The passing of the employee share schemes tax legislation by Federal Parliament yesterday has ushered in a new chapter in the taxation of ESS in Australia. The new tax changes, which will apply to awards granted on or after 1 July 2015, are a step forward from the 2009 tax changes and offer a more practical and intuitive set of ESS tax provisions to apply.
Employers should review their current ESS arrangements in the lead up to their next grant cycles and consider whether to modify their ESS awards in light of the new tax changes. More importantly, startups and unlisted companies, which have, in the past, tended to avoid ESS due to its tax complexity and cost, might like to now dip their toes back in the water.
Here is a list of five opportunities for companies to explore for awards granted on or after 1 July 2015.
1. Shares and options that qualify for the new startup tax concessions
Eligible options or shares granted by eligible startups will not be subject to Australian tax on grant, vesting or exercise. Instead, employees will be subject to capital gains tax, generally when the shares are sold.
This means that the CGT 50% discount will generally be available at that time. As the proposed tax concessions are significant, there are important limitations.
Also, you should be aware that ASIC’s new class order for unlisted companies may not accommodate all offers which attract the start-up tax concessions. It is understood that the ATO is tracking well in relation to the safe harbour valuation methods and the production of standard documents, which it intends to make available on its website from 1 July 2015. If your company doesn’t qualify for the special startup tax concessions, you may find one of the other suggestions below to be appropriate.
2. Rights with an exercise period (zero exercise price options)
One of the main tax changes made back in 2009 was to bring forward the taxing time of options from exercise to either grant or vesting (depending on whether there was a real risk of forfeiture on grant). This 2009 change will now be reversed for options granted on or after 1 July 2015. That is, the taxing time of options that are held by continuing employees will generally revert to when those options are exercised.
This means that rights with an exercise period post vesting (i.e. ZEPOs) may provide employees with more flexibility to manage the taxing time on their rights. However, employers considering granting rights with an exercise period should ensure they consider all the flow-on implications of that plan design choice (e.g. whether additional administrative costs are involved).
Watch out though: cessation of employment remains a taxing time for all tax-deferred awards. Listed companies can manage this issue by including a cash discretion in their plan rules, which conveniently is now also facilitated by ASIC’s updated Class Order relief for listed companies. Unlisted companies may wish to avoid using a cash discretion for corporate regulatory reasons. However, their employees can now rely on the newly expanded refund rules for unexercised rights to manage the leaver issue.
3. Options with an exercise price
Options with an exercise price might come back into favour because reverting to tax on exercise, combined with the changes to the refund rules and lower valuations under the statutory tables, should mitigate the risk of the undesirable tax outcomes that occurred under the 2009 tax changes.
4. Premium priced options
Premium priced options can be attractive in high-growth industries. Such options might now become more attractive in light of the updates to the valuation tables for unlisted options, which result in lower taxable values. For example, an option with an exercise price equal to 143% of the market value of the share on grant and a maximum four-year life will be treated for tax purposes as being taxable on grant on a nil value. Such a grant should also be exempt from fringe benefits tax.
5. Fixed remuneration as rights to shares
In appropriate circumstances, fixed remuneration can be provided as rights to shares because there is no longer a requirement to satisfy the ‘real risk of forfeiture’ test on the grant of rights if the scheme documentation is appropriately drafted. We may therefore see the re-emergence of Non-Executive Director plans and bonus arrangements using rights to shares.
Shaun Cartoon is a tax senior associate at the law firm Allens.