Welcome reforms to Employee Share Scheme Rules

Posted on by Admin

5 August 2021

Tax and Regulatory Changes to ESS Rules

On 30 July 2021, Treasury released draft legislation outlining regulatory and tax changes to the Employee Share Scheme (ESS) rules, which the Government had previously announced in the 2021/22 Budget.

Employers use ESS arrangements to attract, retain and motivate staff by issuing interests such as shares or rights (including options), often at a discount to their market value. The regulatory and tax rules relating to ESS are complex and it is important to ensure that arrangements are structured to ensure that individuals do not have an unexpected tax liability at a time when they are unable to realise the benefit of the ESS interest.

We summarise the key changes below.

Removal of cessation of employment as a taxing point

Amongst the proposed changes is the removal of the cessation of employment as a taxing point for ESS interests. This is a welcome change as under the current rules, it is a disincentive when departing employees are not able to align their tax liability with the realisation of their interests into cash. In many cases, the ESS interests have not even vested at the time of ceasing employment, yet currently the individuals are still taxable on the value of the ESS interests on ceasing employment.

The law as it currently stands requires that if ESS interests are acquired by an individual (or their nominee) at a discount to market value and certain conditions are met, then deferred tax treatment can apply.

As a result, many companies structure their ESS interests to ensure the individual can defer the taxing point of their ESS interests to a later time, instead of being taxable at the time the ESS interests are acquired. Essentially this can allow the individual to defer any resulting tax liability associated with the ESS interests until they are able to realise some value from the disposal of their ESS interests.

Deferred taxing point

Where deferred taxation is available, the deferred taxing point under the new rules will be the earliest of:

  • in the case of shares, when there is no risk of forfeiture and there are no longer any genuine restrictions on disposal;
  • in the case of rights (including options):
    • when the right has not been exercised and there is no risk of forfeiting the right and there are no longer any genuine restrictions on disposal of the right;
    • when the right has been exercised and there is no risk of forfeiting the resulting share and there are no longer any genuine restrictions on disposal of the share; and
  • the maximum period of deferral of 15 years.

The above change will provide an overall better tax outcome for individuals who cease employment. It remains important for companies to seek advice when granting ESS interests to ensure that the terms of the ESS interests are structured correctly to achieve the desired remuneration and tax outcome.

Start date

As many companies and individuals have been eagerly awaiting these changes to come into effect, it is somewhat disappointing that the Government chose to defer the start date of the amendment to ESS interests acquired on or after 1 July after the Bill receives Royal Assent, instead of the 2020/21 Budget announcement date. Therefore, the current rules will remain in place for the 2021-22 year of income. 

Simplifying current regulatory framework and disclosure requirements for ESS interests

The draft legislation will also simplify employee participation in ESS interests by essentially removing much of the associated regulatory ‘red tape’ under the Corporations Act 2001. 

Currently, these rules include restrictions on hawking and advertising and various disclosure requirements.

Specifically, the draft legislation aims to simplify the regulatory rules through the following measures:

  • If an ESS allows employees and directors to participate in an ESS without requiring payment, the scheme will generally not be required to comply with the Corporations Act 2001.
  • However, if an ESS requires payment to participate or is offered to independent contractors, the scheme must comply with a streamlined set of obligations under the Corporations Act 2001.
  • For unlisted companies, an ESS will only receive regulatory relief if each participant has received less than $30,000 worth of interests from the scheme over the previous 12 months (the previous threshold was $5,000);
  • For listed companies, an ESS will receive regulatory relief regardless of how long the interests offered under the ESS have been traded or whether the interests have been suspended.
  • For both listed and unlisted companies, an ESS will receive regulatory relief without disclosure, where those offers would otherwise not require disclosure under the Corporations Act 2001 (e.g. offers to senior managers).

The penalties for non-compliance with regulatory requirements are significant.

Start date

These regulatory changes will come into effect three months after the Bill receives Royal Assent.

Overall, the above proposed legislative changes should lessen the compliance burden and the costs associated with companies offering ESS interests to their employees.

Action Points

As many companies enter the annual reporting and AGM season, we recommend that companies:

  • Reconsider how these changes will affect current and future ESS interests to be granted to employees, noting that the tax changes will not apply for the 2021/2022 year.
     
  • Seek tax advice before new ESS interests are granted and ensure offer letters, AGM notices and wording in Annual Reports is reviewed and is consistent with the desired remuneration and tax outcome.
     
  • Communicate with individuals receiving offers of ESS interest to ensure that the individuals understand the tax outcome and personal tax implications, including where the individual chooses a nominee to acquire the ESS interests. 
     
  • Ensure 2021 ESS statements have been provided to individuals and ESS Annual Reports for the year ended 30 June 2021 are lodged with the ATO by 14 August 2021.
     
  • Seek legal advice regarding compliance with the existing and new regulatory requirements.

NEXT STEPS

If you would like to understand the above measures in further detail, please contact our ESS Specialists, Rachel Pritchard, Simeran Cheema, and Ross Heard on 08 6311 6900.

This newsletter is current as of 5 August 2021, however, please note that announcements and changes are being made by the Government and the ATO regularly, and we expect that the tax and business-related responses will continue to evolve.  Before acting upon the content of this newsletter, please contact us to discuss how the above applies to your specific circumstances.

This information is general advice only and neither purports, nor is intended to be advice on any particular matter.
No responsibility can be accepted for those who act on the contents of this publication without first contacting us and obtaining specific advice.
Liability limited by a scheme approved under Professional Standards Legislation.
For further information please refer to our privacy policy