In the 2021 Federal Budget, the government announced that the ‘cessation of employment’ taxing point for a tax-deferred employee share schemes (ESS) would be removed. The removal of cessation of employment is in line with recommendations made by numerous inquiries over the past 10 years to bring ESS provisions in Australia more in line with international expectations.
This announcement has made its way through the parliamentary process and has been given royal assent.
The new laws come into effect for ESS interests that come into existence on or after 1 July 2022.
The intention of employee share schemes is to provide favourable outcomes in terms of Australian businesses attracting and retaining talent. Overall, these changes have the potential to simplify the administration of offers of ESS interests, and ultimately streamline the regime as a whole.
ESS and deferred taxation
Since its inception in 1995, when an employee becomes an ESS participant and receives shares in a company for free or at a discount, it is a taxing event. Effectively, the individual would be paying tax on the gain as if it was paid as a monetary bonus. This is usually referred to as the market value of the discount on the ESS interest.
However, an employee can access deferred taxation on this discount where one of the following applies:
There is a real risk of forfeiture or loss of the shares/options under the conditions of the ESS.
The share/options are obtained under a salary sacrifice arrangement and the ESS interest does not exceed $5,000 in an income year.
There is a genuine restriction on the individual to immediately dispose of the rights under the ESS rules where the individual is receiving a beneficial interest in a right.
For ESS interests that commence before 1 July 2022, the taxing point is deferred until:
the employee ceases employment
there is no longer a real risk of forfeiture or loss
there is no longer a genuine restriction of the disposal of the interest, or
15 years has elapsed following the acquisition of the share.
Legislative changes
The amending legislation removes the ‘cessation of employment’ taxing point for deferred ESS interests. It will apply to ESS interests that commence on or after 1 July 2022.
This means than an employee is not subject to a tax liability at a time when they may not be able to monetise the ESS interest. This removes a barrier not only from a cash flow point of view but also in a situation where the interest may fall in value between the taxing point and a future vesting date.
Regulatory relief for ESS
There are currently a range of obligations for employers undertaking an ESS under the Corporations Act 2001. These include additional disclosure requirements, the need for an Australian Financial Services License, and obligations regarding advertising, hawking and the on-sale of financial products.
The proposed changes in regulations which accompany this exposure draft are attempting to make it easier for businesses by providing greater flexibility around ESS offers. Any proposed changes will not be effective until after any proposed legislative amendments receive royal assent.
If an ESS is offered to directors and employees, and does not require payment to participate, the scheme can be operated by the company without an Australian Financial Services Licence. There will also be no disclosure requirements that apply to offers under the scheme. Subsequently, general financial advice can be provided and there are no mandatory restrictions on hawking and advertising the products.
Currently, “free” ESS schemes can only have relief from stringent ASIC obligations when there is an annual limit on the amount that can be offered to participants. From 1 July 2022, this limit will increase from $5,000 per annum to $30,000.
Unlisted companies offering ESS interests for monetary consideration
The main aspect of the proposal for regulatory relief for an unlisted company offering an ESS interest for monetary consideration is a streamlined form of disclosure with ASIC.
Importantly, there is also a proposal to cap the number of securities offered in order to be entitled to simplified reporting treatment. Over the course of 3 years, the amount offered in an ESS scheme will not be able to exceed 20% of the company’s issued capital.
