Chapter 1
Introduction and overview of the bill
1.1
On 13 May 2015, the Senate referred the provisions of the Tax and
Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 (the bill) to
the Senate Economics Legislation Committee (the committee) for inquiry and
report by 16 June 2015.
1.2
The bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to
change the taxation treatment of employee share schemes (ESSs). The changes
will apply to ESS interests acquired on or after 1 July 2015.
1.3
The proposed changes reverse some of the changes made in 2009 to the
taxing point for ESS rights for employees of all corporate tax entities. The
changes also introduce a further taxation concession for the ESS interests of
employees of certain small start-up companies. The changes are further intended
to reduce the compliance burden faced by small businesses in establishing and
maintaining an ESS.
1.4
According to the Explanatory Memorandum, the changes:
...will improve the tax treatment of ESS interests so as to
facilitate better alignment of interests between employers and their employees,
and to stimulate the growth of innovative start-ups in Australia by helping
small unlisted companies be more competitive in the labour market.[1]
Conduct of the inquiry
1.5
The committee advertised the inquiry on its website, and wrote directly
to a range organisations inviting written submissions. The committee received
seven submissions, which are listed at Appendix 1. No public hearings were held
as part of the inquiry.
1.6
The committee thanks all who contributed to the inquiry.
Employee Share Schemes and current taxation arrangements
1.7
ESSs are schemes in which an employer issues shares or options (that is,
the right to acquire shares in the company at a later date) to their employees
at a discount to the market value. As the Explanatory Memorandum explains, ESSs
are a 'means of aligning the interests of employees and employers and can
result in more productive relationships, higher productivity and reduced staff
turnover'.[2]
1.8
ESSs are often utilised by start-ups that lack the cash flow to pay
their employees competitive salaries. In this sense, ESSs provide a means of
attracting and retaining staff while still ensuring the start-up has sufficient
capital to grow its business. Employees, meanwhile, are attracted to ESSs
because they offer an opportunity to share directly in the potential success of
the start-up.[3]
1.9
Division 83A of the ITAA 1997 contains specific rules regarding the taxation
of ESS interests. Under current arrangements, as introduced in 2009, the
default position is that ESS interests will be taxed in the income year that
the ESS interest was received.
1.10
Employees with adjusted taxable incomes of $180,000 or less are eligible
for a tax exemption on the first $1000 of discounts received each year on
eligible ESS interests.
1.11
However, the tax treatment differs when there is a real risk an employee
may forfeit eligibility for the shares or options. This risk may be present
when the retention of ESS interests is subject to performance outcomes or a
minimum term of employment. If this is the case, tax is deferred until the
earlier of:
-
removal of risk of forfeiture such that the scheme no longer
genuinely restricts disposal of interests;
-
cessation of employment; or
-
seven years from the acquisition of the interest.
1.12
If tax is paid and the shares or options are subsequently forfeited, a
tax refund is available. However, refunds are not available where shares
are forfeited because their value has fallen due to market forces. In the
instance a refund is not available, the taxpayer would instead have a capital
loss under the capital gains tax provisions.[4]
1.13
Certain basic eligibility criteria must be met before the abovementioned
discount or tax-deferral arrangements can be accessed. These conditions are intended
to ensure, inter alia, that participation is widely available to
employees, and that the concessions cannot be accessed by shareholders who are
able to exert control over the company's operations.[5]
The effect of 2009 changes and
concerns raised by stakeholders
1.14
The current taxation arrangements for ESSs were introduced on
1 July 2009. One of the key effects of the 2009 changes, as explained
by the Minister for Small Business, the Hon Bruce Billson MP, in his second
reading speech, was to tax the discount component of shares or options at the
point when the employee received those shares or options. According to Mr
Billson, this arrangement 'often forces employees to pay tax on their options
before they can take any action to realise a financial benefit from those
options'.[6]
1.15
As the Regulation Impact Statement (RIS) in the Explanatory Memorandum
explains, the changes introduced in 2009 included:
removing the possibility for employees to elect when tax
would be paid on the discount on options provided under an ESS, and as a
result, taxing all discounts on shares and options in the income year in which
the shares and options are acquired, unless there is a real risk of forfeiting
the shares or options, or they are acquired through a salary sacrifice
arrangement...[7]
1.16
For more information on the changes introduced by the 2009 changes, see
Table 1 at the end of this chapter.
1.17
According to the RIS, the 2009 changes were intended to improve the
targeting of tax concessions available for ESSs, bring the taxing point for ESS
interests into line with the taxing point for other forms of remuneration, and
minimise opportunities for tax avoidance and reduction.[8]
1.18
A Treasury review completed in November 2013 indicated the ESS measures
were largely meeting their objectives. However, the review also suggested the
measures were having some negative effects on the ability of start-up companies
to access and utilise ESSs. Further consultations by the government confirmed
this, revealing that companies were predominantly concerned with two aspects of
the current arrangements. Firstly, as the RIS observes:
...many companies have argued that it is not reasonable to tax
options until the employee takes action to realise or convert them to tradeable
shares. Secondly, unlisted start-ups have argued that they face additional
problems around both valuation and liquidity—as their shares are not listed,
there are difficulties determining valuations cost effectively and there is not
a ready market to enable liquidity to pay the tax.[9]
1.19
As the RIS further observes, there are concerns that under the current
arrangements ESS interests may be:
...unaffordable to the beneficiaries due to cash flow issues
arising from the timing of the payment of tax. The current tax arrangements
require tax to be paid in the income year in which options are effectively
acquired, as opposed to the point of exercise or sale of the interest. Given
that only a small proportion of start-ups will succeed, tax may be required to
be paid on something that may never have a convertible or realised value to the
employee. Stakeholders claim that these tax arrangements are inconsistent with
global practice and this can result in talented employees choosing to work
overseas instead of working in Australia.[10]
1.20
The government's consultations also indicated the high ongoing costs involved
in the operation and administration of an ESS, particularly with a company
valuation being required when additional shares or options are issued under an
ESS. According to the RIS, in Australia these costs can run as high as $50,000
per valuation. With multiple valuations sometimes required each year depending
on when shares and options become taxable, this can make ESSs unaffordable for
typical start-ups.[11]
The development of the changes and the consultation process
1.21
In response to concerns expressed by stakeholders, the government
announced its intention to review the tax treatment of ESS interests on
18 December 2013. Over two weeks in January 2014 the government conducted
public consultations on ESSs and start-ups.
1.22
In developing the changes proposed in the bill, the government drew on
these consultations, along with advice from the Prime Minister's Business
Advisory Council and a study prepared by the Business Council of Australia in
July 2014. In October 2014, the government released the Industry
Innovation and Competitiveness Agenda, which included an announcement that
the government would reform the tax treatment of ESS interests to encourage
entrepreneurship and innovative start-up companies. Consultation on an exposure
draft of the legislation was conducted from 14 January to
6 February 2015, and included roundtable discussions in Canberra,
Melbourne and Sydney. The government received approximately 50 submissions
on the exposure draft.
The proposed changes to current taxation arrangements
1.23
In his second reading speech, Mr Billson explained that the bill makes
two main changes to the tax arrangements for ESSs. Firstly, for all companies,
listed and unlisted and regardless of size and age, employees issued options
under ESSs will generally be able to defer tax until the exercise of those
options. This is rather than having to pay tax when they receive the options,
thus benefiting employees 'by deferring their tax liability until they are
actually able to realise a financial benefit from their options'. Moreover, the
changes will extend the maximum time for tax deferral from seven years to
15 years, 'which will give companies more time to build their business and
succeed'. The changes also increase the limit on individual employee ownership
of a company through an ESS from 5 per cent to 10 per cent,
in order to 'help some founders and provide a boost for critical workplace team
members'.[12]
1.24
Secondly, the changes provide new ESS concessions for eligible start-up
companies. Mr Billson explained:
Employees of eligible start-ups can receive options or shares
at a small discount, and if they hold the shares or options for at least three
years, they will not be subject to up-front taxation.
For options, the discount component will be taxed when the
employee is in a better position to fund the tax liability. For shares provided
at a discount of up to 15 per cent, the discount component will be exempt
from tax.[13]
1.25
To qualify for the start-up concession, companies must have been
incorporated for less than 10 years, be unlisted and have turnover of no
more than $50 million per year. Mr Billson explained that the eligibility
criteria was designed to target small and start-up firms, particularly given
they often face additional liquidity and valuation obstacles that larger,
established firms do not. He added that the criteria would also 'limit and
manage the cost [of the measure] to revenue at a time of fiscal repair'.[14]
1.26
In addition to the two main changes outlined above, the bill also includes
measures to address the compliance burden of ESSs. Specifically, the bill
allows the Tax Commissioner to approve optional safe harbour valuation
methodologies that will be binding on the Commissioner. These valuation
methodologies will be developed by the Australian Taxation Office in
consultation with industry.[15]
Mr Billson suggested this will 'help to streamline the process of
establishing and maintaining an employee share scheme, reducing costs and
compliance burdens that may discourage employee share scheme engagement'.[16]
1.27
The bill also makes some changes to the rules relating to the refund of
income tax on forfeited shares or rights. The bill would allow an employee to
obtain a tax refund in relation to previously paid income tax if the employee
decides to let the rights lapse or be cancelled. As the Explanatory Memorandum
explains, this change:
...ensures that a choice not to exercise a right or to let a
right be cancelled is also a choice that does not prevent the application of
the refund provisions. For example, if an employee decides to let a right
lapse, and has previously paid income tax as a result of acquiring the right,
the employee will be entitled to a refund provided the scheme has not been
structured to directly protect the employee from downside market risk.[17]
1.28
Mr Billson explained that the bill also incorporates a number of other
changes to the taxation treatment of ESSs that have been informed by stakeholder
feedback provided during the consultation process on the exposure draft of the
bill. These changes relate to a range of matters, including access to capital
gains tax concessions and eligibility for the start-up concession where certain
venture capital funds are involved.[18]
1.29
Further details on the changes are provided in the Explanatory
Memorandum, paragraphs 1.48 to 1.110. It should be noted that key integrity
measures introduced by the 2009 changes are retained in the bill.[19]
A summary comparison of the taxation treatment of ESSs under the pre-2009
regime, the post-2009 regime and the proposed new arrangements, is provided in
Table 1 at the end of this chapter.
Financial Implications
1.30
According to the Explanatory Memorandum, the measures in the bill will
cost $196 million over three years, as follows[20]:
|
2014-15
|
2015-16
|
2016-17
|
2017-18
|
|
–
|
–$52m
|
–$56m
|
–$88m
|
Table 1: Summary of ESSs taxation treatment under different ESS regimes
|
Pre-2009 regime
|
Post-2009 regime
|
Proposed regime: all
companies
|
Proposed regime:
start-up companies
|
|
Default position was up-front
taxation for both shares and options.
For qualifying shares and
options, subject to certain conditions, the employee could choose between
up-front and deferred taxation.
For options, a deferred taxation
point occurred when the employee exercised the options by converting the
options into shares.
|
Default position is up-front
taxation for both shares and options.
Deferral of tax is 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).
The qualifying conditions are
also applied to access deferral arrangements.
For options, a deferred taxation
point occurs when there is no risk of forfeiture or when any restrictions on
the sale or exercise of the options are lifted (vesting point).
|
Default position will remain
up-front taxation for both shares and options.
However, option schemes will be
able to access deferred taxation treatment more easily, without the options
necessarily being at risk of forfeiture.
Further, for options, the
deferred taxing point at vesting will be moved back to when the employee
exercises the options.
|
Options and shares that are
provided at a small discount by eligible start-ups will not be subject to
up-front taxation
|
Source: Australian Government,
Department of Prime Minister and Cabinet, Industry Innovation and
Competitiveness Agenda, 14 October 2014, p. 80.
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