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ESS Tax Treatment in Australia

Employee Ownership

ESS Tax Treatment in Australia

By , August 10, 2023
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As an employee, you may have heard of an employee share scheme (ESS) and its tax implications. One important aspect to understand is the taxing point for ESS, which refers to when the shares or options granted to you by your employer become subject to taxation.

In Australia, there are two taxing points for ESS – the deferred taxing point and the upfront taxing point. The deferred taxing point is the most common and occurs when you acquire shares or options and defer the taxing point until a later date. This date is generally when you either sell the shares or options, or they cease to be subject to a restriction. Importantly, under the legislation, this can be up to 15 years (the maximum period allowed).

The upfront taxing point, on the other hand, occurs when you acquire shares or options and the taxing point happens immediately. This means that you will be required to include the market value of the shares or options as part of your assessable income for the year in which you received them.

It’s important to note that the choice of taxing point for ESS can have a significant impact on your tax liability. Therefore, it’s advisable to seek professional advice before making any decisions relating to ESS and its tax implications.

In summary, understanding the taxing point for ESS is crucial for employees who participate in employee share schemes.

 

Non-concessional schemes:

If you acquire Employee Share Schemes (ESS) interests at a discount and either the plan or your circumstances, do not meet the conditions for concessional treatment, the discount you receive is
assessable in the year you acquire the ESS interests.

The ESS interests are treated as if they were provided from an upfront scheme – not eligible for reduction.

 

Concessional schemes:

Taxed-upfront scheme: Eligible for reduction – $1,000 tax exempt plans:
If you acquire ESS interests under these plans, you may be eligible to reduce the discount amount that must be included in your assessable income by up to $1,000. To be entitled to the concession, you will need to meet:

  • the ownership and voting rights test (10% of equity and voting rights is the maximum amount of shares each individual can hold)
  • an income test (your taxable income after adjustments must be $180,000 or less).

 

ESS start up plans’ taxation treatment:

To qualify as an Employee Share Scheme using the start-up rules you (the business) need to meet some basic criteria:

  • Not listed on public exchange
  • Aggregated (group – including related entities) turnover less than $50m
  • Less than 10 years old
  • Australian resident taxpayer

The plan also needs to contain rules to ensure it meets the following criteria:

  • Each employee must own less than 10% of shares (and voting rights)
  • Each employee must be employed by holding company or subsidiary
  • Shares must be sold at less than a 15% discount
  • Employees must hold shares for more than 3 years
  • The plan must be available to 75% of employees with more than 3 years’ service

Provided you meet the criteria listed (both the employer and the plan rules) then the taxation treatment is quite generous:

  • There is no upfront taxation
  • No tax on vesting or exercise of options (in options plans)
  • The employee will pay CGT on sale/exit of the shares.

 

Salary sacrifice: Tax-deferred scheme

If you acquire ESS interests under these plans, the tax on any discount you receive on your interests can be deferred until the income year in which the deferred taxing point occurs, provided the conditions are met.

The conditions are:

  • under salary-sacrifice arrangements, you acquire no more than $5,000 worth (per year) of shares or stapled securities in your employer or any holding company of your employer)
  • you meet the ownership and voting rights test (10% maximum ownership)

Real risk of forfeiture: Tax-deferred scheme

Some ESS plans include terms that create a risk that your ESS interests can be lost or forfeited. If you have acquired ESS interests under these schemes your interests are taxed in the income year the deferred taxing point occurs if:

  • you meet the ownership and voting rights test
  • your individual circumstances do not prevent you from being eligible because there is no risk that you will lose your interests.

In some circumstances you may not be able to defer tax even though you have participated in a tax-deferred plan. You need to consider your individual circumstances to determine whether your ESS interests are in fact at a real risk of forfeiture. As an example, if your employer allows only retiring employees to keep their interests when they cease employment, then there will be no risk that you will lose any interests that you acquire after the time you notify your employer of your retirement date.

 

Disposal restrictions: Tax-deferred scheme

If you acquire an ESS interest that is a right, the tax on the discount will be deferred until the deferred taxing point occurs if, at the time you acquired the right under the scheme:

  • you are restricted from immediately disposing of your ESS interest
  • the scheme’s rules state specifically that the scheme is a tax-deferred
    scheme
  • you meet the 10% ownership and voting rights test.

Deferred taxing point

If you acquire ESS interests under a tax-deferred scheme, you will be assessed in the year the deferred taxing point occurs. The amount assessed will be the market value of the ESS interests at the deferred taxing point, reduced by the cost base of the ESS interests.

Shares
The deferred taxing point for a share or stapled security is the earliest of the
following:

  • When there is no real risk of forfeiture, and the scheme no longer genuinely restricts disposal of the share.
  • When you cease the employment in respect of which you acquired the share (this has been announced to be removed as a deferred taxing point (Nov 2021) – but the change hasn’t been legislated yet)
  • 15 years after you acquired the share (the maximum deferral allowed under the rules).

Rights

The deferred taxing point for a right is the earliest of the following:

  • When there is no real risk of forfeiting the right and the scheme no longer genuinely restricts disposal of the right
  • When you cease the employment in respect of which you acquired the right this has been announced to be removed as a deferred taxing point (Nov 2021) – but the change hasn’t been legislated yet)
  • When you exercise the right, there is no real risk of forfeiting the resulting share and the scheme no longer genuinely restricts disposal of that share
  • 15 years after you acquired the right

 

Peak Performance Trust taxation treatment:

The Peak Performance Trust has previously been the subject of Private Binding Rulings from the Australian Taxation Office, these rulings confirm the tax advice for the Peak Performance Trust structure, is summarised below:

1. Employer Company – ATO Ruling Authorisation Number: 1051314640866

a. Contributions paid by the employer company to the Peak Performance Trust will be tax-deductible.

b. Contributions paid by the employer company will not constitute a fringe benefit.

c. Anti-avoidance provisions will not apply to the scheme

2. The Trustee for the Peak Performance Trust – ATO Ruling Authorisation

a. Amounts contributed to the trustee by Employees will not constitute assessable income of the PPT.

b. Amounts contributed by the employer company to the Peak Performance Trust will not constitute assessable income of the PPT.

c. Anti-avoidance provisions will not apply to the scheme.

3. A typical Employee – ATO Ruling Authorisation Number: 1051323914120

a. Division 83A will apply to the acquisition of Units by the Employee, when the Employee does not pay anything to acquire Units (meaning that the scheme is a qualifying Employee share scheme, where the interest has been acquired at a discount).

b. Division 83A–C will apply to the acquisition of Units by the Employee, when the Employee does not pay anything to acquire Units (meaning that the income year in which the Shares are subject to taxation is deferred).

c. Income tax deferral will be triggered at the earliest of:

(i) the Employee exiting employment

(ii) The company or business being sold

(iii) 15 years.

d. The amount that will be included in assessable income of the Employee at the deferred taxing point will be the market value of the share referable to each unit at that time.

e. The Employee is entitled to own Units through an associate (for example a family trust).

f. The Employee redemption amount will constitute assessable income of the Employee, even if he participates indirectly through associate.

g. Contributions made by the Employee to acquire additional Units in the PPT will not constitute assessable income of the Employee.

h. The Employee will not be liable for capital gains tax on any capital gains made upon the redemption of ordinary Units unless the redemption occurs after the first taxing point.

i. Where the Employee has paid market value for the acquisition of additional Units, he will be liable for capital gains tax on any capital gains made upon the redemption of the Units.

There are tax consequences in participating in the PPT and we recommend that you seek independent taxation advice. We also strongly recommend that you speak to your accountant or tax adviser about any amounts you have received as these will need to be included on your individual tax return.

Want to discuss how Employee Share Plans could benefit your business? Talk to our advisers today.

Craig West

Craig West

Executive Chairman | Succession Plus

Craig West is a strategic accountant with over 20 years of experience advising business owners. His background as a CPA in public practice has provided invaluable experience in the key issues of concern to business owners.

In March 2014, Craig was appointed Executive Chairman of the SME Association of Australia, Australia’s largest small business organisation representing over 300,000 business owners.

In October 2014, he was awarded the Exit Planner of the Year at the Exit Planning Institute Annual Conference in Texas, USA, due to his innovative development of an exit planning process to help business owners maximise business value and achieve a successful exit.

Craig’s proprietary structure - a Peak Performance Trust - has won the Australia-wide award for the Employee Share Ownership Plan of the year twice in four years.

In November 2018, Craig launched SME Experts in partnership with Mark Bouris’ Mentored on Podcast One and quickly grew the monthly podcast audience to over 26,500 downloads; in October 2019, he released a new podcast focused on medium-sized businesses - Mid-Market Matters.

In July 2021, Craig joined the NSW Committee for STEP (Society of Trust & Estate Practitioners) – focusing on advising families across generations.

Craig has also launched a SaaS platform, Capitaliz (which captures the 21-step process), to assist other advisers internationally deliver advisory services at scale.

In November 2021, Craig was appointed Executive Chairman of NSW Leaders, a business mentoring group for leading NSW businesses.

In July 2022, Craig West received the award of Doctor of Business Administration for his research thesis titled “Examination of the key factors driving business exit options in Australian Small and Medium Enterprises.”

Craig is passionate about encouraging business owners to think strategically, maximise the value of their business and achieve a successful exit.

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