The taxing rules for Employee Share Schemes (‘ESS’) in relation to start-ups significantly changed on 1 July 2015. An ESS is a scheme where shares or options in a company are provided to its employees.
The new tax concessions provide a positive incentive for employees of start-up companies to participate in an ESS giving start-ups a flexible way to attract and retain staff when funds are tight.
What are the changes for start-ups?
For employees of eligible start-ups there will be no upfront taxation on the grant of the ESS shares or options. This means, that for employees who receive ESS shares or options, they don’t pay any tax until the shares are actually sold and a gain is made on the sale.
Why would you want to do it?
An ESS can have numerous benefits for start-up companies, including:
- rewarding employees who have contributed to the growth of the company;
- producing more flexible remuneration packages for employees (e.g. salary packages can consist of a base salary and options/shares in the company);
- promoting innovation and improving company productivity as a result of employees having a direct interest in the performance of the business enterprise.
The new changes make an ESS more attractive for employees from a taxation perspective.
What are the criteria?
In order to qualify for the tax concessions a company must meet the following requirements to be an eligible start-up:
- It is unlisted. Neither the company nor a member of its corporate group can be listed on any stock exchange worldwide.
- It is less than 10 years old. The company and all members in the corporate group must have been incorporated for less than 10 years.
- It has an aggregated turnover of less than $50 million. Aggregated annual turnover of the company and its affiliates (but excluding its venture capital investors) must not exceed $50 million.
- It is an Australian resident
The terms of the ESS offer must satisfy the following criteria:
- Ordinary shares only or options to acquire ordinary shares.
- Minimum holding period of 3 years commencing from the date the ESS shares or options were acquired.
- 10% limit of shareholding and voting power. The employee and their associates must not hold more than 10% of shares or voting power in the company.
- Market Value — ESS shares: must not be offered for more than a 15% discount on the market value of the shares at the date of grant.
- Market Value — ESS options: The exercise price of the ESS options must not be less than the market value of the shares in the company at the date of the grant.
How can the company determine the market value of its shares? The Australian Taxation Office (‘ATO’) has introduced 2 safe harbour methods of determining the market value of a start-up: the Net Tangible Assets or Market Valuation methods. This avoids the need for an independent market valuation.
Should the company offer ESS shares or options? This is a question for the Board and if it wants to set performance hurdles that employees must satisfy before the shares are granted or the options are vested and exercised (eg financial targets? time based conditions?).
Does the company have to offer the ESS shares or options to all employees? ESS shares must be offered to at least 75% of Australian employees with at least 3 years’ service. This does not mean the terms of the offer have to be the same for all employees, just that the ESS is available in some form to at least 75% of the employees.
In contrast, there is no such requirement in relation to options. For this reason, options may be a more attractive scheme for employers wishing to reward key employees only.
How do you set up an ESS?
The ATO has provided sample documentation to set up an ESS option plan. However it will still need to be tailored to meet the objectives of the individual company.
For more information contact the Corporate and Commercial Team at Meyer Vandenberg: