After much anticipation, yesterday the Government announced substantive changes to Australia’s taxation of employee share and option schemes.

The proposed amendments include concessions allowing ‘start-ups’ (unlisted companies with a turnover of up to $50 million that have been incorporated for less than 10 years) to issue options in circumstances where employees will pay no tax until the shares are ultimately sold.  On sale, the shares will be subject to capital gains tax (potentially providing access to the CGT 50% discount). 

This is in stark contrast to the current law where, even if deferred, any discount received by an employee upon the issue of shares or options is subject to income tax (as ordinary income) at the employee’s marginal tax rate and must often be paid prior to sale of the shares or options, causing cash flow difficulties.

The proposals announced yesterday also mean that employees of ‘start-ups’ may also receive an exemption from taxation for shares acquired at a discount of up to 15% to market value, where there is 3 year holding restriction placed on those shares.

While the above concessions will not be available for  companies which are not ‘start-ups’ (those being listed companies with a turnover of greater than $50 million or companies that have been incorporated for more than 10 years), the proposals do allow greater deferral of the taxing point for shares and options issued to employees of such companies. 

Under the current law, for those plans subject to deferred taxation, the deferral period ends:

  • where forfeiture conditions no longer apply and there is no restriction on disposal of the right or option (e.g. the options vest)
  • if the employee ceases employment, or
  • after 7 years.

Under the new proposals, the deferral period (in respect of options) can continue until those options are exercised (even in circumstances where any forfeiture conditions have already been removed and options have vested).  While under the proposed changes, deferral will still end if an employee ceases employment, the maximum time limit on deferral will be extended from 7 to 15 years.

Unfortunately, the new proposals will only apply to shares or options issued on or after 1 July 2015.  Until that time, shares and options issued to employees will be taxed under current rules.

While these are generally restrictive, with appropriate care, there remain some tax effective alternatives to remunerate and incentivise key employees under employee share scheme and similar incentive arrangements. 

McCullough Robertson share and option plans are structured to provide a framework for a company’s incentive plan, but to allow flexibility for each issue of shares or options as the economic environment, tax and company law requirements change. Plans put in place now should accommodate objectives under both the current and future rules.

More detailed draft legislation and consultation on the proposed implementation of the new rules is expected to occur in the period leading up to the introduction of the new rules.   As part of this process, the Government also intends to update the safe harbour valuation tables currently used in valuing unlisted rights issued under employee share schemes.