Since the last changes to the tax treatment of ESS in July 2015, there has been general consensus that the changes did not go far enough and that additional changes from both a taxation and regulatory framework perspective were needed to make the schemes more attractive to employees and less of an administrative burden for employers. There was also general support for addressing the inequities between the Australian ESS system and those of other comparable nations as a means of attracting international talent and to stem the movement of promising entrepreneurial talent to other jurisdictions.
Following an initial inquiry, in late 2018 the Government announced changes to the regulatory framework to reduce the time and cost burdens for business in implementing an ESS but these changes were never enacted. A further inquiry was announced in February 2020 which included a focus on the tax treatment of these schemes, however this inquiry was delayed because of the COVID-19 pandemic. The announcements tonight has somewhat addressed the issues raised in both inquires.
From a taxation perspective, the only change has been to remove the contentious ESS taxing point at cessation of employment for tax-deferred ESS Plans. This is a welcome change as it means that employees who participate in ESS Plans where the taxing point is deferred to a later date, will not be subject to tax on ceasing employment. Instead the ESS taxing point will continue to be deferred until the earliest of the following remaining taxing points:
- in the case of shares, when there is no risk of forfeiture and no restrictions on disposal;
- in the case of options, when the employee exercises the option and there is no risk of forfeiting the resulting share and no restriction on disposal; and
- 15 years.
The change will apply to Shares, Options or Performance Rights issued from the first income year after the date of Royal Assent of the enabling legislation. While these changes are very welcome for participants in deferred plans, they have little impact on other plans such as ESS Start-up and premium exercise priced option plans as cessation of employment does not have any impact under these plans.
The Budget announcement also proposes a number of changes in relation to simplifying the current regulatory framework and disclosure requirements when implementing an ESS Plan which are likewise a welcome change. We recommend you discuss with your lawyer these proposed changes to ensure you fully understand the impact of issuing Shares, Options or Performance Rights in the future.
While the proposed changes will assist companies to attract and retain their employees, in our opinion the Government has lost a golden opportunity to make the ESS rules even more concessional and attractive. For example we would have liked to have seen a broader range of plans subject to the capital gains tax rules and able to access the 50% CGT discount rather than being taxed under the ESS rules as ordinary income. In addition we believe that the Government should have looked at extending the ESS Start-up concessional valuation methods to all private companies, not just to those who qualify for the ESS Start-up concessions.