Inquiry Overview
1.1
On 6 February 2020, the House of Representatives Standing Committee on Tax and Revenue (the Committee) adopted an inquiry referred by the Treasurer, the Hon Josh Frydenberg MP, to inquire into and report on the tax treatment of Employee Share Schemes (ESS) (the inquiry).
1.2
The Terms of Reference for the inquiry are set out in the front pages of this report.
1.3
On the same day the Committee announced the inquiry and called for written submissions from relevant individuals and organisations.
1.4
In total, 35 submissions were received. Four were confidential and two had the name withheld. Submissions are listed at Appendix A.
1.5
The Committee held three public hearings in Canberra. Details of public hearings are listed at Appendix B.
1.6
At the hearings on 4 and 19 June 2020, the Committee heard primarily from government agencies, and legal and tax experts about the effects of the policy and related rules.
1.7
At the hearing on 16 July 2020, the Committee heard from businesses with first-hand ESS experience about how the rules worked in practice.
1.8
Submissions and transcripts for all public hearings can be found on the Committee’s website.
1.9
The Committee acknowledges the thoughtful and comprehensive contributions of witnesses. All the evidence brought to the attention of the Committee, both written and verbal, has been given careful consideration.
Report Outline
1.10
In undertaking this inquiry, the Committee was concerned as to what further reforms, if any, should be made to the taxation and administrative treatment of ESS to bolster productivity by encouraging entrepreneurship and supporting start-up companies in Australia.
1.11
The remainder of this chapter gives an overview of the evolution of the ESS regulatory framework. The following chapters in the report broadly mirror the inquiry’s terms of reference.
1.12
The report highlights the benefits, but also the difficulties in measuring the usage of ESS in Australia (Chapter 2), before examining the effectiveness of the reforms brought about by the Tax and Superannuation Laws Amendment (Employee Share Schemes) Act 2015 (2015 Act) and its impact on the Income Tax Assessment Act 1997 (Income Tax Assessment Act) (Chapter 3).
1.13
The report then examines whether any further reforms are appropriate to ensure the current taxation treatment of ESS remains relevant, in particular for start-up companies. The report focuses on the Income Tax Assessment Act and the Corporations Act 2001 (Corporations Act), which both regulate the ESS regime in Australia, and the interaction between the Corporations Act and Australian Securities and Investments Commission (ASIC) class orders.
1.14
This report has adopted two roadmaps as recommendations. The first roadmap is contained in Recommendations A and B. In the event that the Government would prefer a more iterative approach the remaining recommendations present an alternative roadmap (see ‘List of Recommendations’ at page xvii).
Recommendation A
1.15
The Committee recommends that Employee Share Schemes be treated as capital for the purposes of taxation. That a tax liability would arise on the disposal of the assets granted through an Employee Share Scheme using the current capital gains tax regime.
Recommendation B
1.16
The Committee recommends that the Government grant regulatory relief to companies issuing shares under an Employee Share Scheme so that disclosure requirements are minimal unless employees are being asked to contribute financially.
Employee Share Schemes in Australia
1.17
ESS ‘involve an employer offering shares, options or other financial products to employees as part of an employee’s remuneration package.’
1.18
There are three classes of ESS in Australia: taxed-upfront schemes; tax-deferred schemes and schemes focusing on start-ups.
1.19
Compared to other economies, Australia has a relatively low uptake of ESS. The 2014 Industry Innovation and Competitiveness Agenda emphasised the need for Australia to remain competitive in the global economy, stating that:
Other advanced countries are aggressively reforming their economies. They are reducing barriers to trade in goods and services, reining in inefficient public spending, reducing taxes, deregulating and improving competition, stimulating entrepreneurship, investing in infrastructure and giving research a greater commercial focus.
1.20
In the past decade or so, several regulatory reforms have been implemented to bolster entrepreneurship in Australia and support start-up companies. This chapter provides an overview of these reforms.
The current regulatory environment
1.21
ESS are regulated by certain provisions of the Corporations Act. These provisions give rise to a number of obligations relating to disclosure, financial services licencing, advertising, hawking, managed investment schemes and the on-sale of financial products. It is fair to say that these obligations provide no consumer or employee benefit, are costly, onerous and only serve to generate work for legal firms. They further interact with the Income Tax Assessment Act in contradictory ways that require ASIC to grant relief, which they do slowly and often arbitrarily, costing often hundreds of thousands of dollars.
1.22
To reduce the regulatory burden for companies offering ESS, ASIC created class orders CO 14/1000 (for companies listed on an eligible financial market) and CO 14/1001 (for unlisted companies). However, these are limited and are not found to be useful by those attempting to establish ESS.
1.23
The class orders provide conditional relief from the following provisions of the Corporations Act:
the requirement to lodge a disclosure document with ASIC for the offer;
the requirement to hold an Australian Financial Services Licence (AFSL) for the incidental provision of financial services in connection with the scheme;
the advertising and hawking provisions;
the requirement to register a managed investment scheme for a contribution plan (listed bodies only); and
1.24
ESS are also currently subject to provisions in the Income Tax Assessment Act. Individuals and any related entities are taxed on any discount they receive on an issue of an ESS interest. The amount of tax payable depends upon the conditions of the relevant ESS and individual circumstances.
The 2009 regulatory reforms
1.25
In 2009, reforms were made to the taxation regime to ‘better target eligibility for [ESS] tax concessions’, ‘reduce opportunities for tax avoidance’ and ‘protect Commonwealth revenues needed to support jobs and invest in vital nation-building in the face of the global recession.’
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The key features of the reforms were:
the default position being upfront taxation for both shares and options;
deferral of tax being limited to schemes where there is a risk of the employee forfeiting the shares or options, and schemes provided through salary sacrifice (up to $5,000, and subject to conditions);
qualifying conditions being applied to access deferral arrangements; and
for options, a deferred taxation point when there is no risk of forfeiture or when any restrictions on the sale or exercise of the options are lifted (vesting point).
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The Law Council noted that ‘prior to 2015 the regime had reached a point where the take-up, or the rollout, of employee equity, because of its complexity, had significantly reduced.’
1.28
Between 2004 and 2009, the percentage of employees receiving shares as an employment benefit reportedly declined from 5.9 per cent to 3.4 per cent. This coincided with the 2009 reforms, which were ‘argued by the business sector to have discouraged the incidence of ESS.’
1.29
However, despite this evidence government departments and agencies consistently argued that policy settings had not impacted the deployment of share schemes. The Department of Industry, Innovation and Science found that ‘the incidence of ESS increased across almost all firm sizes, ages and sectors and showed little change in 2009–10.’
1.30
The Department noted that ESS intensity (the proportion of ESS-based payments in relation to salaries) had the largest decline in 2008-2009, but attributed this to ‘poor or uncertain economic conditions such as the global financial crisis [rather] than policy changes.’
1.31
Throughout this Inquiry, the Committee noted that Treasury showed little interest in this policy area. Indeed, their submission to the Committee and evidence presented consistently stated that they had little to no data on the policy area, nor were they likely to gather any. It was therefore very surprising to see in the Budget Papers that Treasury had been able to cost the impact of removing the taxation point at the cessation of employment. Given the attention and interest that Treasury showed throughout this inquiry, it seemed curious that they were able to provide such detailed costings to the Government.
1.32
Therefore, it was no surprise that a Treasury review in 2013 indicated that the 2009 measures were ‘broadly meeting [their] objectives.’ The review also noted that ‘concerns have been raised that the tax treatment of ESSs may have a negative impact on the ability of some sectors of the economy to attract employees, such as start-up companies.’
The 2015 regulatory reforms
1.33
In 2014 the Government conducted public consultations on ESS taxation treatment and ESS administrative arrangements for start-ups in response to concerns raised across the business community. This resulted in the 2015 Act, which commenced on 1 July 2015.
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These reforms were intended to ‘help better realise the potential of ESS, and ensure Australian firms are able to remain internationally competitive in attracting and retaining talented employees,’ and align with the Industry Innovation and Competitiveness Agenda.
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The key features of the 2015 Act included that:
all companies’ employees who are issued options to be able to defer tax until the exercise of the options;
extension of the maximum time for tax deferral to 15 years;
increasing the limit on individual employee ownership from five per cent to 10 per cent;
new ESS concessions for start-up companies, including no up-front taxation if shares or options are held for three years and exemption from tax where the discount on shares is 15 per cent or less;
the Tax Commissioner be able to approve optional ‘safe harbour’ valuation methodologies; and
employees to obtain a tax refund if rights lapse or are cancelled.
1.36
The effectiveness of the legislation was designed to ‘be measured by the change in take-up of ESS among small to medium sized business entities (SME)’. A five-year review, from the enactment date, was proposed in the draft legislation explanatory memorandum.
1.37
In 2015, the Productivity Commission raised some concerns about these reforms and recommended a review by 30 June 2020. As a result, the Productivity Commission recommended reviewing the use of tax concessions for start-up companies and eligibility requirements for such concessions. The Productivity Commission also suggested removing the deferred taxation point at cessation of employment.
Recent regulatory reforms
1.38
Further to the 2015 reforms, on 13 November 2018 the Government announced a proposal to ‘simplify and expand the current regulatory exemptions that apply to an employee share scheme,’ including by:
creating a dedicated exemption for disclosure, licensing, advertising and on-sale obligations under the Corporations Act;
increasing the value limit of eligible financial products that can be offered in a 12-month period from $5,000 per employee to $10,000 per employee;
expanding ESS to include contribution plans, where an employee can make a monetary contribution to acquire eligible financial products; and
allowing small businesses to offer ESS without publicly disclosing commercially sensitive financial information unless they are otherwise obligated to do so.