Chapter 2
Views on the proposed changes
2.1
As outlined in the previous chapter, the bill amends the ITAA 1997 to
change the taxation treatment of ESSs by:
- reversing some of the changes made
in 2009 to the taxing point for rights for employees of all corporate tax
entities;
- introducing a further taxation
concession for employees of certain small start-up companies; and
- supporting the Australian Taxation
Office to work with industry to develop and approve safe harbour valuation
methods and standardised documentation that will streamline the process of
establishing and maintaining an ESS.[1]
2.2
Submitters expressed a range of views on the changes to the taxing point
for ESS interests and the new start-up concessions, which are outlined below.
No comment was received on the new arrangements for valuation methods, and as
such the issue is not addressed in this chapter.
Support for the bill
2.3
For the most part, submitters were supportive of the intent of the bill
(although, as discussed below, several believed its scope and application
should be broadened). For instance, the AIMIA Digital Policy Group suggested
the changes would 'foster and support a vibrant technology and start-up
sector'. The changes, it argued, would also:
...bring Australia closer to the tax arrangements which have
already been put in place in countries like the United States and the United
Kingdom specifically to promote entrepreneurship and the development of the
business models and business success stories of the future.[2]
2.4
Similarly, Greenwoods & Herbert Smith Freehills wrote that the
changes, particularly the new concessions for start-ups, would 'significantly
improve the ability of Australian enterprises to compete for and retain global
talent'.[3]
Eligibility for the new start-up concessions
2.5
Several submitters suggested that the bill's definition of a 'start up'
was overly narrow, and might, as Ernst & Young (EY) put it, 'inadvertently
disqualify companies which would, for practical purposes, be considered to be
within the start-up phase'.[4]
2.6
In particular, concerns were expressed about the requirement for a
company to be unlisted to be eligible for the start-up concessions. EY
explained that many start-up companies may have in fact listed 'as a means of
funding projects that are yet to generate revenue'.[5]
EY argued:
As the proposed rules provide concessional treatment for
prospective growth in the value of shares only, companies who would otherwise
be considered 'start-ups' by the nature and size of their business should not
be disqualified from doing so merely because they are listed.[6]
2.7
EY further suggested that the restriction of the start-up concessions to
companies that had been incorporated for less than 10 years might exclude
some companies that could arguably be considered start-ups. For example, some
companies might have been incorporated longer than 10 years, but have been
inactive for many years before the start-up business commenced. Alternatively a
start-up company may have acquired an older company that is not significant to
the start-up company's main business. EY also noted that some companies, such
as biotech and exploration companies, face long lead times due to the nature of
their business.[7]
2.8
EY recommended that discretion should be provided for the Tax
Commissioner, or a body such as AusIndustry, to 'determine that the start-up
concessions are available in cases where the company could reasonably be
expected to qualify from a policy perspective'.[8]
2.9
Similarly, the Tax Institute argued that listed companies should not be
precluded from accessing the start-up concessions. It noted that:
...many 'small cap' listed companies (in industries such as
life science, IT and mining exploration and development) clearly meet the other
eligibility criteria in section 83A-33 for being considered a 'start-up'.[9]
2.10
The Association of Mining and Exploration Companies (AMEC) also argued
that eligibility for the start-up concessions should extend to listed
companies. It challenged the notion that this would prove costly to the budget:
AMEC contends that broadening the start-up measures to
include listed start-ups will change behaviour by increasing participation and
reducing the complexity of arrangements. This should in theory result in more
exercises of options and sales of shares, thereby increasing the incidence of [capital
gains tax] and therefore increased revenue to Government.[10]
2.11
The committee notes that Mr Billson acknowledged in his second reading
speech that some stakeholders believe the start-up concession should be
available to older, listed technology and mining start-ups. However, Mr Billson
argued that:
...all policy needs to be weighed against other priorities and
the cost to taxpayers. So keeping this at the forefront of our mind, and on
balance, we have decided to keep the additional concession focussed on
genuinely early-stage firms that are more likely to have cash flow issues.[11]
Cessation of employment as a deferred taxing point
2.12
EY notes that the bill does not remove cessation of employment as a
trigger for the payment of tax on ESS interests. It argued this is:
...inconsistent with encouraging the long-term ownership of
shares and the premise that employees should only be taxed on equity awards
when they are able to realise a benefit. It is also inconsistent with the
taxation treatment of equivalent cash-based incentive awards, which are
generally only taxed when the participant receives the cash payout, rather than
at termination of employment.[12]
2.13
The Tax Institute also argued that cessation of employment should not be
an ESS deferred taxing point. It contended that:
...the fact that Australia continues to tax employees on ESS
interests on cessation of employment notwithstanding those interests are
unable to be converted into cash at that time puts Australia out of step with
almost every other country that taxes share plans and is clearly not
competitive by international standards.[13]
2.14
Greenwoods & Herbert Smith Freehills made a similar argument against
retaining cessation of employment as a deferred taxing point.[14]
2.15
The committee notes that in his second reading speech, Mr Billson
acknowledged concerns about the retention in the bill of cessation of
employment as a taxing point. Mr Billson suggested:
The refund rules contained in this legislation should help
address some of this concern. The refund rules mean that income tax paid on
options when employment ceases will be refundable if the option is subsequently
not exercised or lapses, or is cancelled.[15]
2.16
The committee notes that there are further matters, in respect of
employee share ownership, worthy of consideration. For example, the present
system of taxation on cessation of employment seems to be an anomaly
internationally, and might provide an opportunity for further reform.
Transitional arrangements and new refund rules
2.17
The new arrangements would apply to EES interests granted on or after
1 July 2015. EY recommended that the proposed arrangements should
'also apply to any ESS interests where the taxing point has not yet arisen,
including those granted prior to 1 July 2015'.[16]
It argued that this would help reverse:
...the adverse impact of the 2009 changes, in particular for
options which have not yet been taxed. It will also reduce the burden on
employers to administer the reporting requirements and for employees to
understand the taxation point under three different regimes, being Division 13A
Income Tax Assessment Act 1936, the current Division 83A and Division
83A after the proposed changes.[17]
2.18
Several submitters also expressed concern that the new refund rules
proposed in the bill (as outlined in the previous chapter) would only apply to
grants made on or after 1 July 2015. EY recommended that the new
refund rules should apply to all ESS interests that are forfeited on or after 1
July 2015, regardless of the grant dates.[18]
Similarly, Greenwoods & Herbert Smith Freehills suggested that tax refunds
under the new arrangements should also extend to options still on foot as at
1 July 2015, rather than being limited to rights and options issued after
that date.[19]
2.19
The Tax Institute also argued for transitioning ESS interests granted
before 1 July 2015 into the proposed new arrangements, including the
arrangements regarding refunds.[20]
Three year rule
2.20
Greenwoods & Herbert Smith Freehill's argued that the three year
holding requirement for the start-up concessions, as currently written, might
inhibit the operation of 'drag-along' and 'tag-along' rights in employee equity
offerings. It explained:
Drag-along rights ensure that founder shareholders can
realise value when an opportunity arises. Venture capital providers, which are
typically 'closed-end' funds, also require the ability to exit investments to
comply with their investment mandates. Absent drag-along rights employee
shareholdings could operate as blocking stakes.
Tag-along rights ensure that employees can participate in
these significant value realisation events ('exit' events), rather than being
left holding potentially illiquid minority investments.[21]
2.21
Greenwoods & Herbert Smith Freehills further explained that for many
successful start-ups exit events may occur within three years of establishment,
and that for start-ups with ongoing employee equity programs exit events will
inevitably occur within three years of at least the most recent grants.[22]
It acknowledged that the current drafting was designed to promote genuine
(rather than short-term) employee equity participation. However, it suggested
the same end could be achieved by leaving the waiver of the three year rule to
the Tax Commissioner's discretion, with guidance possibly included in the
Explanatory Memorandum.[23]
Concern the changes disproportionately benefit some taxpayers
2.22
The Australian Council of Trade Unions (ACTU) expressed concern that the
proposed changes would disproportionately benefit taxpayers in receipt of ESS
interests. It explained:
The ACTU supports ESSs that are available to all levels of a
company's workforce and which are effectively regulated by government to
minimise the risk of unfair avoidance, particularly by senior company managers
and executives. However, we believe the current proposals risk incurring a cost
to public revenues and public faith in the fairness of our tax system that is
disproportionate to the purported benefits.[24]
2.23
In contrast to submissions suggesting the new start-up concessions were
too narrowly targeted, the ACTU expressed concern that the bill's definition of
a 'start-up' was in fact 'unduly expansive'. Noting that the bill's definition
of a 'start-up' included companies which had been incorporated for up to
10 years and have an aggregated turnover of up to $50 million, the
ACTU suggested:
...it is not clear why a company that has established a
successful business after 5 years, and which is generating a taxable
profit of perhaps $8 million, should be entitled to taxpayer support to
reward some of its employees.[25]
2.24
The ACTU recommended further consideration of the criteria for
determining a company's status as a start-up in order to ensure the concession
was well targeted. One option, it suggested:
...could be to limit eligibility to companies incorporated for
7 years or less and whose level of taxable profit as a proportion of
turnover is less than a specified percentage. This would link the availability of
any concession to the likely ability of a company to do without it.[26]
2.25
The ACTU further argued that the proposed concessional arrangements
would be 'excessively generous'. The ACTU explained that as most employees do
not have access to an employment-related share scheme of any sort, they will
need to pay tax at their full marginal rate on any bonus or pay increase they
receive. In contrast, the only tax payable on ESS interest would be capital
gains tax, generally payable with a 50 per cent discount on the
taxpayer's marginal rate.[27]
2.26
Finally, the ACTU raised concerns about the extension of the maximum tax
deferral period for ESS interests from 7 years to 15 years,
suggesting that 'a tax deferred is more likely to become a tax reduced'. It
further argued that this increase in the deferral period was 'likely to encourage
tax avoidance, particular among senior employees with high-value stakes in an
ESS who can afford to delay realising that value until they pay little or no
tax on it'.[28]
Committee view
2.27
The committee does not agree that the proposed changes would
disproportionately benefit taxpayers in receipt of ESS interests. On the
contrary, successive governments have supported ESSs as an important means of
aligning employee and employer interests, and supporting and encouraging
enterprise and innovation. The committee is satisfied that the proposed changes
will help better realise the potential of ESSs, and ensure Australian firms are
able to remain internationally competitive in attracting and retaining talented
employees.
2.28
The committee acknowledges that while most submitters supported the
intent and general direction of the bill, several feel the changes could go
further still. Nonetheless, the committee believes the proposed changes
represent a significant improvement in the taxation treatment of ESSs, and is
satisfied the new arrangements will be highly competitive by international
standards.
Recommendation 1
2.29
The committee recommends that the Senate pass the bill.
Senator
Sean Edwards
Chair
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