Australia’s Treasury has released draft legislation to implement proposed changes to the taxation provisions of employee share schemes that would see options taxed at the point of exercise instead of upfront.
The government wished to reverse changes made by the former Labor Government, noting that the new rules were reducing the competitiveness of Australian start-up companies and hampering their ability to attract and retain high quality employees.
These proposed changes apply to all companies; however, the government has also introduced a further taxation concession for employees of certain small start-up companies.
Changes applying to all companies
As foreshadowed when the changes were first announced, the new legislation will:
- Allow schemes offering rights (including options) that do not contain a real risk of forfeiture to access tax deferred treatment, as long as the scheme rules state that tax deferred treatment applies and the scheme genuinely restricts an employee from immediately disposing of the right. Taxation can be deferred until the disposal restriction on the rights and the underlying shares is lifted.
- Change the taxation point of rights from the point at which a right “can” be exercised to the point at which it “is” exercised.
The legislation has also increased the maximum deferral period for shares and rights from seven years to 15 years (unless the employee ceases employment).
Employee share schemes must still meet general eligibility conditions, although the ownership condition – where employees could not participate in schemes if they owned more than a 5% interest (or rights to own interest) in the company – has been extended to 10%.
Employees can also now reclaim tax paid on rights they decide not to exercise, for example in the case that an option is underwater. This does not apply where the scheme protects the employee from market risk.
As proposed, Treasury has released revised tables for the valuation of rights granted in employee share schemes, using updated assumptions to reflect current market conditions. Commentary from taxation experts such as KPMG notes that the new tables generally reflect lower values than the existing tables.
In addition, the Taxation Commissioner will receive new powers to approve different valuation methodologies. If the taxpayer uses the approved methodology, they can rely on that method as reflecting the market value of the asset or non-cash benefit being valued.
Changes applying to selected start-ups
Some start-ups will be eligible for additional concessions where:
- Shares can be issued at a discount up to 15% of market value; and
- Rights can be issued with exercise price equal to or above the market value of an ordinary share,
with taxation to be deferred until the shares are sold, when they will be subject to capital gains tax with a cost base reset at market value for shares and the employee’s cost of acquiring the right for rights.
To qualify, the general eligibility conditions for all ESS concessions must be met and the scheme must mandate a three-year holding period for the interests issued under the share scheme unless employment with the company is ended earlier.
In order to be eligible to offer the tax concession the companies must:
- Not be listed on any stock exchange when the share or right is acquired
- Have incorporated under Australian or foreign law less than ten years before the acquisition of the share or right (the incorporation rule also applies for the company’s subsidiaries, holding companies and subsidiaries of the holding company)
- Have aggregated turnover of no more than $50 million in the year before the income year in which the employee acquires the share or right
- Be an Australian resident taxpayer at the time the employee acquires the right
The closing date for written submissions is 6 February 2015. The proposed legislation is to be valid for shares or rights acquired under employee schemes on or after 1 July 2015.
Disclaimer: This article has regards to legislation that is yet to pass into law. This material does not constitute tax, legal or accounting advice.