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Tax considerations will continue to inhibit the take-up of employee share schemes unless changes are made, with Treasury needed to rethink proposed changes to the regulatory framework.
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Why tax changes are needed for employee share schemes
30 August 2019
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9 minute read
Commonwealth Treasury recently completed a consultation period for several proposed changes to the framework applying to employee share schemes.
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The proposed changes, announced in November 2018, include:
- Consolidating current exemptions from requirements that would usually apply under the Corporations Act to sell shares.
- Increasing the value limit of equity that can be offered by unlisted companies each year from $5,000 per employee to $10,000 per employee.
- Expanding opportunities for unlisted companies to seek employee contributions to purchase equity.
- Allowing small businesses to offer employee share schemes without publicly disclosing commercially sensitive information, unless they are otherwise required to do so.
Employee share schemes are often an important part of helping companies grow, innovate and reward employees — and have become a fixture of innovation hotspots such as Silicon Valley.
But in Australia, they remain administratively difficult for small to medium businesses to access and have taxation implications that can significantly impede their effectiveness.
Without changes to the taxation system, the proposed changes would deliver minimal benefits to the middle market.
We always welcome simplification and streamlining of regulatory requirements for middle-market businesses, and indeed these proposed changes will have some benefit.
However, we believe taxation considerations will remain the biggest impediment to middle-market businesses using employee share schemes.
In our submission, we set out a number of taxation challenges including the taxing point for employees, and other challenges that particularly apply to smaller companies, including the valuation of their equity.
It highlighted the taxing point for employees as a particular problem.
“Under current taxation arrangements, employees incur a tax liability at a time before an employee has received any cash from the arrangements, meaning the employee is forced to pay the tax from personal resources,” said Michael Dundas, private business, family advisory and tax consulting partner at Pitcher Partners Sydney.
“Employees of listed companies can sell a portion of granted equity to meet a tax liability if required; however, this is rarely so straightforward for unlisted companies.
“The fact that the taxing point occurs prior to the receipt of cash by the employee is the biggest single barrier limiting the use of employee share schemes by middle-market business, and should be the highest priority for reform.”
Pitcher Partners suggests a potential solution lies in the existing approach to deferred settlements for the sale of capital gains tax assets. If this approach were applied to employee share schemes, then an employee would only become liable for tax on granted equity at the time of sale.
Other areas for reform relate to making it easier to determine the value of the business when equity is granted.
For listed companies, the value of an equity grant and associated tax liability is clear, based on the traded market value of the company.
However, for unlisted companies, if a costly valuation needs to be undertaken on each occasion that equity is granted to employees, this adds significant costs to implementing the scheme. It also leaves the assumptions of each valuation open to challenge by the ATO, which creates a further risk.
The ATO has approved two safe-harbour valuation methodologies for start-ups; however, these do not apply to mature businesses. There is a strong case that these safe-harbour provisions should be made available to established small and medium businesses.
While changes to the taxation arrangements for employee share schemes could have revenue implications for the Commonwealth, any revenue costs would need to be weighed against the economic benefits that employee share schemes can help deliver.
Employee share schemes are a powerful tool to align business and employee incentives, which, in turn, drives productivity and innovation.
Without reform to taxation arrangements, they will not be widely adopted by the small and medium businesses which represent the engine room of the Australian economy.
Ali Suleyman, tax consulting partner for Pitcher Partners Melbourne
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