Proposed Employee Share Schemes (ESS) Changes

Posted on 16th April 2015 by Chris Grieve


The Federal Government has released proposed changes to the taxation of Employee Share Schemes (ESS) to take effect for interests acquired from 1 July 2015.  This includes incremental changes for all ESS arrangements and a new regime designed for unlisted start-up companies only.

Current Regime

An employee share scheme (ESS) is a scheme under which shares, stapled securities, or rights to acquire them (ESS interests) in a company are provided to an employee or their associate in relation to the employee’s employment.

These ESS interests are often provided at a discount or as a bonus for work performed by the employee.  In brief, employees who receive such interests are required to include the discount to market value as assessable income in their personal tax return.  The timing of the inclusion of this income has always been a controversial topic as share prices fluctuate and at times significant tax is payable without having a liquid asset to meet the tax arising from its inclusion in the return.

Under the current regime unless a “real risk of forfeiture” can be demonstrated, the taxpayer must include the discounted shares as assessable income when they are granted to the taxpayer.

Key Reforms                       

Some of the key reforms include:

  • Rights to acquire shares (including share options) will become taxable at exercise
  • The opportunity to defer taxation on ESS rights, that are not subject to real risk of forfeiture, but only a restriction on disposal
  • The maximum period for deferral of tax will increase from 7 to 15 years
  • Employees with ownership and voting rights up to 10% (increasing from 5%) will be eligible for deferral of taxation on ESS grants

General Changes – all ESS Arrangements
Implications of the proposed changes to the general ESS regime are likely to include:

  • When issued at a discount, rights (including options) will always be tax deferred.  Tax deferral for up to 15 years (from seven at present) will be permitted.  The most common taxing point will be when the rights are exercised, instead of when there is no longer any real risk of forfeiture as with the present regime.  The current ESS regime is unpopular because it can be difficult to determine exactly what constitutes “real risk of forfeiture” and the resulting taxing point is rarely aligned with the time when the taxpayer crystallises cash from the arrangement.
  • The changes with respect to rights are likely to have different impacts depending on the size of the employer.  Larger companies with relatively stable share prices are likely to use the extended tax deferral to offer taxpayers longer term options.  Tax is deferred, but the gain is taxed on revenue account.
  • Smaller listed companies often have higher growth potential, at least in percentage terms.  We see the existing practise continuing where options are issued with a steeper exercise price, thus implying a much lower option value at issue (and almost nil if the exercise price is steep enough).  By issuing at full value (i.e. avoiding a discount) the option is now on capital account and thus eligible for the 50% CGT discount if held for at least 12 months.
  • Just because a tax “concession” exists, doesn’t mean you should take it.  Rather the ESS automatic deferral on rights should be seen as a fork in the road.  Path A offers tax deferral, with the eventual gain being on revenue account. Path B requires the option to be acquired for full value up front, but is then on capital account and eligible for the 50% CGT discount.  Both paths are valid, with the choice likely to be dependent upon the profile of both the employee and the employer company.
  • Present ESS tax concessions can only apply when an employee owns less than 5% in the company which causes issues, particularly for smaller organisations.  That threshold will be increased to 10%.

Please call our office to discuss any issues arising from ESS or how the proposed changes may influence your decision to enter ESS arrangements.


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