4.1
The Australian Small Business and Family Enterprise Ombudsman described the current regulatory and taxation framework for Employee Share Schemes (ESS) as ‘complex and fragmented.’
4.2
The Committee heard that there remained ‘inconsistences and limitations in the regulatory framework that reduce the attractiveness of ESS for Australian companies and employees’ despite the 2015 reforms to the taxation treatment of ESS having been well received.
4.3
The Taxation Law Committee of the Law Council of Australia (Law Council) noted that a coordinated body previously ‘loosely’ existed after the 2009 changes:
There were meetings with Treasury, the tax office, ASIC and industry. That was one of the most effective bodies for actually understanding others' concerns and trying to develop a more cohesive framework to improve the regulation system that we had in Australia. If I could put an advertisement out for one thing, it would be for creating that kind of forum so that there's a better understanding so regulators can understand what we want better and we can understand what regulators want better.
4.4
This chapter includes a look at the following regulatory and compliance hurdles, and their attendant relief or exemption provisions, that currently exist in relation to ESS:
the complexity of exemptions from the requirements of the
Corporations Act 2001 (Corporations Act);
privacy issues arising from mandatory disclosure obligations;
difficulties with the use of the Australian Taxation Office’s (ATO) start-up documentation; and
the inconsistencies with tax treatments of different types of interests, holding arrangements and disposals.
Regulatory hurdles and exemptions
Disclosure exemptions
4.5
The Corporations Act mandates that a company making an offer pursuant to an ESS must provide a disclosure document, such as a prospectus, offer information statement or Product Disclosure Statement (PDS). The Corporations Act offers exemptions in certain circumstances.
4.6
The Australian Securities and Investments Commission (ASIC) class orders
CO 14/1000 and CO 14/1001 provide further exemptions from the Corporations Act disclosure requirements. In place of the disclosure, these class orders provide that if certain conditions are satisfied, an offer document can be provided to eligible employees instead of the more detailed documents required under the Corporations Act.
Small scale offer exemption
4.7
The Corporations Act states that if the offer is a ‘small scale offer’ or the proposed investor is a ‘senior manager’, the company making the offer will be exempt from the disclosure requirement.
4.8
Further, ASIC provides case-by-case relief for employers who cannot meet all the conditions of the class orders, provided that the relevant ESS is otherwise consistent with ASIC’s Regulatory Guide 49: Employee incentive schemes.
Public access exemption
4.9
In 2017, the Government introduced provisions into the Corporations Act preventing public access to disclosure documents relating to eligible ESS offers by eligible start-ups.
4.10
This was part of the Government’s National Innovation and Science Agenda and designed to protect commercially sensitive information that may be contained in the start-up’s disclosure document.
On-sale obligations conditional relief
4.11
The Corporations Act restricts the on-sale of financial products issued without disclosure within 12 months of their issue.
4.12
ASIC class orders offer conditional relief from this restriction.
Licensing exemptions
4.13
Under the Corporations Act, an Australian Financial Services Licence (AFSL) may be required to conduct activities associated with implementing an ESS, such as circulating and explaining the conditions of the ESS, providing custodial services such as a professional trustee, or dealing in financial products.
4.14
The Corporations Act provides an exemption from this requirement in relation to eligible ESS. ASIC class orders CO 14/1000 and CO 14/1001 also provide conditional relief from the requirement to hold an AFSL.
Advertising exemptions
4.15
There are restrictions on advertising an offer or intended offer of financial products in the Corporations Act.
4.16
Whereas the Corporations Act does not provide any exemption from the restrictions on advertising, ASIC class orders provide conditional relief on advertising restrictions.
Hawking exemptions
4.17
The Corporations Act has a prohibition on hawking:
Under the Corporations Act, a person (the ‘offeror’) must not offer financial products for issue or sale in the course of, or because of, an unsolicited meeting or telephone call.
4.18
However, there are limited exemptions from the hawking prohibition and ASIC class orders provide additional conditional relief from the hawking prohibition.
‘Complex and fragmented’ exemptions
4.19
The Committee heard that unlisted companies still struggle to comply with the disclosure requirements of the Corporations Act, despite these exemptions.
‘Employee Share Scheme’ definition
While the current regulatory framework provides a range of exemptions that enable offers of financial products under an ESS, these exemptions are complex and fragmented across the Corporations Act and ASIC class orders. In addition the definition of ESS offers under the Corporations Act for the statutory exemptions does not align with the broader scope of ESSs covered by the ASIC class orders.
4.21
To simplify the current exemption regime, it was suggested in Treasury’s consultation paper that the definition of ‘eligible ESS’ under the statutory exemptions be simplified and expanded to align with the broader category of ESS eligible for relief under the ASIC class orders.
Complex disclosure statements
4.22
KPMG suggested that unlisted companies in particular were likely to struggle with compliance:
Ensuring compliance with disclosure and other requirements in the Corporations Act can be costly for unlisted companies (including start-ups) from both a monetary and time perspective. In addition, this disclosure regime restrict an unlisted company's ability to offer ESS awards where the relevant Corporation Act exemptions or ASIC class order relief is not available.
4.23
Similarly, Right Click Capital provided evidence that some start-ups could find the disclosure requirements to be unnecessarily onerous. They suggested:
Start-ups should be exempt from the requirement to prepare a product disclosure statement to employees; even ASIC has argued preparation of such statements to be disproportionately burdensome. If we want founders to focus on the growth of their business, the arduous task of a PDS will only serve as a distraction.
4.24
Palantir Technologies criticised the requirement to file ‘expensive and public’ prospectus and financial report documents with ASIC as being ‘unique to Australia vis-à-vis similarly situated nations, such as the US, UK, France and Germany.’
4.25
Stripe cited the ASIC disclosure filing requirement as one of the key hurdles.
4.26
The 2019 Treasury ESS Consultation Paper also suggested that:
the ASIC class order relief for disclosure, licensing, advertising, hawking, managed investment scheme and on-sale obligations be moved into the Corporations Act and consolidated with the existing statutory exemptions for licensing and hawking;
ASIC continue to have powers to grant individual relief from the disclosure, licensing and other obligations in the Corporations Act.
Limited scope and application of the exemptions
4.27
PricewaterhouseCoopers noted that the existing exemptions will often not be available to start-up companies as ‘the intended recipient population includes contractors, consultants or non-executive directors – all of whom often fulfil significant roles in start-up companies.’
4.28
Palantir Technologies described existing exemptions as ‘very limited’ and noted that the disclosure requirements are unique to Australia. To protect company confidential information and company growth, they suggested the Government should:
clarify and expand the statutory disclosure exemptions and/or ASIC employee equity class order relief; and
expand the reporting exemptions for foreign controlled local proprietary companies.
4.29
StartupAUS suggested ‘changing the regime so that employees are not considered investors’ as ‘employees receiving these options are not making an arms-length investment decision in the traditional sense and (as employees) are naturally already well-informed about the business when they are offered stock.’
Privacy concerns
4.30
It was also raised that despite the 2017 changes to the Corporations Act, privacy issues arise for most companies as employee shares remain publicly available via an ASIC search.
4.31
The Tax Institute noted that ‘an employee share trust could be used to alleviate this lack of privacy. However, these are complex vehicles which are costly to manage and also require an AFSL.’
Laws versus regulatory frameworks
4.32
Income tax laws and the regulatory framework have different objectives that can result in inconsistences between the two systems. Income tax laws are ‘designed to maintain the equity and integrity of the tax system,’ whilst the purpose of the regulatory framework is ‘to provide consumer protection for employees.’
4.33
The Australian Small Business and Family Enterprise Ombudsman suggested that despite the inevitable differences between the systems, ‘implementing the proposed changes flagged in the 2019 Treasury consultation paper would make significant inroads to achieving a closer alignment between corporate (ASIC) and taxation (ATO) requirements for ESSs.’
4.34
Further changes may need to be made to ASIC’s class order relief to improve alignment. For example, the Law Council noted that ‘the start-up rules under the Income Tax Act and the relevant ASIC class order conflict such that it is impossible for a start-up to meet the requirements of both.’
4.35
The Law Council referred to the requirement for a maximum 15 per cent discount for the tax concession for shares under the start-up regime, compared with the minimum 100 per cent discount under the terms of the ASIC class order relief.
The Australian Taxation Office’s assistance for start-ups
4.36
The Australian Taxation Office (ATO) has developed some template documents that are ‘designed to help eligible start-up companies to establish and operate an employee share scheme (ESS) of options to acquire newly issued ordinary shares.’
4.37
These documents were described as ‘very useful’ and ‘have been welcomed by some as a positive step that should help to reduce start-up companies’ compliance costs and address uncertainty.’
4.38
However, Ernst & Young suggested that additional guidance was needed, given the complexities associated with implementing an ESS. They recommended ‘a more prominent disclaimer encouraging companies to seek legal advice prior to the implementation of the ESS arrangements’ and indicated that ‘the sample performance conditions in the standard documents need to be clearly flagged as being for illustrative purposes only to mitigate the risk that companies may adopt the sample performance conditions in the standard documents.’
4.39
Pitcher Partners also expressed concern that the ATO’s template Plan Rules have led to companies considering implementing an ESS without obtaining legal advice and they ‘may not be appreciating the regulatory considerations when making offers to employees.’
4.40
They recommended the inclusion of added guidance in the standard documents, such as key planning considerations a company should consider before adoption and simplification of the regulatory relief guidance in the documents. They also suggested that the ‘current commentary in respect to the provisions of the Corporations Act, the ASIC class order, and other potential relief mechanisms, could be made clearer.’
4.41
The Inspector-General of Taxation and Taxation Ombudsman noted the standard documents ‘do not appear to include some of the more common clauses in ESS arrangements.’ It was suggested that compliance costs could be reduced if the ATO provided ‘a repertoire of standard clauses for the standard documents’ that are commonly used in ESS arrangements as default provisions.
4.42
In 2012, the United Kingdom (UK) Government commissioned an independent review into employee ownership - the Nuttall Review. In response to the recommendations of this review, the UK Department for Business Innovation and Skills released a range of model documentation to facilitate businesses moving to employee ownership, including:
a model articles of association of a company with employee ownership;
a model trust deed of an employees’ share trust; and
a model articles of association of a trustee company limited by guarantee.
4.43
Employee Ownership Australia considered that ‘making similar documents available in Australia would be a most helpful addition to the current range of guidance and model documents the ATO provides.’
4.44
The Law Council raised that ‘there are good documents available and there's a good description there’, but ‘it's just that the tax office or ASIC are not obvious places to look for information about the best outcome to structure my business.’
The Australian Taxation Office’s reporting requirements
4.45
Companies that provide their employees with ESS interests have reporting obligations to both employees and the ATO.
4.46
Fortescue Metals Group noted that ‘ESS reporting, though necessary, has undoubtedly increased compliance costs for employers. As such, where possible, reporting requirements should be simplified.’ They suggested:
the removal of the 30-day rule for employer reporting purposes, as this increases the complexity and requirement to perform additional calculations for the employer; and
the simplification of the way the ATO receives the ESS annual reports. Fortescue Metals Group explained that:
the online forms are cumbersome to complete and require manual entry of data, which increases the chance of error and is impractical for large employee populations. The historical option of being able to lodge in a spreadsheet format would be the most cost effective as it does not require employers to acquire a specific software only for the purposes of lodgement.
Inconsistencies in Employee Share Schemes’ tax treatment
Share buy-backs
4.47
Share buy-backs are where an organisation repurchases its own shares from existing shareholders, often at a price higher than the current market value. There are five types of share buy-backs. One of them relates to ESS and is where:
A company buys back shares held by or for employees or salaried directors of the company or a related company. This type of buy-back, referred to as an employee share scheme buy-back.
4.48
Share buy-backs are a necessary part of ESS for unlisted companies as employers ‘must offer some form of opportunity to dispose of their shares where there is no ready third party market such as an [Initial Public Offering] IPO or trade sale.’
4.49
Currently, if the deemed market value of the shares exceeds the buy-back price, the difference in price is treated as a dividend paid by the company to the shareholder and the balance of the purchase price is treated as capital proceeds for Capital Gains Tax purposes.
4.50
As noted by Employee Ownership Australia:
[T]he disposal of shares to the company under an ESS buy-back may lead to a significantly different tax outcome for a participant than if the shares were disposed of via an employee share trust or an existing shareholder. It can also be administratively cumbersome for the company, for example, with a company needing to obtain a ruling from the ATO every time such a buy back occurs to determine the dividend/capital split.
…[Employee Ownership Australia] recommends that a safe-harbour methodology be introduced for ESS buy-backs for the purposes of determining the dividend / capital split, or for the allowance of an administrative treatment where no part of the purchase price paid to an ESS participant under an ESS buy-back is deemed to be a dividend.
4.51
The Tax Institute argued that ‘most small and medium businesses do not want to retain departed employees on their equity register’, but undertaking a share buy-back or equivalent on the exit of an employee in order to remove them from the equity register was said to be problematic under current arrangements as it can create funding and liquidity issues for companies.
Employee Share Scheme loan plans
4.52
Currently a share buy-back can be complicated by changes in the market value of the shares if the shares were acquired by the employee using a loan from the employer. In the event the value of the shares to be bought back by the company has decreased to less than the loan value, if the company treats the loan as discharged this could be considered to be a debt forgiveness for tax purposes and therefore subject to Fringe Benefits Tax (FBT).
4.53
Pitcher Partners stated:
…ATO ID 2003/317 concludes that such a discharge of a loan in these circumstances does not give rise to a debt waiver for Fringe Benefits Tax (“FBT”) purposes because the transfer of property in full and final satisfaction of a loan is not considered to be a release or waiver. However, a debt forgiveness for income tax purposes can also occur where a debt is extinguished other than by repaying the debt in full – see paragraph 245-35(a) of [the Income Tax Assessment Act] ITAA 1997.
Some further clarity around this issue as well as whether subsection 109F(4) of ITAA 1936 applies as an exception for Division 7A purposes would provide further certainty to taxpayers who have entered into ESS loan plans.
Employee share trusts
4.54
A company may use an employee share trust to hold ESS interests on behalf of employees, for the purpose of obtaining commercial and tax benefits.
4.55
The ATO recently issued the Taxation Determination – Income Tax: what is an employee share trust (2019/13), which explains the Commissioner's views on the interpretation of subsection 130-85(4). The subsection sets out the permissible sole activities for a trust to meet the definition of an employee share trust under the Income Tax Assessment Act 1997 (Income Tax Assessment Act), including activities that are allowable as ‘merely incidental’ to the permissible sole activities.
4.56
Pitcher Partners noted that this definition adopted ‘a fairly restrictive view of when an entity can qualify as an “employee share trust” with a single breach resulting in the trust forever being disqualified from obtaining this status.’
4.57
King & Wood Mallesons expressed concern that the Taxation Determination 2019/13 did not ‘clarify that actions taken in common corporate transactions, such as a rights issue or other capital raising transactions, are also merely incidental’ and would not result in an employee share trust losing tax concessions.
4.58
King & Wood Mallesons suggested that a discretionary trust structure model (discussed in Chapter 2) be used in Australia, given the benefits of providing a more stable structure for ownership, providing an effective means of financing employee ownership, and providing a straightforward tax position.
Different tax treatment of shares and rights
4.59
An ESS can give employees a benefit such as shares in the company they work for at a discounted price, or the opportunity to buy shares in the company in the future, referred to as a right or option.
4.60
Shares are treated differently to rights in the Income Tax Assessment Act. The Income Tax Assessment Act allows tax to be deferred on both, but the conditions for the deferral vary. For example to access a deferred taxing point for shares:
they must have been offered to 75 per cent of a particular category of employees, rather than only a limited set as is the case for rights; and
there must be a real risk of forfeiture of an offer of shares for a deferred taxing point to apply.
4.61
Whereas this condition does not apply to an offer of rights.
4.62
Ernst & Young noted that ‘there is no rationale for the difference’ and that ‘different conditions to allow for tax deferral on grants of shares compared to awards of rights cause unnecessary complexities and discourage companies from awarding shares to employees.’
4.63
Ernst & Young recommended that the tax deferral conditions for shares be made consistent with the conditions that apply for rights.
4.64
The Law Council likewise suggested that there should be consistency in the tax deferral conditions on rights and shares, which could be achieved by removing the real risk of forfeiture requirement for shares and removing the 75 per cent offer requirement for shares.
Committee comment
4.65
Evidence provided during this inquiry suggests that aspects of ESS legal reporting requirements and regulatory frameworks are complex and at times contradictory.
4.66
Some submissions referred to issues relating to the use of trusts in conjunction with ESS and it was suggested that the establishment of a system similar to that in the UK would resolve some of these issues.
4.67
The Committee has recommended changes that will benefit employers and employees, while ensuring that appropriate regulatory safeguards remain in place and that the Government can gather the information it needs to make effective policies.
4.68
The Committee supports the findings of the Treasury ESS Consultation Paper, but notes that the changes proposed by the Government in 2018 and discussed in the consultation paper were positively received.
4.69
The evidence received by the Committee indicates that the inconsistencies between the Corporations Act framework and the ASIC class orders are especially problematic, and this issue should be resolved by consolidating the class orders into the Corporations Act.
4.70
The Committee recommends that the Government proceed with the proposals announced on 13 November 2018 and discussed in the Treasury Employee Share Schemes Consultation Paper dated April 2019.
4.71
The Committee notes that whereas the taxation and corporate regulatory regimes have different purposes, it is desirable for the relevant legislation and instruments to be consistent with each other whenever possible.
4.72
The Committee recommends that the requirement for a maximum 15 per cent discount under the Income Tax Assessment Act 1997 start-up regime be scrapped.
4.73
The Committee recommends that the Australian Taxation Office simplify its documentation to no more than two pages, and make recommendations to the Government of any legislative changes that could further simplify this process.
4.74
The Committee recommends that the Australian Taxation Office establish a one stop shop approach to ESS, including documentation, processes and Australian Securities and Investments Commission reliefs to enable start-ups in particular to find all they need in one place, combined with a help line to answer any questions specific to their circumstances.
4.75
The Committee recommends that the Australian Taxation Office re-instate the option for lodgement of the ESS annual report in a spreadsheet format.
4.76
The Committee notes that share buy-backs are a necessary part of ESS scheme management. However, some stakeholders indicated that the process to determine the dividend / capital split when a buy-back occurs is overly cumbersome, largely due to the need to obtain binding ATO advice.
4.77
The Committee also notes that under the current arrangements, share buy-backs can produce inconsistent tax outcomes depending on the way in which the shares are disposed of.
4.78
The Committee therefore considers it would be appropriate to introduce a
‘safe-harbour’ methodology for ESS buy-backs for the purposes of determining the dividend / capital split and to allow for administrative treatment where no part of the purchase price paid to an ESS participant under an ESS buy-back is deemed to be capital.
4.79
The Committee recommends that a ‘safe-harbour’ methodology be introduced for ESS buy-backs for the purposes of determining the dividend / capital split and administrative treatment be allowed when no part of the purchase price paid under an ESS buy-back is deemed to be capital.
4.80
The Committee notes that the effect of the interaction between sections 109F(4) and 245-35(a) of the Income Tax Assessment Act 1997 and ATO Interpretive Decision Fringe Benefits Tax (2003/317) is unclear with respect to the application of Fringe Benefits Tax.
4.81
The Committee acknowledges this lack of clarity could compromise tax professionals’ ability to advise their clients and lead to unanticipated tax liabilities.
4.82
The Committee recommends that the Australian Taxation Office (ATO) clarify whether sections 109F(4) and 245-35(a) of the Income Tax Assessment Act 1997 and ATO Interpretive Decision Fringe Benefits Tax (2003/317) mean that Fringe Benefits Tax is not in fact payable for discharged ESS loans.
4.83
The Committee notes that some submissions expressed concern that the definition of an employee share trust and permissible sole activities set out in the Income Tax Assessment Act were too narrow and any breach could result in a trust permanently losing its tax concession entitlement. The Committee considers these conditions are necessary to preserve the integrity of employee share trust concessions.
4.84
However, the Committee agrees that participation in common corporate transactions should not disqualify a trust from being considered an employee share trust.
4.85
The Committee recommends that the Australian Taxation Office include in its examples of ‘merely incidental’ activities in Taxation Determination Income tax: what is an ‘employee share trust’ (2019/13), actions that are taken in common corporate transactions such as rights issues, demergers and other capital raising transactions.
4.86
The Committee agrees that there is a need to reduce complexity by ensuring the rules apply equally to both shares and rights.
4.87
The Committee recommends removing the real risk of forfeiture requirement for shares and removing the 75 per cent offer requirement for shares.
4.88
The Committee recommends that the Australian Taxation Office expand its model documents to include documents similar to those produced by the United Kingdom Department for Business Innovation and Skills.
Mr Jason Falinski MP
Chair