Employee share schemes are a fundamental tool for cash-strapped entrepreneurial and start-up businesses to attract, motivate and retain talented staff. However the ability of these business to take advantage of this tool in Australia has been significantly hampered by our complex, unworkable and counter-intuitive tax rules in this area, which is been the target of much ridicule worldwide.
Further to earlier press announcements and comments by Abbott ministers of their intention to address this problem, yesterday the government has announced some details on plans to amend the law in order to support Australia’s start-up sector. The changes were announced as part of the government’s $400m Industry Innovation and Competitiveness Agenda.
The following are what you need to know and practical tips on how to take full advantage of the changes.
Problems with existing rules
- Employees are often taxed on shares in a start-up company which are illiquid, resulting in a cash flow burden
- Tax paid on shares/options are not refundable to employees if they are forfeited as a result of a choice of the employee (e.g. if options are underwater, the employee chooses to not exercise them) – they merely result in carried forward capital losses which are of limited value to many taxpayers
- Complexities around the scheme and finding solutions to its shortcomings resulted in a heavy compliance burden for start-ups whose shoestring budget may not allow for top level specialist advice to overcome the problems.
As a result of these challenges, many business have shied away from share schemes as a whole or adopted complex alternative schemes which mimic the result of overseas regimes.
Proposed changes
For eligible start-up companies:
- Employee options or shares that are provided at a “small discount” will not be subject to up-front taxation, so long as the shares or options are held by the employee for at least three years.
- Some options will have taxation deferred until sale.
- Shares issued at a “small discount” will have that discount exempt from tax.
- Maximum time for tax deferral extended from 7 years to 15 years.
- The ‘safe harbour’ option valuation tables will be updated to reflect current market conditions.
To be eligible for these concessions a company need to satisfy certain conditions:
- “Aggregate turnover” of not more than $50 million;
- Company is not listed; and
- Company is incorporated for less than 10 years.
As you can see the eligibility criteria is in fact surprisingly broad and a large number of companies will be able to utilise the concessions, regardless of whether they are innovative or a quintessential “start-up”.
In addition to the above, for all companies:
- Discounted options issued to employees are to be taxed when they are exercised (converted to shares), rather than when the employee receives the options.
Timing
No draft legislation has yet been released. The government will consult with industry to work out the finer details, with the legislation proposed to come into effect on 1 July 2015. Further details will be available when draft law is released by the government in the coming months.
It is disappointing that the government will have taken 6 years since 2009 (when the current rules came into effect) to address the problems, however it is better late than never.
For businesses that urgently need to put a scheme into place prior to 1 July 2015 we are looking into interim solutions which satisfy their requirements.
What you should do now
Whilst the changes will not apply for another nine and a half months, there are a number of action items that business will need to kickstart now because the race to attract the best talent using share schemes will now resume in ernest. Businesses must ensure that their remuneration policies are competitive in the market place or risk losing out to savvy employers.
- Restart past negotiations which have stalled due to being thrown in the “too hard basket”.
- Take advantage of employee shares/options during remuneration negotiations, with a general understanding amongst the parties that the shares/options will only be issued from 1 July 2015.
- Unwind or modify existing “stop-gap” schemes such as limited recourse loans and phantom non-equity based schemes.
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