A Comprehensive Guide: Scaffolding Taxation in Employee Share Schemes

Invest in Your People

Employee share schemes (ESS) are an incentive tool used by employers in Australia to

–        attract and retain employees that provide value to their employer; whilst

–        allowing the employee to be personally and financially invested in the employer’s business success.

Where an employee receives shares from their employer at a discount, that discount amount forms part of the employee’s assessable income and tax return.

Employee share schemes (ESS) give employees a benefit such as:

  • purchase shares in the company they work for at a discounted price.
  • have the opportunity to buy shares in the company in the future (also known as a right or option).

In most cases, employees will be eligible for special tax treatment (known as tax concessions).

ESS Basics: Special tax treatment

If employee share schemes (ESS) interests are granted at a discount, special tax treatment may apply (as long as the eligibility conditions are met). It is important to know how ESS works so you understand the eligibility conditions that apply to you.

To improve the tax treatment of ESS interests and encourage innovation, in Australia if the ESS meets specific conditions, employees may receive a taxation concession on their ESS interest. If no concession applies and shares are provided to employees at a discount, the employee will be taxed on the discount in the year they acquire the shares.

Note: The potential problem with this is that the employee is taxed upfront on a benefit that has not yet been practically materialised.

Generally, under an ESS the employer may provide the employee with shares at a discount in order to incentivise the employee to take up those shares. This objective is facilitated by the ATO tax concessions that may be utilised by the employee.

There are three broad types of concessions that may be utilised by an employee where stock is acquired at a discount:

·                 The deferral concession;

·                 The exemption concession; and

·                 The start-up concession.

In order to qualify for any of the concessions, there are general conditions that the offer must satisfy. These general conditions are that:

·                 The employee must be employed by the company or subsidiary of the company providing the ESS;

·                 The ESS must relate only to ordinary shares;

·                 The business of the company providing the ESS interest is not predominantly in share trading and investment; and

·                 After acquiring the ESS interest, the employee does not hold more than 10% of the shares in the relevant company and is not in a position to cast or control the casting of more than 10% of the number of votes at a general meeting.

Definition of Deferral Concession in ESS

This refers to an employee deferring the taxing point for the shares or option to a later date. To utilise this deferral, along with the general conditions, the following specific conditions must also be satisfied:

·                 At least 75% of permanent Australian employees of the employer with a minimum of three (3) years’ service must have been entitled to acquire ESS interest under the same scheme or another scheme of the employer;

·                 There is a ‘real risk’ that under the conditions of the scheme, the employee will forfeit or lose the right or option acquired under the ESS interest (other than by exercising the right, letting the right lapse or by disposal); and

·                 For options, at the time the employee acquired the interest, the scheme genuinely restricts the employee from immediately disposing of the right and the rules of the scheme expressly state the relevant division under the Income Tax Assessment Act 1997 (Cth) apply.

In relation to a share

In relation to a share, where all conditions are met, the deferred taxing point is the earlier of:

·                 When there is no real risk of forfeiture and the scheme no longer genuinely restricts disposal of the shares;

·                 where the employee ceases their employment; or

·                 15 years after the employee acquired the shares.

In relation to a right

In relation to a right, where all conditions are met, the deferred taxing point is the earlier of (other than the point of disposal):

·                 when the right is not yet exercised but:

i.                 the scheme no longer restricts the employee from immediately disposing of the right; and

ii.               there is no real risk of forfeiture or loss of the interest;

·                 When the employee’s employment is terminated;

·                 When the right is exercised and:

i.                 there is no real risk of forfeiture or loss of the interest in the share after exercising the right; and

ii.               the scheme no longer restrict the employee from immediately disposing of the share; or

·                 15 years after the interest is acquired.

The benefit of Exemption Concession in ESS

An employee including the discount at which an ESS interest is acquired in their taxable income may enjoy the following benefits:

–         reduce this amount (therefore reducing their taxable liability) by $1,000.00 where the employee’s ‘adjusted taxable income is not more than $180,000.00 for the relevant income year.

Note: Adjusted taxable income refers to an individual’s total income tax after all deductions are applied.

Along with the requirement for satisfying all general conditions, the reduction of $1,000.00 can only apply where there is ‘no real risk’. Otherwise, the employee will forfeit or lose their ESS interest before or after exercising the right.

The benefit of Start-Up Concession in ESS

Where an employee acquires an ESS interest at a discount, the employee may reduce the discount amount to be included in their taxable income to nil if conditions for the start-up concession are met.

For the offer to be eligible for the start-up concession:

·                 the company in which the ESS interest is provided (or any subsidiary or holding company) must not have shares listed on any stock exchange;

·                 the company must be an Australian resident taxpayer (not necessarily the company in which the shares are offered);

·                 the company must not have been incorporated for more than 10 years; and

·                 the company’s aggregate turnover should be less than $50 million for the most recent income year before the year the ESS interest is acquired by the employee.

Take-aways for Employee share schemes (ESS)

It is important that where employers want to provide such incentives to employees, the employer prepares an employee share scheme that is compliant and will be eligible for the tax concessions above.

Whilst the concessions are predominantly for the benefit of the employee, it further facilitates the incentive for the employee to take up an offer for shares where the scheme presented is beneficial to the employee in this regard.

NB Lawyers, Lawyers for Employers are experienced in all matters of preparing an employee share scheme and can advise on the commercial law aspects. If you are in the process and require a lawyer on your team, contact NB lawyers today on (07) 3876 5111.

Commercial Team Members

Daniel Dash
Senior Associate
NB Lawyers – lawyers for employers
[email protected] 
+61 (07) 3067 6153

Zahra Rashedi
NB Lawyers – lawyers for employers
[email protected]
+61 (07) 3067 6153

Daniel Dash and Zahra Rashedi are part of the commercial law team at NB Lawyers – lawyers for employers working with individuals and business owners on a range of matters including business sales, property disputes, estate disputes, shareholder agreements, intellectual property, litigation and taxation matters.