Changes to Employee Share Scheme Tax Laws – What You Need to Know

The May 2021 Federal Budget announced welcome changes to the tax regime around employee share schemes. In particular, employees will not be taxed for the shares they hold as part of an ESOP when they cease employment with the company. These changes are expected to come into effect from 1 July 2022.

What is an Employee Share Scheme?

Employee share schemes, also known as an ESS or an ESOP (employee stock option plan), is a mechanism which gives employees of a company the option to buy shares in that company at a future time. The options will often vest in parcels over a period of time. For example, 1/36^th of the options may vest every month until all the options are vested over three years.

Employees will have the ability to convert these options into shares at a time set out in the ESS agreement. This may be any one of the following:

• At or prior to the company undergoing an IPO;
• Any time after the options have vested, but prior to a set expiry date; or
• Another time as set out in the agreement.

Generally, the options can be converted into shares at a discounted price, fair market value, or some other ‘exercise price’ determined by the company.

Why do company’s use ESOPs?

An ESOP or ESS is a great way to reward loyal employees, as it grants them ownership in the employer company in exchange for their ongoing service. It also makes the employee directly invested in the company, thereby encouraging an ownership mentality so that the employee sees the company as more than just a job.

Employee share schemes are particularly popular in startups and other early stage high risk businesses. This is usually because such businesses may be unable to pay their employees competitive salaries. An employee’s overall remuneration package becomes more attractive with the addition of share schemes, as the value of the share options can increase as the business expands and continues to grow.

In addition to the above, Share schemes are attractive to employees as they attract certain tax concessions if implemented correctly.

For more information on employee share schemes, check out the ATO’s resources here.

What is the new change?

The new changes have altered what is known as the ‘deferred taxing point’ in an ESS. The deferred taxing point is a benefit that allows employees to defer paying income tax in relation to the ESS shares. Prior to the change, the deferred taxing point was the earliest of: 

• Cessation of employment;
• When there is no risk of forfeiture or genuine restrictions on disposal of the shares. In other words, once the shares have been vested without the company’s ability to buy them back or prevent the employee from selling them; or
• The maximum deferral period of 15 years.

The impact of these tax rules, however, is that when employees leave their jobs, they could be faced with a huge tax bill as a result of the deferred taxing point being triggered. This has resulted in situations where employees have had to sell all their shares immediately on cessation just to cover the taxes.

The new rules remove cessation of employment as a taxing point. This removes the risk of employees facing onerous tax consequences when they leave their job. This welcome change will continue to enable employers to encourage loyalty in their company, without the employee being punished by tax consequences for leaving.

Need Help? Contact Us

At Allied Legal, we regularly help startups and other businesses navigate the complex regime around employee share schemes. Our team of startup lawyers can help you understand the best way to implement a share scheme for your employees, to the maximum benefit of the company and the employee.

If you need assistance with employee share scheme arrangements, or if you want to know how these new tax laws effect you, then please feel free to give us a call on 03 8691 3111 or send us an email at hello@alliedlegal.com.au.

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