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New rules for employee share schemes: a guide for start-ups

New rules for employee share schemes: a guide for start-ups

The treatment of employee share schemes in Australia has been the perennial bugbear for start-ups, particularly early-stage technology companies that use equity as a way to attract and retain top talent before the business can afford to pay market salaries.

The long-awaited changes announced by the government yesterday go a long way towards solving the problem, which meant employees were taxed at the point of issue on share options rather than when the options were exercised. It’s not very attractive for the employee if they are forced to pay tax on something that may have never reached its proposed value.

In a recent start-up survey conducted by LawPath, only one in 10 companies had an employee share scheme (ESS) in place. More than 90 per cent of the start-ups listed the high cost and complexity as the reasons for not having an ESS. Eight out of 10 start-ups said they would put in place an employee stock ownership plan (ESOP) if the tax and cost implications were lowered.

Under the new scheme that will be in force from July 2015, there will be no up-front taxation. Companies of all sizes can now move to give employees options after having been stymied by the tax regime since 2009.

Foreign companies (especially US tech companies) will be very pleased as it will now be far simpler for them to extend their employee share regimes to Australian employees. Previously Australian employees of multinationals would miss out as it was often too difficult for the foreign employer to localise their schemes in a tax-effective way.

Start-ups will be given further concessions in an attempt to bolster the Australian innovation sector. Companies that have an aggregate turnover of less than $50 million, are unlisted and have been incorporated for less than 10 years will be given further financial concessions.

“Eligible start-ups” will be allowed to issue shares to employees at a small discount (up to 15 per cent) and issue options under advantageous conditions. Shares and options that were allocated at a discount will also not be subject to up-front taxation, so long as they are held by the employee for at least three years. Importantly, the options/shares will only be taxed at the time the shares are sold. This means that employees only have to pay tax when they actually receive value.

Start-ups also benefit by having their gains on the options taxed as capital gain and not income, therefore are taxed at the lower concessional tax rate.

The government will extend the maximum time for tax deferral of seven years from acquisitions of interests to 15 years, allowing more time for the start-up to succeed.

The reforms, although not in force until July 2015, cannot come quickly enough for struggling start-ups that are losing talent to international companies and larger, cashed-up competitors. These changes are a step in the right direction to making Australia a competitive early-stage economy.

Start-ups that are eligible for the concessions are encouraged to wait until the new rules come into play before establishing their own employee share scheme.

Under the new scheme, companies can do away with complex synthetic loan plans currently used and establish an ESOP with a simple employee option agreement. Legal and tax costs will be heavily reduced as there are no tax implications at the outset.

We expect a huge demand for “off-the-shelf” ESOPs similar to legal products found in the United States. The government has announced that it will work closely with industry to develop standardised documentation that will streamline the process of establishing and maintaining an employee share scheme.

Early-stage companies will now be able to attract talent and retain employees by paying them with equity rather than vital capital needed to grow the business. The new ESOP rules will enable young Australian companies to offer a portion of their business to match the generous salaries offered by well-funded international companies, which are bidding for the same talent.


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