Prior to 1 July 2015 ESS interest had to satisfy a “real risk of forfeiture” test for the taxation of the ESS interest to be deferred. Where the “real risk of forfeiture” test could not be satisfied, this would generally result in the ESS interest being taxed at the time where the ESS interest had no “real risk of forfeiture”.
From 1 July 2015 the “real risk of forfeiture” test no longer needs to be satisfied which means most ESS interest will be taxable at the time the ESS interest are exercised (and able to be sold). In addition to this a number of additional concessions are available to employees of eligible startup companies.
Changes applicable to all companies
ESS interests are subject to deferred taxation if the following points are satisfied:
- The ESS restricts the employee from disposing the ESS interests
- The ESS rules state the ESS is subject to deferred taxation
- The other eligibility conditions (excluding the “real risk of forfeiture” test) for ESS tax deferral are satisfied.
Practically, this would mean most companies should be able to keep their current ESS plans in place and state in the offer document for ESS granted after 1 July 2015 the scheme is subject to deferred taxation to make future ESS interest subject to deferred taxation.
Another change for ESS interests granted after 1 July 2015 defers the taxation of the ESS interest holder until the actual ESS interests are exercised (rather than when the employee can exercise the right). This provides the ESS interest holder with more flexibility and options as to the disposal date of their ESS interest.
The maximum period for tax deferral has been increased to 15 years from the 7 years.
There are new valuation tables which general result in a lower taxable value for the options. These tax tables can be used to determine the value of options that have a taxing time after 1 July 2015.
The old rules considered the ESS interests to be taxed when an employee ceases employment, and unfortunately no changes have been made to legislation in this regard. The ESS interest will continue to be taxed when an employee ceases employment.
Tax concessions for eligible startup companies
From 1 July 2015 holders of ESS interests in eligible startup companies will only be taxed on on these ESS interest when they are sold (i.e. not taxed on grant, vest or exercise date). The ESS interest will be taxed under the CGT provisions and will also be eligible for the 50% general discount in the majority of cases.
To be able to access this concessions, the company, offer and the employee will all need to be eligible.
For a company to be eligible the following conditions will need to be satisfied:
- The company must have aggregated turnover of less then $50m in the prior to the ESS interest are granted.
- The company must not be listed on any stock exchange.
- The company must be incorporated for less than 10 years.
- The employing company must be a resident Australian Company.
For the offer to be eligible the following conditions will need to be satisfied:
- All the ESS interests under the scheme must relate to ordinary shares.
- A minimum holding period applies where all ESS interest holders are not permitted to sell their shares before 3 years from the ESS grant date or when the employee ceases employment if prior to the 3 year period.
- The ESS is available to at least 75% of permanent employees, who have been employed for more than 3 years.
- The exercise price of an option must not be less than the market value of the ordinary shares at the grant date of the option.
- The discount on the share must not be greater than 15% of the market value of the shares at the date of purchase.
For the employee to be eligible the following conditions will need to be satisfied:
- The employee must be employed by the company or a subsidiary of the company which the ESS interest is granted.
- The employee and their associates must not have more than 10% ownership or voting rights in which the ESS are granted.
There are a number of valuation methodologies that are now accepted by the ATO in determining the value of unlisted shares. This will reduce the costs associated with obtaining a formal valuation and provide a clearer picture as to the tax liability associated with ESS interests.
In addition to this, there are requirements as to the information required to be disclosed to ESS interest holders for the concessions to apply.