Treasury has this month released a discussion paper about the impact of employee share schemes (ESS) on Australian start-ups. The government announced a review of the schemes after feedback that the current taxation arrangements for ESS in Australia are complex, costly and a disincentive for start-ups to set up a scheme.
Currently, any discount on the market value of an interest in a share or right is taxed in the income year of acquisition. Due to prior industry criticism, when the review was announced many believed the government would consider delaying the relevant taxing point from the vesting date to the exercise date. We voiced our views of deferring the taxation point in our July newsletter.
Deferral of the taxation point (until the earliest of when the employee exercises the options, the employment ceases, or seven years after the shares or rights were acquired) has in fact turned out to be one of the options the government is considering. All of the options as set out in the discussion paper were:
The Government is considering a range of options to address the concerns of start-up companies, including:
- retain the current arrangements;
- defer taxing point or payment of tax;
- tax ESS for start-ups at lower rate; and
- increase the ESS up-front discount.
The review will also look into adjusting the valuation methodology of options and options for reducing the administrative burden of setting up an employee share scheme.
When the review was first announced, some had hoped any changes to the taxation of schemes would be applicable to all listed companies and not just start-ups – the discussion paper notes that ESS concerns have been raised by a “broad range of stakeholders”. However it appears the government’s focus will remain firmly on the small end of town: the discussion paper firmly states that “at this time, the government is not looking to make general changes to the ESS arrangements or extend any of the options to other unlisted companies”.
To make sure that any changes will only benefit start-ups, the government wants to develop a “robust” eligibility criteria for start-ups that is “cost effective to administer and comply with” before any new taxation options are considered. The paper suggests defining a start-up as:
- a business that has 15 employees or fewer;
- has an aggregated turnover of less than $5 million and is not a subsidiary, owned or controlled by another corporation;
- has been in existence for [five/seven] years or less;
- is not undertaking an excluded activity [OR] is providing new products, processes or services based on the development and commercialisation of intellectual property;
- is unlisted; and
- has the majority of its employees and assets in Australia.
The definition has already been criticised as too restrictive by high-profile figures in the technology industry. Atlassian co-founder Mike Cannon-Brookes told the Australian Financial Review that companies don’t generally start their real growth until they hit 10 people, arguing that the plan would not foster start-ups as they transition into the growth phase where the most wealth was created. Seek co-founder Paul Bassat said that start-ups wouldn’t implement a share scheme until they had reached 15 people.
The definition’s possible exclusion of certain activities, for example property development or land ownership, banking, insurance, construction, mining and mineral exploration or farming and agriculture, would also reduce the scope of any changes.
Submissions on the discussion paper are due by 30 August.