The Federal Treasury has announced on Tuesday 14 October 2014 that it will reverse changes to the taxation of employee share schemes introduced by the then Rudd Government in 2009.  The apparent intention of the changes are to reverse a trend of innovative Australian businesses moving offshore because of the current tax treatment of employee share schemes. 

In the case of options, under the current rules, employees are typically taxed on an option’s discount when it is provided (if there is no risk the employee will forfeit the options) rather than when converted into shares  (that is, before the employee can generally take practical steps to realise any gain to pay the tax).

While no draft legislation has been provided as yet, the key takeaways based on a Treasury press release and a publication issued by the Department of the Prime Minister and Cabinet are as follows:

  • the taxing point for employee share schemes where options are issued to employees at a discount to market value will now generally be the time of exercise.  This is a welcome development, as it gives the employee greater control over when they are taxed and reduces the risk of there being a taxing point at a time when there is no liquidity in the shares or options;
  • certain startups (eligibility criteria will include the company having an aggregate turnover of <$50m, it being unlisted and being incorporated for less than 10 years) will be able to issue options or shares that are provided at a small discount without triggering up front taxation, provided the shares or options are held for at least 3 years.  It would appear, from the Cabinet papers, that the discount threshold for shares will be set at no more than 15% below the prevailing market value of the share.  “Out of the money” options issued (under certain conditions) will have tax deferred until sale and shares issued at a “small” discount will have the discount exempt from tax (it is not entirely clear how tax on sale will be determined and, in particular, whether the employee will be able to rely on the capital gains tax (CGT) discount – subject to meeting the other eligibility criteria);
  • the maximum period of tax deferral for shares or options issued by startups will be extended from 7 years to 15 years; and
  • changes are to be made to the tax valuation tables which are often used to determine the value of unlisted options for tax purposes

A key consideration will be whether employees will able to rely on the benefits of the CGT discount on an ultimate disposal of their shares (or options). Employees taxed under the existing rules have their gains taxed at their marginal tax rates (such that the value of the shares or options are taxed similarly to an bonus), whereas Australian resident individual, trust or superannuation fund shareholders are often able to have their capital gains reduced by up to half where they have held their shares for at least 12 months prior to the disposal and hold their shares on capital account).

Further, it would not appear that the proposed amendments will impact the current treatment of loan funded share schemes, although it may be that the new rules affect the manner in which plans are structured.

The law is proposed to come into effect from 1 July 2015 following a period of industry consultation.