On 14 October 2014, the Government announced that it will reform the tax treatment of employee share schemes to support start-up companies and boost entrepreneurship. The Government said it will unwind the tax changes introduced by the previous Government in 2009. Specifically, it said it will reverse the changes made in 2009 to the taxing point for options. The change will apply to all companies and will mean that discounted options are generally taxed when they are exercised (converted to shares), rather than when the employee receives the options.
The Government said it will also 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 concessional treatment will include the company having aggregate turnover of not more than $50 million, it being unlisted and being incorporated for less than 10 years. Furthermore, the Government will extend the maximum time for tax deferral from seven years to 15 years.
The Government said it will also update the "safe harbour" valuation tables, which are used by companies to value their options, so they reflect current market conditions. The integrity provisions introduced in 2009 and the $1,000 up-front tax concession for employees who earn less than $180,000 per year will be retained.
The Government noted the ATO will work with industry to develop and approve standardised documentation that will streamline the process of establishing and maintaining an ESS.
The Treasurer is expected to consult with industry on draft legislation and the changes are proposed to commence on 1 July 2015.
Note that as part of the announcement, the Government issued a Factsheet entitled Improving taxation arrangements for employee share schemes. The Factsheet contains four examples which illustrate when options are eligible for the start-up concession and when shares are eligible for the start-up concession. It also contains a summary of taxing points for options and shares provided by a qualifying ESS under the new proposed arrangements.
Kerry works for a small company that meets the eligibility criteria for the start-up concession*. On 1 July 2015, Kerry is given 10,000 options to purchase shares in her employer's company for $5 per share (ie the exercise price is $5) between 1 July 2018 and 1 July 2019 under a qualifying ESS.
The market value of shares in her employer's company on 1 July 2015 is $4 per share (which is less than the exercise price of the options) so the shares are "out of the money". Because the shares are not "in the money" (which occurs when the exercise price is lower than the market value of the shares), Kerry is eligible for concessional treatment under the start-up concession.
Kerry does not pay anything for the options, but they are worth $0.50 each (total value of $5,000) when they are provided to her. The total discount provided to Kerry is $5,000, equal to the market value of the options ($5,000) minus any amount paid by Kerry ($0).
Under the old rules, and assuming there was no risk that Kerry could forfeit the options, Kerry would have had to pay income tax on the discount component ($5,000) in the income year that she received the options (2015–2016).
Under the new concessional start-up rules, Kerry will be able to defer any tax on this ESS arrangement until she sells the underlying shares, unless another taxing point** occurs first. If Kerry sells the shares for more than $5 per share (the exercise price, which will also likely be her cost base for CGT purposes), she will be liable for CGT upon sale of those shares. In this example, if Kerry sells the shares for $8 per share, she will pay CGT on her gain of $3 per share when she sells the shares (the sale price of $8 minus what she paid for each share, $5).
*Eligibility criteria include: the three-year minimum holding period; company having aggregated turnover of not more than $50m; being unlisted; and being incorporated for less than 10 years.
**Another taxing point will occur if a non-sale CGT event occurs to the options or shares before the sale event occurs (eg Kerry stops being an Australian resident taxpayer).
Source: Government Factsheet entitled "Improving taxation arrangements for employee share schemes", http://www.dpmc.gov.au/publications/Industry_Innovation_and_Competitiveness_Agenda/employee_share_schemes.cfm
Encouraging employee share ownership is one of the key initiatives forming part of the Government's Industry Innovation and Competitiveness Agenda announced on the same day. Among other things, the Agenda aims to create "a lower cost, business friendly environment with less regulation, lower taxes and more competitive markets". Other key initiatives forming part of the Government's Agenda include:
- reforming the vocational education and training sector;
- promoting science, technology, engineering and mathematics skills in schools;
- accepting international standards and risk assessments for certain product approvals;
- enhancing the 457 and investor visa programs; and
- establishing Industry Growth Centres.
The Industry Innovation and Competitiveness Agenda Report and accompanying Factsheets are available on the Department of the Prime Minister and Cabinet website at: http://www.dpmc.gov.au/publications/Industry_Innovation_and_Competitiveness_Agenda/index.cfm.
Source: PM, Treasurer and Small Business Minister's joint press release, http://bfb.ministers.treasury.gov.au/media-release/055-2014/