Are all employee share options now taxed at the time of exercise of the options?

When the Employee Share Scheme (ESS) rules were amended from 1 July 2015, one of the reasons behind the amendments was to provide more concessional tax treatment for options. Previously, many taxpayers were either taxed at the time of acquisition of the options (‘taxed upfront’) or at the time of vesting of the options, despite the fact that the options were ‘underwater’ and could not be exercised.

Many employers and taxpayers believe that as a result of the 2015 amendments, all options are now taxed at the time of exercise of the options. However, in order for options (and rights) to be taxed on exercise, there are certain conditions that must be satisfied.

Firstly, the options must be acquired by the employee at a discount and therefore, the options must fall within the ESS rules.

Secondly, the options must be acquired on or after 1 July 2015. If the options are acquired before this date, the previous ESS rules apply and the time of exercise was not generally one of the taxing points under those rules.

Thirdly, the options must not be taxable on an ‘upfront’ basis and must therefore satisfy the conditions for tax deferral to be available. Broadly, these conditions include:

  • The employee is employed by the company (or a subsidiary of the company) issuing the options;
  • The options are to acquire ordinary shares in the company;
  • The employee must not hold a beneficial interest or voting rights in the company of more than 10%, after the options are acquired (including any shares that may be acquired as a result of exercising the options); and
  • Either a or b applies:
    • a. there is a real risk of forfeiting or losing the options or resulting shares, other than by disposing of the options, exercising them or letting the options lapse (e.g. time or performance based conditions are applied under the scheme); or
    • b. at the time the options were acquired, the scheme genuinely restricted the employee from immediately disposing of the options (or rights) and the governing rules of the scheme expressly state that Subdivision 83A-C of the Income Tax Assessment Act 1997 applies.

Where these deferral conditions are satisfied, the options may be taxable at the time of exercise subject to there being genuine disposal restrictions imposed on the options at the time of acquisition. There can also be an earlier taxing point such as where employment is ceased. The taxable amount is the market value of the options at the time of the taxing point determined in accordance with the ESS rules.

It is important that employers carefully consider and seek advice regarding the tax implications of issuing options, rights or shares to employees before the ESS interests are issued. If the details of the employee share or option scheme are not considered carefully, there may be adverse tax implications for employees which have the effect of negating the benefits of granting ESS interests as an employee incentive.