Employee Share Schemes

Employee equity, through an Employee Share Scheme (ESS), can be a powerful tool for any business looking to supercharge its growth, especially a start-up business that is running on finite capital. Properly constructed, and implemented, it can attract and incentivise employees  and align the interests of employees with the business’s investors and founders.

In Australia, younger and smaller companies have not readily adopted ESS, with few entrepreneurs and their advisers fully across the complexities. This is understandably so as the strategy can be complex with many interactions across tax and corporate law. Thankfully, in recent years legislative changes have made it more appealing. However, correctly implementing the strategy needs the right approach and knowledge.

What is an Employee Share Scheme?

An ESS, also known as employee share purchase plans or employee equity schemes, give employees the opportunity to own equity in the company they work for. Sharing equity in a company is a way of attracting, retaining and motivating staff. Further, and importantly, it aligns the interests of employees with shareholders. It means that employees and other equity holders will benefit financially if the company performs well.

Tax Treatment of Employee Equity

Like many aspects of business, tax is a driving force that shapes the opportunities and the barriers to implementing an ESS. As a starting point, any equity you give to an employee is treated as income and the employee will be taxed on the value of it immediately.

In the case of an early-stage business, this may be immaterial, but in many cases the value may be more than expected. Employees could find themselves in a situation of having to pay tax without receiving the cash to pay for it! Given the motivations for providing the equity (outlined above), the payoff may come much later with the potential for significant benefits if all goes to plan.

Enter the world of tax legislation governing ESS. Where the aim is to align the taxation of the benefits to when the benefits are realised as cash so that the tax can be paid.

Australia has been somewhat of a laggard in providing a working system that achieves this, but in recent years it has been catching up and further amendments, likely to be introduced soon, will make employee share schemes a common place in Australian start-ups and SME’s.

In 2015, the favourable ‘Startup Concession’ was introduced which enables certain businesses to offer their employees equity that is taxed when the employee eventually sells their shares in the company. And even better, the shares are taxed on a capital basis instead of ordinary income. So, much like you would receive a 50% deduction on the capital gain you make holding any other investment for more than 12 months, the employee gets an attractive discount on the tax they must pay on any future gain.

Types of ESS

In the eyes of the Australian Taxation Office (‘ATO’), ESS fall into two types:

• Non-concessional; and
• Concessional.

The earlier example of Sarah would constitute a non-concessional scheme, whereas a scheme implemented using the Startup Concession is just one example of a concessional scheme. Other concessional schemes have different tax outcomes and the type of concessional scheme a business can use hinges on several factors including, but not limited, to:

• Age of the business
• Number of employees
• Revenue of the business
• Expected changes in ownership (e.g. as a result of raising capital)
• Current ownership of the business
• Structure of the business (i.e. company, trust, partnership)

Ultimately, depending on the type of concessional scheme there will be very different tax outcomes for the employee.

Commercial Objectives

In addition to considerations such as tax, a business needs to weigh up its commercial objectives. Often, businesses make the mistake of focusing on helping their employees pay the least amount of tax, to the detriment of implementing a scheme that will drive the outcomes they desire.

Is an ESS right for my business?

Before you start thinking about structure, equity share, tax, and disclosure considerations you first need to take a realistic look at your company and the industry that it operates in.

While market forces will be a consideration as your business competes for the best talent, you should carefully consider your business’ current situation, its existing team and the people you are looking to attract, to determine the most appropriate terms and structure for an ESS. The starting point should be whether an ESS is right for your company.

Contemplating this point is important and the answer will require you to reflect on your company’s goals and industry trends. If you are looking to use an ESS to retain staff in the long-term and your company operates in an industry where talent is in high demand, then creating a well-structured ESS may help you gain a competitive advantage and attract the staff you want and keep them.