This is the third and final article in our three-part series explaining a number of key aspects of the Australian employee share scheme (ESS) tax rules:
- The first article discusses how you qualify to defer any tax otherwise payable on shares and options you acquire under an ESS, and when that deferral comes to an end;
- Our second article explains how you work out the ‘discount’ (if any) that arises when you acquire an interest under an ESS, in other words, how much tax you may be up for; and
- This article explains how to access and the benefits that arise under the ‘start-up concession’.
As discussed elsewhere, the general position when an interest is granted under an employee share scheme (i.e. an ESS interest) is that:
- You (being the employee) will be taxed on any ‘discount‘ you receive at the time you acquire an ESS interest, unless you qualify to defer the taxing point to a time in the future under the ESS provisions; and
- If you qualify for deferral, then when the deferral comes to an end, the difference between the market value at that time, and what you paid for the ESS interest, will be taxable as ordinary income, i.e. you will pay full marginal rates at that later time.
You will get a better tax outcome if the ESS qualifies for the ‘start-up concession’.
What is the benefit of qualifying for the start-up concession?
If you qualify for the start-up concession, then:
- Any ‘discount’ the employee receives when they acquire the ESS interest will not be taxable to the employee at the time of grant;
- The employee will hold the ESS interest on capital account, and may therefore qualify for the 50% CGT discount on a later disposal of the ESS interest;
- If the ESS interest is an option, and you sell the option, the cost base of the option is any amount you paid to acquire and sell the option. If you exercise the option and then sell the resulting share, the amount you paid to exercise the option will be added to the cost base;
- If you acquire a share by exercising an option, the date of acquisition of the share is taken to be the date the right was first acquired. This can assist in qualifying for the 50% CGT discount; and
- If the ESS interest is a share, the CGT cost base of the share will be the market value of the share when you acquired it. This is very favourable, because the employee effectively gets the market value tax-free.
How do you qualify for the start-up concessions?
To qualify for this concessions you need to satisfy the following general criteria:
- The ESS interest must either be an ordinary class share, or an option over an ordinary class share;
- The company in which you get the ESS interest must not be a share trader or investment company;
- You must not be able to dispose of the ESS interest for a minimum of either 3 years from the time you acquire it, or when you cease your employment with the company. This period may be reduced if 100% of the company is sold to a third party before the 3 years elapses; and
- The employee, together with their associates, must not hold, or have the right to acquire, more than 10% of the shares in the company. This includes any shares the employee acquires or has a right to acquire under the ESS.
In addition, you must satisfy the following criteria that only apply to the start-up concession:
- The company in which you get the ESS interest, and each company of which it forms a group (the Company Group), cannot be listed on a stock exchange;
- Each company within the Company Group must have been incorporated less than 10 years before the start of the income year in which you acquire the ESS interest;
- The aggregated turnover of the Company Group must be less than $50 million;
- If the ESS interest is a share, then the discount must be no more than 15% of its market value when acquired;
- If the ESS interest is an option, the exercise price must be equal to or greater than the market value of the ordinary share that will be acquired; and
- The entity the employee is working for must be resident in Australia.
To qualify for this concession there is no need for the share or option to be subject to any genuine risk of forfeiture.
There is also no need for the scheme to be made broadly available to at least 75% of permanent employees.
It is not clear whether the company needs to specifically state that the scheme is intended to qualify for the start-up concession. However, this would be a good idea so that the employees know that the concession applies.
Valuing the ESS interests under the ‘safe habour’ rules
In a binding legislative instrument (ESS 2015/1) the Tax Office has outlined two accepted methods of valuing shares and options when applying the start-up concession. If you choose one of these methods, you have the certainty that the Tax Office will accept the valuation (which is why it is referred to as a ‘safe-harbour’ valuation).
The approved market valuation methods can be used to value shares and options to make sure that you satisfied the criteria set out above.
The first valuation method is based on a modified version of the ‘net tangible assets‘ of the company. The company must meet certain criteria to be able to apply this method, most notably that the company’s accounts have been prepared in a professional manner.
The second valuation method is a ‘director’s valuation‘ based on a valuation performed by the CFO of the company, or another person with relevant knowledge, experience and training in undertaking a valuation. The Tax Office has specified a list of relevant factors that the person performing the valuation must take into account. Most of these are in line with what a valuer would ordinarily consider.
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