to be considered. Many companies have typically used the ‘small scale threshold’ (if they have made no more than 20 offers to raise no more than $2 million in any 12 month period) or the senior manager exemptions to avoid having to prepare a disclosure document. These rules need to be considered whenever a grant is made and are a ‘point in time’ test. Companies that have traditionally relied on the small scale threshold exemption may find it more difficult to meet that threshold as the company and their headcount grows. As many will know, the Corporations Act has been amended with effect from 1 October 2022 to expand the types of fundraising concessions, but this issue always needs to be considered whenever a grant is made.

…and payroll tax

  • Every State and Territory treats the grant of options under an ESOP as taxable wages to which payroll tax applies. It is no longer surprising the number of companies that fail to pay payroll tax on their ESOP grants. In broad terms, companies can choose to pay payroll tax on the grant, or at a later time when the options vest.

Tax reporting

  • Any grants made under an ESOP require you to report annually to employees on certain details of the equity (by 14 July after the year in which the grant is made) and to the ATO, a month later, by 14 August.

It is relatively easy for startup companies to implement an ESOP and the great danger is that annual grants are made without regard to the specific tax and regulatory requirements that need to be complied with to ensure that employees are not adversely taxed and that the company is not subject to civil and criminal penalties under the Corporations Law.