Proposed changes to the taxation of ESS provide avenue for cash poor businesses hiring employees

12 August 2021

On 29 July 2021, Treasury released draft legislation that, if enacted, will change the way discounts on Employee Share Schemes (ESS) are taxed under one of the options available.

These changes will apply to ESS interests issued on or after the beginning of the financial year that follows Royal Assent and, with the proposed removal of certain regulatory barriers [1] dealing with ESS, may help cash poor businesses to hire employees with ESS offers, in addition to wages.

How Employee Share Schemes are currently taxed

An ESS provides employees with shares or rights to acquire shares in a company and is usually issued to employees at a discount to the market value.

Generally, an ESS discount is taxed up-front and included in the employee’s assessable income (and taxed at their marginal tax rate) in the year the ESS interest was issued.

However, the taxation of the discount will be deferred to a later time (called a deferred taxing point) if the ESS interest is, amongst other conditions:

  • At a real risk of forfeiture or loss.
  • Obtained under a salary sacrifice arrangement and does not exceed $5,000 in an income year.
  • A right to acquire shares that cannot be disposed of immediately and the ESS rules expressly states that the deferred option of taxation applies.

Currently, the deferred taxing point, or point in time where the discount on an ESS interest that is subject to deferred taxation will be taxed, is the earliest of the following three times.

Shares

Right to acquire shares

1

When there is no real risk that the share will be forfeited or lost (other than by disposal) and there are no longer any genuine restrictions preventing the disposal.

For a right that has not been exercised:

  • When there is no real risk that the right will be forfeited or lost (other than by disposal) and there are no longer any genuine restrictions preventing the disposal.

For a right that has been exercised:

  • When there is no real risk that the share will be forfeited or lost and there are no longer any genuine restrictions preventing the disposal.

2

When the employee ceases the employment in respect of which they acquired the share.

When the employee ceases the employment in respect of which they acquired the right to acquire the share.

3

At the end of the 15-year period following the acquisition of the share.

At the end of the 15-year period following the acquisition of the right.

However, if ESS interests (or the shares acquired by exercising a right to acquire shares) are disposed of within 30 days of the earliest time of the above taxing points, the ESS deferred taxing point will instead be the time of disposal.

Proposed changes to the way the ESS discount is taxed under the deferral option

The exposure draft proposes to remove point 2 in the table - the cessation of employment for both shares and rights - as a taxing point for ESS interests that are subject to deferred taxation.

If this proposal becomes law, an employee’s deferred taxation arrangements would continue when they cease employment, and the earliest of the remaining deferred taxation points (points 1 and 3 in the table) would apply. Additionally, by removing the time when an employee ceases employment as a taxing point under the deferral option, an income tax liability would no longer be triggered for the employee once such an event happens.

To discuss the different options available to remunerate your employees, or if you require a viability study of your ESS arrangements, please speak with your adviser or contact the Findex Tax Advisory team.

[1] Some examples include the removal of the Corporations Act 2001 requirements for ESS if (1) employees do not pay or incur a debt to participate in ESS schemes, or (2) the value of the shares offered under an ESS by an unlisted company are under $30,000 (currently the cap is only $5,000) and the relaxation of requirements to lodge disclosure documents.