The Assistant Treasurer recently released a discussion paper inviting submissions on possible changes to relax the administrative and tax arrangements for shares or options granted to employees under employee share schemes (ESS) for start-up companies.
The discussion paper is part of the government’s current push aimed at encouraging high growth start-up companies. It recognises that although ESS’s can be a valuable tool for start-ups in attracting and retaining talented people, while ensuring sufficient capital is conserved to grow their business, improvements could be made to their administrative and taxation arrangements for start-ups to reduce their costs and complexities for these companies.
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Current ESS arrangements
Under the current tax arrangements, broadly speaking any discount in the market value of an interest in a share or right provided to an employee under an ESS is taxed upfront in the tax year it is granted, unless certain other conditions apply, in which case it may be deferred until a later point in time. If it was taxed up front and certain conditions are met, then a $1000 “tax-free” concession may apply.
Overall, many have complained that the current system is complex, costly and creates a disincentive for start-ups to adopt an ESS.
Proposed tax reform options for treatment of ESS interests
The paper puts forward four possible options to ease the taxing of ESS interests that apply to start-ups. These are broadly aimed at pushing back the date tax must be paid on the discount received on the interests or reducing the amount of tax payable and include:
- deferring the time the ESS interests are taxed from the time they are granted until a later date such as when the employee stops working for the start-up or seven years after the ESS interests were acquired;
- calculating the tax payable on the ESS interests at the time they are granted but postponing the time that tax must be paid until the ESS interest is sold or exercised;
- taxing the ESS interests at the time they are granted but at a lower tax rate (the paper currently proposes a fixed rate of 15% regardless of the employee’s marginal tax rate); or
- increasing the upfront “tax free” concession on the discount between the value of the ESS interest and the amount paid for it from its current amount of $1000 to $5000.
To define the companies that would be eligible to take advantage of the proposed new rules, the government proposes a definition of “start-up company”, as a business that is not listed on a securities exchange and:
- has 15 or less employees;
- has a turnover of less than $5 million and is not owned or controlled by another company;
- has been in existence for less than a certain period (currently proposing five or seven years or less);
- either its business does not involve an “excluded activity” or it is providing new products, processes or services based on the development and commercialisation of intellectual property; and
- has the majority of its employees and assets in Australia.
Proposed valuation options for ESS interests
The discussion paper acknowledges that the requirement to calculate the market value of the ESS interests at the time they are granted increases their costs to start-ups. In fact, in many cases an independent or formal valuation is required to identify the discount, which can be costly and must be paid for by the company.
It proposes a number of alternative methods of valuing the interests that are aimed at reducing costs and complexity of calculating the market value of the ESS interests by allowing start-ups to determine their value using information that the start-ups already have available to them.
One of these proposed methods is a “net asset backing method” that would allow the start-up to value the ESS interests from information contained in its balance sheet. Other methods proposed are by reference to Australian Accounting Standards Board Standard No.2 and using recognised formula-based valuation methodologies.
Simplifying the creation of an ESS
To help address concerns regarding the costs of professional advisors required in establishing ESSs, the discussion paper also suggests developing standard/template documents that could be used for basic ESSs. The intention is that these “approved” template ESS documentation for start-ups are made available for the start-ups to simply insert their relevant details to reduce the legal and accounting fees for setting up and operating the ESS.
Submissions on the discussion paper close on August 31, 2013 with the Treasury expected to report back to the government on the outcome by December 2013. It is therefore unlikely that any changes will be implemented until at least mid-2014. If you are interested in making a submission or want to keep up to date with the discussion paper, please feel free to connect with me through email or LinkedIn.