20 Nov Employee Share Schemes Upgraded: Are you using them yet?
The recent changes to the tax treatment of shares and options awarded to employees have made employee share schemes (ESS) more attractive to small business, especially start-ups.
What’s an ESS again?
Under an ESS, employees, contractors, or executives of the company can be offered shares or options in the company, usually at a discount or for free. This is sometimes unfalteringly called “sweat equity”.
Shares or options are often vested over time during the period of employment to reward employees or cofounders who become employees for continued contribution or meeting certain milestones. ESS are particularly relevant for start-ups where they are used to attract and retain the sort of talent that a start-up company would otherwise be unable to afford.
What are the changes and how do they help you?
However the tax treatment of discounted shares in Australia has, for a long time, made ESS unattractive. If shares are issued for less than market value, the discount is considered to be income for tax purposes. The problem under the old regime was that workers received a tax bill at the time they received the shares or options, often before any value was actually realised.
This year the government amended the legislation to align the taxation point of ESS interests with the point in time that employees are likely to receive actual benefit. Employees may also be eligible for a tax write-off if they earn less than $180,000 p.a or if they work for a start up company.
The changes have meant that option schemes are now making a comeback as the preferred structure for ESS. An option is the right to purchase shares at a future date for a set price. They can be given out to workers over time as they satisfy the ESS conditions. Options are generally more favourable in that employees can purchase shares at a time when the market is right, and the company will not be burdened with the administrative hassle of minor voting shareholders until options have been exercised.
Where do I get help?
The Australian Taxation Office has published a template ESS plan to assist start up companies in setting up their ESS. The standard documents can be found at: https://www.ato.gov.au/General/Employee-share-schemes/In-detail/Standard-documents-for-the-start-up-concession/.
Whilst the changes do make ESS an attractive option to attract talent for early stage startups, the mechanics are not always easy, and it’s worth consulting your advisers on how to best structure the ESS in practice.
By Legal Counsel Katherine Bulog. Clearpoint ed Anna Reeves.