Draft law released on Employee Share Scheme changes

The Federal Government released on Wednesday 14th January the draft legislation to fix Australia’s much-criticised rules around the taxation of Employee Share Schemes. This is the follow up to the announcement made in October 2014 as part of the government’s Industry Innovation and Competitiveness Agenda.

The draft law answers many of our questions around the October announcement. The changes can be classified into two categories:

1. Rules applying to eligible start-up companies; and
2. Rules applying to all companies

Start-ups

You may recall from our previous article that the definition of start-up in this instance is surprisingly broad and will include companies that may not fit within the common understanding of the term. The  conditions are:

1. “Aggregate turnover” of not more than $50 million;
2. Company is not listed; and
3. Company is incorporated for less than 10 years.

Broadly, the changes for start-ups will be as follows:

1. For shares issued at a discount to market value of less than 15%, the employee is not taxed on the discount (Note: there are other extensive requirements that must be met including broad availability to employees, the shares must be ordinary shares, maximum ownership condition and integrity rules).
2. For out-of-the-money options (strike price exceeding market value) issued at a discount to market value, the employee is not taxed on the discount. The discount is effectively taxed upon sale of the underlying shares under the Capital Gains Tax rules.

All companies

The changes applicable to all companies are broadly as follows:

1. Taxing point on discount on certain options pushed back from grant date to exercise date
2. Discount received by employees on certain shares and options can potentially be deferred for up to 15 years (up from 7 years)
3. ATO to introduce “safe harbour” valuation methodologies which should reduce the need for costly external independent valuations
4. Maximum shareholding limit (necessary for some concessions) increased from 5% to 10%
5. Employees choosing not to exercise an option because it is out of the money no longer prevented from obtaining a refund of prior year tax paid on those options
6. Changes to valuation methodologies
7. Standardised share scheme documents to reduce compliance costs

Comments from Azure Group's technology sector team

As a firm with a strong focus on the tech and high growth entrepreneurial business sector, it is a welcome relief to see the first draft.

Currently, Australia is at a competitive disadvantage to the rest of the developed world in terms of attracting, retaining, and rewarding talented employees using equity arrangements.

Rachel White, a prominent CFO and Strategic Advisor to the tech sector, considers this draft to be a major step forward in being able to engage high quality staff in start-up businesses and away from the big remuneration from established players, making it an exciting time for the sector.

It is hoped that the proposed changes will “resurrect” the use of options in Australia, where the tax rules have caused their use to plummet and gave rise to limited recourse loan arrangements which are designed to mimic options (but introduce complex, often unworkable problems of their own).

However, we note that problems remain. For example, for discounts on shares that do not qualify for the tax exemption, employees could still be taxed on illiquid shares that are difficult to sell, even though there are no “disposal restrictions” written into the agreement.

Keep an eye out for our in-depth analysis of the new rules and how you can take advantage of the changes, due to be published next week.

In the meantime do not hesitate to contact us with any questions.