On 14 October 2014, the Federal Government, as part of its National Industry Investment and Competitiveness Agenda, announced proposed changes to the taxation treatment of options and shares issued as part of an Employee Share Scheme (ESS).
In 2009, changes were made to how ESS arrangements were taxed.
One of the changes meant that an employee would have to pay tax immediately when options for shares were issued to them (provided that there was no risk the employee would forfeit the options) rather than when the options were exercised and converted into shares.
The 2009 changes proved a significant deterrent for start-ups as a majority of their eligible employees were not in a position to pay the tax upfront.
As a result, many companies and start-ups in particular, experienced difficulty in attracting and retaining highly experienced employees as they had no effective means of remunerating and incentivising them.
The Government now plans to reverse some of the 2009 changes to make the use of an ESS more viable. These are of particular benefit to start-ups and early stage companies.
Some of the key changes are set out below.
Changes to taxing point of options
The Government will reverse the 2009 changes made to the taxing point for options issued to employees under an ESS. This means that discounted options will now generally be taxed when they are exercised (and converted to shares) and not when they are first issued.
Eligible start-ups will not be subject to upfront taxation
Eligible start-ups will also be able to offer ESS shares and options to their employees at a ‘small discount’, and have that discount exempt from up-front taxation. This will apply so long as the shares or options are held by the employee for at least three years. The meaning of a ‘small discount’ is not as yet clear.
Tax on the discount provided by the employer may be deferred or exempt depending on whether the employee receives options or shares.
Eligible start-ups will include companies that have an aggregate turnover of less than $50 million, are unlisted and have been incorporated for less than 10 years.
Extension of tax deferred period
The Government will extend the maximum time for tax deferral from seven years from acquisition of interests to 15 years.
Update of safe harbour tables
The Government will also update the ‘safe harbour’ valuation tables to reflect current market conditions. The ‘safe harbour’ valuation tables are used by companies to value their options.
The legislation to give effect to the proposed changes is yet to be drafted.
The Government has indicated that it will consult with industry to ensure that any legislation introduced in this area delivers the intended outcomes.
It is proposed that the amending legislation will come into effect on 1 July 2015.