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Current ESOPS regime

The current legislative environment for employee share plans is sustained chiefly by the Income Tax Assessment Act 1997 (Division 83A), and the Taxation Administration Act 1953, and the Corporations Act (Divisions 2 & 5).

Also the Corporations Act and the Financial Services and Managed Investment Scheme regulations have important and complex implications. In this document we focus on the key legal infrastructure provided by the taxation legislation.

Tax Law

On 14 December 2009 Division 83A of the Income Tax Assessment Act became the primary legislation governing the design and implementation of employee share plans. The new Division sets out the basic conditions that a share (or rights) plan has to meet in order to benefit from the concessions provided by the legislation.  The Division also describes the tax implications for employers offering, and for employees participating in, these plans.

Basic conditions

The basic conditions for a share (or rights) plan to come within Division 83A are that an offer of shares must:

  • be made to an employee of the company making the offer of shares (or an employee of one of its subsidiaries);
  • be an offer to acquire a beneficial interest in shares, or in  “rights” to shares, in the employer’s company, or in the parent company of the employer; and must
  • be made in relation to the employee’s employment.
Concessionary share and rights plans

If a plan satisfies the above conditions, the plan may also qualify for one of two types of concessions, provided further conditions are met.  The two types of concessions are:

  •  tax-exemption; and
  •  tax-deferral.

For an employee to access either of these concessions, a plan must have the following additional characteristics:

  • the offer must be one to acquire only ordinary shares or rights to acquire ordinary shares;
  • the offer cannot result in the employee holding more than 5% of the shares in the company and in exercising control over more than 5% of the votes that could be cast at a general meeting of the company;
Tax-exemption

Plans that qualify for the tax-exempt concession allow employers to provide their employees with up to $1,000 worth of discount, per tax year, on the value of shares or rights acquired.  The following conditions must be satisfied for the employee to access the tax exemption:

  • the employee’s taxable income (adjusted for reportable superannuation contributions, reportable fringe benefits, net investment losses and the exempt shares) must not be greater than $180,000 per annum;
  • the offer to participate in the plan and any associated financial assistance scheme must be made to at least 75% of Australian resident permanent employees of the company with at least 3 years of service;
  • the shares or rights acquired are not subject to a real risk of forfeiture; and
  • the shares or rights cannot be disposed of until the earlier of three years after acquisition of the shares or rights, or termination of employment.
Tax-deferred plan

Plans may qualify for tax deferral via one of two routes: meeting the criteria for a prescribed salary sacrifice plan, or by granting shares or rights that are subject to a real risk of forfeiture.

Salary sacrifice plans

Salary sacrifice plans allow employees to acquire up to $5,000 of shares in their employer (or a holding company of their employer) out of pre-tax salary.  The shares must be subject to a genuine sale restriction, and tax is deferred until the earliest of:

  • the date the sale restrictions lift;
  • the date the employee ceases employment; or
  • seven (7) years from the date of grant.

In addition, in order to qualify for the deferral, at least 75% of Australian resident permanent employees with at least 3 years service need to be eligible to participate in an employee share scheme whether in that particular salary sacrifice scheme or another scheme.

Plans with a real risk of forfeiture

Under this plan, the payment of tax on the discount on the value of shares (or rights) acquired is deferred because the shares (or rights) are subject to a real risk of forfeiture.  Tax is be deferred until the earliest of:

  • the date the risk of forfeiture  of an unexercised right ceases and any disposal restrictions on the right or underlying share lifts;
  • in the case of a share grant, the date the risk of forfeiture of the share lifts and there are no disposal restrictions in respect of the share;
  • in the case of a right, the date the risk of forfeiture of the right ceases, there is no restriction on exercising the right, and any forfeiture conditions and disposal restrictions on the underlying share lift;
  • the date the employee ceases employment; or
  • seven (7) years.
Tax integrity

The new employee share scheme regime now includes obligations regarding employer reporting of grants and obligations to withhold withholding tax in certain cases.

Employer reporting
Employers must now report on grants made to employees both in the year of grant and in the year such grants become taxable.  A form, anticipated to be much like an employee payment summary, must be provided to both the employee and the Australian Taxation Office for each relevant year.

Withholding of taxes
Where the employee has not provided their tax file number to the employer, the employer must withhold TFN Withholding Tax (ESS) at 46.5% when grants made under an employee share scheme become taxable.

Corporations Law

Corporations Law (Division 2) specifies that all offers of securities, which includes offers of shares under a share plan, require the issuing of a "disclosure document". These disclosure documents - a prospectus, short-form prospectus, profile statement or offer information statement - are defined in Division 3.

Exemptions from disclosure are provided under Section 708. Failure to meet Section 708 exemptions is not final. Further relief can be sought by application to the Australian Securities & Investment Commission. ASIC judgements on these applications are governed by ASIC Policy Statement 49 (reissued 1 May 2003) and a new omnibus Class Order (CO 03/84 issued 30 April 2003) drawn up to give effect to that policy.

These exemptions and reliefs are very narrowly defined. As a result only listed companies and very small unlisted companies can make effective use of this system. Consequently, most unlisted companies, would need to issue an expensive prospectus - or some alternative disclosure document - to accompany an offer of shares under any proposed ESOP.