Prime Minister Tony Abbott released this week the government’s National Industry Investment and Competitiveness Agenda. Amongst other things, it included proposed changes to the legislation on the way taxation is calculated on employee share options.
Why use Employee Share Options?
Many corporates offer shares or options at a discount (i.e. issued for a cost lower than market value) to employees as part of an employee share scheme. They are a tool used by start-ups and smaller businesses to retain key employees, their innovation, knowledge and remain competitive with large businesses who can afford higher salary packages.
We have seen many of these share scheme arrangements used successfully in the United States with the large listed technology companies nearly all making instant millionaires and in some cases billionaires of some of their long standing staff (e.g. Facebook, LinkedIn etc). These companies potentially would not have retained these talented employees and achieved the final Initial Public Offering (IPO) or trade sale had they not been able to offer these schemes to retain the talent through the early stages of the business.
Broader than just technology companies, we are witnessing current issues associated with transitioning ownership between owners and their key employees. The reasons for this are wide-ranging. Some reasons include funding issues with the banks, minimal cash savings (as the younger generation has spent a large portion of their funds on a family home) and/or witnessing a propensity for the younger generation to not wish to pay for something now but to only receive a benefit in the event of a future transaction or event (in other words ‘sweat it’).
Employee share options can help facilitate this process and provide the original owners with retention policies for key employees and the ability for employees to share in any future windfall - A win/win situation for many private businesses.
In 2009, the legislation surrounding employee share schemes was changed to be more complex and costly to set-up and administer and ineffective (from a tax perspective). Many employees were being taxed on an options discount when it was granted rather than when it is converted to shares (before receiving a known benefit).
The proposed changes reverse many of the 2009 rules and will apply to all companies. This will mean that generally discounted options are taxed when they are exercised (converted to shares), rather than when an employee receives the options.
Further, the Government will allow employee share scheme options or shares that are provided at a small discount by eligible ‘Start-Up’ companies to not be subject to up-front taxation, so long as the shares or options are held by the employee for at least three years. Options under certain conditions will have taxation deferred until sale. Shares (issued at a small discount) will have that discount exempt from tax.
Criteria to define eligibility for this ‘Start-Up’ concessional treatment will include the company having aggregate turnover of less than $50 million, be unlisted and incorporated for less than 10 years. Furthermore, to give ‘Start-Ups’ more time to be competitive and succeed, the Government will extend the maximum time for tax deferral from seven years to 15 years.
Proposed legislation is expected to come into effect on 1 July 2015 so the devil is always in the detail of the final legislation and most will take a wait and see approach. If changes proceed as proposed, we expect a lot of new employee share scheme arrangements will be issued later this year as the proposed changes are a a step in the right direction.
How can we help?
This proposal is still a draft and we will notify you if it comes into effect. If you are involved with a company that have employee share schemes in place or if you are thinking of structuring employee share schemes, you should contact your Altus Adviser.
Written by: Scott Young - Director
