What do you need to consider when implementing an employee share ownership plan (ESOP)?

A number of companies are currently reviewing their remuneration of Directors, executives and employees and the type of ESOP that should be offered.

The design and implementation of an ESOP requires consideration of a number of areas.  For example, a company needs to consider:

• The purpose of the ESOP – reward or retention?
• The type of ESOP (e.g. performance rights, option, loan share, performance share or salary sacrifice plan) will it achieve its purpose?
• What type of KPI’s should be attached to the ESOP?
• Accounting implications
• Does the ESOP need to be (or should it be) approved by shareholders?
• The taxation implications to the company and the employee
• Obtaining legal assistance with drafting the ESOP rules/offer letter to the employee, and ensuring compliance with the various ASX Listing and Corporation Act requirements
• The valuation of the ESOP for Annual General Meeting or General Meeting notices, and accounting purposes
• Corporate Governance requirements

The taxation of the ESOP to the Director, executive or employeee (“the employee”) is one of the common areas that companies implementing an ESOP are keen to understand.

The Australian Government introduced significant changes to the taxation treatment of ESOP’s issued to employees after 1 July 2009. As a result, from a taxation perspective we recommend that companies consider the following when designing and implementing an ESOP:

1. Under the new Employee Share Scheme (“ESS”) rules the ability to defer taxation is dependent on the plan structure and will no longer be a choice of the employee.
   
   Generally only plans with “genuine forfeiture conditions” will qualify for deferral of taxation. The ATO has published limited guidance on what constitutes a “genuine forfeiture condition”. We recommend that you consult with your Grant Thornton advisor to ensure that this requirement is complied with if you want to defer tax under the ESOP.
   
   
2. Generally taxation is deferred to the latter of when there is no risk of the employee forfeiting the ESS interest, and if at the time you acquired the ESS interest the scheme genuinely restricted the employee from disposing the ESS interest, the time when such restriction no longer exists. Companies should review how they monitor their insider trading policies to see if these policies constitute a genuine sales restriction and whether they will defer taxation under the ESS rules until a later date. This is particularly important, especially in the current volatile market, as the value of the ESOP could be significantly affected by when the insider trading rules are lifted.
   
   
3. The acquisition date of the ESS interest is important in determining the value of the ESS interest for tax purposes and whether the ESS interest was acquired at a discount. ESS interests acquired at a discount are subject to the ESS rules.
   
   Generally, for Directors, the acquisition date of the ESS interest for tax purposes is the Annual General Meeting date. Hence this is the date that should be used when valuing their ESS interests to determine how they are assessed under the ESS rules. We often see companies agree the terms with the Director before going to shareholders to approve the issue of the ESS interests at an Annual General Meeting. While this may make sense commercially, it can lead to a different tax outcome, due to movements in the share price between the date the terms are agreed with the Director and the Annual General Meeting date. 
   
   
4. A number of companies are issuing ESS interests to employees and are not providing a tax outline to the employee advising them on the tax implications of receiving the interest.  We believe issuing a tax outline to the employee is good practice as the employee is notified of their tax implications before acquiring the ESS interest and can take this into consideration before accepting the offer. The outline also assists the employee in meeting their tax obligations under the ESS provisions and CGT provisions when then arise.
   
   
5. Under the new ESS rules the ability to defer tax under salary sacrifice plans was significantly changed. The new ESS rules allow an employee to defer tax under a salary sacrifice plan, without forfeiture conditions, if the total value of ESS interests issued to the employee under a salary sacrifice plan during a year is less than $5,000. The ESOP plan rules also need to stipulate that the plan is a salary sacrifice plan.
   
   
6. Since the introduction of the new ESS rules on the 1 July 2009, employers are required, by the 14th of July each year, to provide an annual ESS Statement (similar to a PAYG Summary) to any employees who they provided an ESS interest at a discount, and who have a “taxing point” during the tax year. The “taxing point” may differ between pre and post 1 July 2009 schemes. It could for example be at grant, exercise or on vesting. Because there are so many possible “taxing points” we recommend that this is carefully considered.
   
   The ESS Statement is required to be provided to employees irrespective of whether the shares or rights were issued to them under the old ESS rules or the new rules.

Grant Thornton can assist with the design and implementation of an ESOP for your company. If you would like to discuss the design and implementation of an ESOP please contact Peter Hills or your usual Grant Thornton advisor.

Peter Hills
Director - Tax
T  +61 8 9480 2000
M  +61 421 051 004
E peter.hills@au.gt.com