In our January 2015 Tax Alert: Changes to Employee Share Scheme tax laws we highlighted proposed changes to the Employee Share Scheme (ESS) tax rules contained in the Government’s exposure draft legislation. Following a consultation process during which some 50 submissions (including a submission from Grant Thornton Australia) were submitted in respect of the proposed changes, the Government has now introduced legislation into Parliament to reform the ESS tax laws with effect from 1 July 2015.

It appears that the Government has definitely taken notice of the feedback received during the consultation period with the Bill containing a number of important additional concessions, enhancements and consequential law changes, most of which are intended to benefit eligible start-up companies. However, the decisions not to make the start-up concessions available to listed companies, or to extend the improvements to the ESS refund rules to cover unexercised options granted before 1 July 2015, are disappointing.

Significant changes contained in the Bill include: 

  1. The acquisition time for Capital Gains Tax (CGT) discount purposes of shares obtained on the exercise of ESS rights that are subject to the start-up concessions will be pushed back to when the rights were acquired, rather than when they are exercised, thus increasing the likelihood of a CGT discount being available on the ultimate disposal of the shares.
  2. Investments by tax exempt entities that are deductible gift recipients and eligible venture capital investments will be ignored in determining whether ESS interests qualify for the start-up concessions.
  3. The Bill extends the unlisted eligibility condition for the start-up concessions beyond the provider company to encompass the holding company and all subsidiaries in a corporate group and modifies the time at which satisfaction of the ‘unlisted’ and the ‘less than 10 year incorporation’ conditions are tested. 
  4. To be entitled to access the start-up concessions for ESS rights, it will not be necessary for the (75%) ‘broad availability’ test (contained in the existing ESS laws) to be satisfied. 
  5. The Commissioner of Taxation will have a discretion to relax the (three year) minimum holding requirement (for accessing the new start-up and existing ‘upfront’ reduction ESS concessions) in situations where an earlier disposal of ESS interests is effectively outside of an employee’s control (for instance, where there is an initial public offering or sale of a company requiring employees to dispose of their ESS interests).

Further, an acknowledged technical defect in the current ESS tax laws by which unlisted ESS rights which have a $Nil value on acquisition for ESS tax purposes represent a fringe benefit, is being corrected by the Bill.   

Grant Thornton comment
The reform of the ESS rules is very good news for all companies and will provide greater flexibility and structuring opportunities to companies in selecting the right equity-based incentive arrangement to meet their needs. 

In particular, the start-up concessions (particularly, the expanded availability to the CGT discount afforded by the changes to the CGT acquisition rules for the underlying shares acquired on the exercise of ESS rights) are a major drawcard for eligible private companies, many of which are now likely to seriously contemplate introducing an inaugural ESS as an important component of their overall employee remuneration strategy. Further, we recommend that all companies closely examine the overall suitability of their existing ESS arrangements in the light of the new laws. In this regard, we expect that the reform of the tax deferral timing and refund rules for ESS rights will greatly increase the appeal and utilisation of option plans (involving ‘$Nil value’ or discounted options, as appropriate) as tax effective and easily administered ESS arrangements.