A simpler system for employee share schemes

4 August 2021

In brief

The Federal Government has released for consultation draft legislation that will implement previously announced reforms to regulatory and tax arrangements for employee share schemes (ESS). These reforms should make it easier for businesses to offer ESS and will support Australian businesses to attract and retain the talent they need to compete on the global stage.

ESS provide an opportunity for employees to share in the productivity and growth of businesses - aligning employee and shareholder interests. In light of the current skills shortage, where the need to attract, retain and incentivise employees is critical for business (especially for small business and start-ups), the Government’s focus on ESS is a positive move. 

In detail

The exposure draft legislation covers the removal of cessation of employment as a taxing point and reforms to simplify the disclosure and licensing requirements which was announced in the 2021-22 Federal Budget. These issues are discussed in further detail below.

Removal of cessation of employment as a taxing point

Tax will no longer be payable on tax-deferred ESS when an employee leaves the business. The removal of termination of employment as a taxing point means:

• Employees who cease employment and retain their unvested equity (“good leavers”) are no longer subject to tax on the value of their equity on termination of employment. This will remove the significant cash flow burden that tax on cessation of employment imposed on many good leavers, as the tax was payable with the employee often not having access to the shares to fund the tax.
• The value being taxed should typically align to the time the award vests or is exercised and the individual has access to the shares.
• In a regulatory world where it is typically no longer acceptable to vest equity early for good leavers, we can finally align regulatory expectations with the individual tax treatment.
• Perhaps a return to simpler award instruments? The increased use of Indeterminate Rights was a valid means to alleviate cash flow complexities associated with tax on termination but it generated a host of administrative complexities relating to the way the equity needed to be reported. Could this reform be the return to a world before Indeterminate Rights and a move towards simpler and administratively less burdensome equity instruments?
• For companies that do not use indeterminate rights, but structure their awards as restricted shares or rights that convert to shares which are required to remain on foot post termination to allow the application of consequence (common among regulated financial services companies), the removal of tax on cessation of employment will be most welcomed.

By removing the cessation of employment taxing point, the measure will result in tax being deferred until the earliest of the remaining taxing points:

• in the case of shares, when there is no risk of forfeiture and no restrictions on disposal;
• in the case of most options and rights, when the employee exercises the option/right and there is no risk of forfeiting the resulting share and no restriction on disposal; or
• the maximum period of deferral of 15 years.

This change will apply to ESS interests granted on or after 1 July following Royal Assent of the amending legislation. This means that the earliest time that these measures can take effect is from 1 July 2022.

Simplifying disclosure and licencing requirements

The draft reforms proposed by the Government to simplify disclosure and licensing requirements are significant and welcomed changes for implementing and administering employee incentive schemes in Australia, particularly for unlisted companies. 

The key regulatory changes proposed in the exposure draft include:

• certain ESS interests (including performance rights over ordinary shares) can be offered to employees, directors and prospective employees and directors without having to comply with the disclosure and Australian Financial Service Licence (AFSL) obligations in the Corporations Act; 
  • where certain ESS interests are to be offered to independent contractors, or otherwise require monetary consideration for those ESS interests (including via a loan or contribution, which were previously not permitted under ASIC Class Order 14/1001), they can potentially now be made without having to comply with the disclosure and AFSL obligations provided strict conditions are met. These requirements include:
    • a ‘notice of intent’ is lodged with ASIC prior to an ESS offer being made;
    • the value of ESS interests offered to certain participants in the prior 12 months does not exceed AUD 30,000, which has been increased from the AUD 5,000 value limit in Class Order 14/1001;  
    • participants are provided with prescribed ‘ESS supporting information’ (including company financial information, a valuation report and solvency resolution); and
    • a 20 per cent ‘issue cap’ is not exceeded.
• for listed companies: 
  • where ESS interests are not offered to independent contractors, or do not require monetary consideration by the participant, the information currently required by ASIC Class Order 14/1000 to be included within offer documentation provided to participants has been removed;
  • the current 5 per cent ‘issue cap’ from ASIC Class Order 14/1000 will now only apply to ESS interests offered to participants where monetary payment is required;
  • they will no longer be required to be listed on an “approved market” for a continuous three month period before being able to access the ESS exemptions, or otherwise have to seek specific relief from ASIC; and
  • there will no longer be restrictions for those companies that have been suspended from trading from being able to rely on the ESS exemptions. 

In addition, ASIC has been given express enforcement powers to assist with ESS regulation (including the ability to issue ‘stop orders’). There are also provisions which seek to protect ESS participants from certain misleading or deceptive statements and certain loss or damage (including the ability to impose civil and criminal penalties).

The regulatory changes are proposed to apply three months after the amending legislation receives Royal Assent. 

The takeaway

Meaningful reform to facilitate the growth of ESS in Australia is crucial. The proposed changes will go a long way to creating a significant and positive impact on companies being able to implement ESS within Australia. Yet there are still many ESS which will not be eligible to access the new reforms, or which the time and costs involved to access the new reforms will outweigh the incentive effect for participants. 

Comments can be made on the draft materials by 25 August 2021. PwC will be preparing a written submission to the Treasury on the exposure draft legislation. We welcome responses and thoughts on the proposed changes from our clients and professionals. Following our submission, we will release a more detailed analysis of the proposed changes and our submission.