The regulatory changes seek to reduce the red tape and expand the accessibility to make such arrangements an attractive tool for Australian businesses to compete for international talent.
Employee Share Schemes
Employee share schemes (ESS) enable businesses to provide equity participation to directors and employees, generally in the form of shares or options (collectively referred to as “ESS interests”). Private and public companies use ESS to attract, retain and motivate employees by providing additional benefits without impacting their cash position. They are also beneficial to businesses as they align employees’ interests with those of shareholders and thus can boost participant performance and improve business outcomes.
Current ESS regime
The regulation of ESS offers under the Corporations Act 2001 (Corporations Act) have been relaxed through a series of reforms and have become a useful tool for remunerating and incentivising employees/contractors of emerging businesses. Proposed amendments to the Corporations Act and Income Tax Assessment Act 1997 will ease the compliance burden further.
Expanding the scope and removing the red tape
Under the ESS reform, proposed amendments to the Corporations Act will come into force on 1 October 2022 which will reduce the regulatory burden on listed and unlisted companies when offering ESS interests. Notably, under the new regime, different rules apply to ESS that require payment of monetary consideration from participants (including upon exercise of an option) as opposed to ESS that offer the ESS interest ‘for free’.
The key changes to regulatory requirements include:
General
| New Law | Current Law | |
|---|---|---|
| Eligible Participants | All people who provide services to a business. | Only employees, directors and certain independent contractors. |
| General concepts | For ESS which require monetary consideration, streamlined obligations under the Corporations Act will apply including where an ESS interest is offered to independent contractors. If no monetary consideration is required, the ESS is generally not required to comply with the Corporations Act. | Streamlined obligations apply to ESS under Class Order 14/1001 for unlisted companies and under ASIC Class Order 14/1000 for listed companies, regardless of whether they require monetary consideration. |
For unlisted companies
| New Law | Current Law | |
|---|---|---|
| Monetary Cap | For ESS which require monetary consideration, a monetary cap applies which only allows a participant to outlay up to $30,000 on ESS offers over a 12-month period, plus 70% of any dividends and 70% of cash bonuses received by the participant in that year. The cap can be accrued for option plans over a 5-year period up to a maximum cap of $150,000. | For ESS which require monetary consideration, a monetary cap of $5,000 per year per participant applies under ASIC Class Order 14/1001. |
| 20% Issue Cap | For ESS which require monetary consideration, a 20% ‘issue cap’ must not be exceeded. This means that the number of ESS interests offered over a 3-year period commencing from the date of the offer must not exceed 20% of the total issued share capital of the company. The company’s constitution may specify a different issue cap. | 20% ‘issue cap’ must not be exceeded to rely on ASIC Class Order 14/1001. |
For listed companies
| New Law | Current Law | |
|---|---|---|
| No Monetary Cap | There is no limit on the value of ESS interests that may be offered to a participant. | There is no limit on the value of ESS interests that may be offered to a participant. |
| 5% Issue Cap | For ESS which require monetary consideration, a 5% ‘issue cap’ must not be exceeded. This means that the number of ESS interests offered over a 3-year period commencing from the date of the offer must not exceed 5% of the total issued share capital of the company. The company’s constitution may specify a different issue cap. | 5% ‘issue cap’ must not be exceeded to rely on ASIC Class Order 14/1000. |
| Trading requirement | An ESS can receive regulatory relief regardless of how long the interests offered under the ESS have been traded on a stock exchange. | An ESS can only receive regulatory relief under ASIC Class Order 14/1000 if the interests offered under the ESS have been traded on a stock exchange for more than 3 months before the offer is made. |
| Suspension from trading | An ESS can receive regulatory relief regardless of whether the interests offered under the ESS had been suspended from trading. | An ESS can only receive regulatory relief under ASIC Class Order 14/1000 if the interests offered under the ESS have not been suspended for more than 5 days from trading over the previous 12 months. |
For both, listed and unlisted companies
| New Law | Current Law | |
|---|---|---|
| ASIC Notification | For ESS which require monetary consideration, a written notice of intent must be provided to ASIC before an ESS offer is made. If no monetary consideration is required, ASIC does not need to be notified of the ESS offer. | A ‘Notice of Reliance’ must be submitted to ASIC to rely on the relief (see ASIC Class Order 14/1001 for unlisted companies and ASIC Class Order 14/1000 for listed companies). |
| Offer Document | For ESS which require monetary consideration, the company must provide an ESS offer document to participants which must contain certain prescribed information, including company financial information, a valuation report and solvency resolution. However, an offer document is not required if the offer falls under one of the exemptions in Chapter 6D of the Corporations Act (for example, offers to senior management or small scale offerings). If no monetary consideration is required, an ESS offer document in the prescribed form is not required. However, participants will need to be provided with information on the ESS interests offered and the terms and conditions on which the ESS interests are being issued or granted. | The company must provide an ESS offer document as prescribed by ASIC Class Order 14/1001 for unlisted companies and by ASIC Class Order 14/1000 for listed companies, regardless of whether monetary consideration is required. Also, in order to rely on the regulatory relief under the relevant ASIC Class Order an offer document must be provided, even if those offers would otherwise not require disclosure under the Corporations Act (for example, offers to senior management or small scale offerings). |
In addition to the changes outlined above, the amendments also seek to minimise the ‘red tape’ on ESS under the current regime. Relevantly, the following requirements will be removed for eligible ESS:
- ESS can be operated without an Australian financial services licence;
- general financial advice can be provided in relation to ESS without an Australian financial services licence; and
- the restrictions on advertising and hawking securities and financial products in the Corporations Act do not apply to ESS.
Amendments to the deferred taxing point
In addition to the regulatory relief, the ESS taxing point will be amended by removing the cessation of employment as a deferred-taxing point for ESS interests. This comes into effect on 1 July 2022 and will apply to all ESS interests (including existing ESS interests) that are subject to deferred taxation provided that the cessation of employment occurs on or after 1 July 2022.
This will mean that where an employee ceases employment, their deferred taxation arrangement will continue and the earliest of the following remaining deferred taxation points will instead apply:
- in the case of shares, when there is no risk of forfeiture and no restrictions on disposal;
- in the case of options and other rights, when the employee exercises the option/right and there is no risk of forfeiting the resulting share and no restriction on disposal; or
- the maximum period of deferral of 15 years.
Removing the cessation of employment taxing point for tax-deferred ESS will support Australian businesses to attract the talent they need to compete on a global stage. These changes will bring Australian equity tax rules in line with those of corresponding international jurisdictions.
Start-up Tax Concession remains unchanged
The start-up tax concession which came into effect in July 2015 will continue to apply to employees of eligible small start-ups. This concession essentially provides an income tax exemption for the discount received on shares (provided the discount does not exceed 15%) and the deferral of the income tax on the discount on options (provided the exercise price is at least the fair market value of a share at the date of the grant of the option). Instead, the value received from these ESS interests will be taxed under the capital gains tax rules at the time of disposal. To be eligible, the company must have been incorporated for less than 10 years before the ESS interest was acquired and must not be listed.
Conclusion
The ESS reform will reduce compliance costs and enhance the ability for new and emerging companies to attract and retain employees. Notably, by expanding the scope of ESS which are entitled to regulatory relief and reducing the ‘red tape’, small and emerging companies will be afforded the opportunity to compete with larger or listed companies and secure talent employees during their early years of operation. In addition, by removing cessation of employment as a deferred taxing point, these schemes will be more attractive to participants. On the other hand, from the company’s perspective, the ‘incentive’ for the employee to stay with the company to avoid this taxing point is removed.
In light of these changes, it is time for companies to review their constitution and current ESS terms and conditions to identify any changes that may be adopted to enable them to fully utilise the benefits of this new ESS regime.