Employee Share Scheme Changes: Equity Incentives
On 30 June last year, the Tax and Superannuation Laws Amendment (Employee Share Schemes) Act 2015 received Royal Assent, retracting many of the 2009 changes to employee share scheme (ESS) interests, such as the inability to defer the taxing point on options until exercise.
Division 83A, which in 2009 replaced Division 13A, effectively eliminated the tax advantages historically associated with employee share schemes. From 2009, Div 83A imposed upfront taxation on ESS interests, whether shares or options, unless:
- acquired under a qualifying salary sacrifice arrangement; or
- there was a ‘real risk of forfeiture’, such that a reasonable person would consider the interests in danger of being lost or forfeited other than by disposal.
In those limited circumstances in which deferred tax was available, the shares or options were then taxed at the earliest of:
- the time at which there was no longer any real risk of forfeiture nor restriction on disposal, and any exercise restrictions on an option had ceased;
- the employee’s employment ended; or
- 7 years had elapsed since the interest was acquired.
Many commentators attributed the decrease in employee share plans to the changes, which effectively removed any tax advantage to the employee receiving equity in lieu of salary.
The new law
Div 83A was amended so that:
- the 5% maximum shareholding/voting limit for ESS interest recipients was eased to 10%;
- the maximum period of tax deferral was extended to 15 years (from 7); and
- options are now largely taxed on exercise rather than on the mere removal of impediments to exercise (i.e. “vesting”).
The rules relating to shares remain similar; i.e. the holder is assessed on the difference between their market value on acquisition and any amount paid to acquire them.
The original shares or underlying shares (acquired by exercising options) will then be subject to CGT when sold, with the capital gain being the amount by which the sale price exceeds market value on either the exercise date (if acquired through options) or the date on which the real risk of forfeiture ceased to exist.
Another change is that holders of ESS interests are now entitled to a refund when they pay tax on a discounted option that is subsequently lost or cancelled (without being exercised).
The requirement that the offer be non-discriminatory and to 75% of the permanent employees of the company (i.e. including directors) of at least 3 years’ service remains.
Start-up companies – new regime
A new, more generous set of rules now applies to eligible start-ups (in this instance defined as unlisted companies of less than 10 years’ existence with a turnover of less than $50m).
- the discount does not exceed 15% of the market value (in the case of shares) or the “strike price” is at least the value of the underlying share (in the case of options); and
- the employee holds the interest for at least 3 years;
tax can be deferred until the sale of the shares, or if acquired through the exercise of options, the underlying shares are sold (i.e. even after exercise of the option).
The subsequent sale will be subject to CGT, with the shares’ cost base being either their market value on acquisition, or the exercise price if acquired through options.
The general CGT discount (which requires CGT assets to be held for 12 months) will treat shares obtained through the exercise of an option to have been acquired at the same time as the option, allowing more people to access the discount.
The changes assist in providing an efficient means of rewarding employees and directors of embryonic companies getting in “on the ground level” and new ventures with welcome flexibility, freeing them to direct scarce capital elsewhere.
Employees (particularly of eligible start-ups) will again be appropriately incentivised for agreeing to forego salary in return for equity.