Are you having trouble attracting and keeping key employees? This is becoming more common for employers as unemployment rates are at an all-time low. An Employee Share Scheme ('ESS') may be the answer you are looking for!

What is an Employee Share Scheme?

An ESS is a scheme under which ESS interests in a company are provided to employees (including associates). An ESS interest in a company is a beneficial interest in a share, a stapled interest that includes a share, or a right to acquire a beneficial interest in a share in the company (options).

The definition of an employee for ESS purposes is broad and aims to capture employee-like relationships such as directors and certain independent contractors. The ESS provisions apply to current, past and prospective employees.

Employee share schemes are an effective method of motivating employees and aligning their interests with those of the owners of the company. Employee share schemes incentivise employees to ensure the company is successful in the long-term.

The Basics of ESS

Division 83A of the Income Tax Assessment Act 1997 ('the Act') outlines the Tax implications of providing an ESS interest to employees.

A discount arises where the market value of the shares exceeds the amount paid to acquire the shares, with the excess being the amount of the discount. The ESS provisions operate to Tax employees at their marginal Tax rate on the discount amount in the income year in which an upfront or deferred Taxing point occurs.

In the case of options, the Act provides guidance on the valuation of options (essentially following the Black-Scholes methodology).

Generally, employees will be Taxed upfront on the amount of the discount. This means the employee must include in their assessable income the amount of the discount in the income year the shares were acquired.

In certain circumstances, employees will be able to defer the Taxing point where the ESS interests acquired under an ESS are at a real risk of forfeiture or are obtained under certain salary sacrifice arrangements.

Real Risk of Forfeiture

A real risk of forfeiture occurs where there is a real risk that, under the conditions of the scheme, you will forfeit or lose the ESS interest. The Explanatory Memorandum to Act No 133 of 2009 explains that there is no requirement for the conditions of the scheme to impose a 'significant or substantial' risk of forfeiture, but simply 'more than a mere possibility'. Common examples of where there might be a real risk of forfeiture include meaningful performance hurdles and minimum employment period requirements.

There are a number of other requirements that must be satisfied. If the relevant requirements are met, the Taxing point will be deferred to the earlier of when there is no longer a real risk of forfeiture or 15 years from the date of acquisition of the shares.

Salary Sacrifice Arrangement

If shares in a company are acquired by an employee under a salary sacrifice arrangement, the Taxing point may be deferred provided certain conditions are met. The discount must be equal to the market value of the ESS interest (meaning the employee acquires the shares for nil consideration), and the salary sacrificed amount cannot exceed $5,000.

There are a number of other requirements that must be satisfied. If the relevant requirements are met, the Taxing point will be deferred to the earlier of when the employee is no longer restricted from disposing of the shares or 15 years after the date of acquisition of the shares.

$1,000 Reduction

The amount which must be included in an employee's assessable income may be reduced by up to $1,000 if various conditions are met.

The key conditions include:

  • the sum of the employee's Taxable income, reportable fringe benefits, reportable superannuation contributions and total net investment losses for the income year must not exceed $180,000;
  • the ESS must be offered to at least 75% of permanent employees with at least three years of service (whether continuous or non-continuous);
  • the ESS interest cannot be at risk of forfeiture;
  • the employee must be employed by the company (or a subsidiary) offering the ESS interest;
  • the ESS interest must relate to ordinary shares;
  • the ESS interest cannot be sold within three years of the date of acquisition (unless the employee ceases to be employed by the company); and
  • the employee does not, after acquisition of the shares, own or control more than 10% of the company.

Start-Up Companies

Special concessions are available for eligible start-up companies which satisfy certain conditions. The provisions are intended to increase the number of new entrepreneurial companies in Australia by assisting them to attract and retain employees by providing those employees with a Tax concession for acquiring shares under an ESS.

If the relevant conditions are met, the discount is not subject to income Tax (in other words, the employee is not required to include the amount of the discount in their assessable income).

The capital gains Tax ('CGT') rules will apply to the ESS interests. The cost base of the shares will be equal to the market value of the shares at the time of acquisition. If the employee acquires rights, the cost base of the resulting shares will be the equal to the amount paid by the employee, being the amount paid for the option plus the exercise price.

A company will be an eligible start-up company if various conditions are met.

The key conditions include:

  • the company must not be listed on a stock exchange;
  • the company must have been incorporated less than 10 years ago;
  • the company's aggregated turnover must not exceed $50 million;
  • if the ESS interest is a share, the discount cannot be more than 15% of its market value at the time of acquisition. If the ESS interest is a right, the amount that must be paid to exercise the right must be greater than or equal to the market value of an ordinary share in the company when the right was acquired; and
  • the employer must be an Australian resident company.

Fringe Benefits Tax

The granting of ESS interests is exempt from Fringe Benefits Tax.

Want to know more?

Early engagement in this area can often provide significant benefits to both the company and its employees. If you would like to know more about these incentives, please do not hesitate to reach out to your trusted Hall Chadwick advisor.