Employee share schemes (ESS) are plans that are specifically aimed at providing employees with ownership in company shares. ESS is available to all companies, regardless of whether they are publicly listed or privately owned.

Tax concessions can apply to ESS interests if you and your employee have followed special tax rules. To gain the benefit of tax concessions, the plan has to be set up in such a way to ensure that the conditions of Division 83A of the Income Tax Assessment Act 1997 are met.

If you provide ESS to your employees at a discount, you must meet specific obligations.

There are many types of employee share schemes (ESS). Generally, the type of scheme determines the tax treatment that applies.

The tax treatment can be either:

• non-concessional – this means the employee or scheme does not meet the conditions for special tax treatment to apply; or
• concessional – this means the employee and scheme meet the conditions for concessional tax treatment to apply.

Some employee share schemes (ESS) don’t qualify for concessional tax treatment. These are known as non-concessional ESS.

If you provide your employees with a discount on ESS interests but either the scheme or the employee do not meet the conditions for concessional tax treatment, your employee will be taxed on the discount in the year they receive the ESS interests.

The ESS interests are treated as if they were provided from an upfront scheme, and are not eligible for the reduction.

Most employee share schemes (ESS) allow your employees concessional tax treatment if they receive their ESS interests at a discount and meet certain conditions.

As a general rule, if you acquire an interest under an ESS you will be taxed (at your marginal rate of tax) on any ‘discount’ you receive at the time you acquire an interest under an employee share scheme (ESS interest), unless you:

• qualify for the ‘start-up concession’ which reduces the extent of the discount to nil; or
• qualify to defer the taxing point to a future point in time, in which case you will be taxed on the difference between the market value of the interest when the deferral comes to an end and the amount you paid for the interest.

There is a ‘discount’ if the amount you pay to acquire the ESS interest is less than the market value of the ESS interest at that time.

This requires a confirmation of the amount paid (or payable) by you to acquire the ESS interest and the market value of the ESS interest at the time it is granted.

If there is no ‘discount’ then you do not need to worry about deferring the tax.

If there is a ‘discount’, you will be liable to pay tax on the discount, notwithstanding the fact that you have not received any benefit from the ESS.

It is for this reason that the Income Tax Assessment Act 1997 (Cth) (Tax Act) provides you with an opportunity to defer calculation of the discount and the point in time at which you are required to pay tax in relation to the ESS interest to a future point in time.

Before you can consider whether you are entitled to defer payment of tax on the ESS interest, it is important to consider whether any other concessions reduce the extent of the discount to nil.

For instance, you may qualify for the ‘start-up concession’ which reduces the taxable discount to nil.

You will qualify for the start-up concession if you satisfy the following criteria:

• (Ordinary Share) the ESS interest must either be an ordinary class share, or an option over an ordinary class share;
• (Share Trader or Investment Company) the company in which you get the ESS interest must not be a share trader or investment company;
• (Disposal of ESS interest) you must not be able to dispose of the ESS interest until either 3 years from the time you acquire the ESS interest or when you cease your employment or engagement with the company;
• (Share Threshold) you, together with your associates, must not hold, or have the right to acquire more than 10% of the shares in the company;
• (Stock Exchange) the company in which you get the ESS interest cannot be listed on a stock exchange;
• (Incorporation Date) the company must have been incorporated less than 10 years before the start of the income year in which you acquire the ESS interest;
• (Aggregated Turnover) the aggregated turnover of the company must be less than $50 million;
• (Discount Threshold for Shares) if the ESS interest is a share, then the discount must be no more than 15% of its market value when acquired;
• (Exercise Price for Options) 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;
• (Residency Status) the company must be an Australian resident.

If you qualify for the start-up concession:

• any ‘discount’ you receive when you acquire the ESS interest will not be taxable to you at the time of grant;
• you 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 of the share;
• 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; 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.

If you have a discount that is not reduced to nil by any other concessions, then you will either have to pay tax at the time you acquire the ESS interest or qualify for deferral of that tax.

What you need to do to qualify for deferral will depend on what sort of ESS interest you get under the scheme, i.e. whether you acquire shares or options to acquire shares.

If the ESS interest is a share

If the ESS interest is a share, then the ESS must satisfy the following criteria in order for you to qualify for tax deferral:

• the ESS interests granted must be ordinary class shares;
• the company in which you get the shares must not be a share trader or investment company; and
• you, together with your associates, must not hold, or have the right to acquire, more than 10% of the shares in the company or control the exercise of more than 10% of the votes in the company;
• there must be a requirement that at least 75% of the company’s permanent Australian-resident employees who have been employed by the company for at least 3 full years, must be entitled (or have been entitled at an earlier time) to acquire shares under the scheme or to acquire shares under another scheme operated by the company (or its holding company);
• you must not be able to dispose of the shares for a minimum of either 3 years from the time you acquire them, or when you cease your employment with the company;
• either there is a real risk that, as a result of the scheme conditions, you will forfeit or lose the shares (other than by disposing of them) or the shares are acquired under a qualifying ‘salary sacrifice arrangement’.

The concept of there being a ‘real risk’ of forfeiting your shares can be a hard one to get your head around. The policy behind this is to require you to perform to a certain standard or remain with the company for a material period of time, so as to justify the tax deferral.

If the ESS interest is an option

If the ESS interest is an option to acquire a share, then the scheme must satisfy the following criteria in order for you to qualify for tax deferral:

• the ESS interests granted must be rights to acquire ordinary class shares;
• the company in which you get the options must not be a share trader or investment company;
• you, together with your associates, must not hold, or have the right to acquire more than 10% of the shares in the company or control the exercise of more than 10% of the votes in the company;
• the options must be non-transferable; and
• either there must be a real risk that, as a result of the scheme conditions, you will forfeit or lose the options (other than by disposing of or exercising them) or the company must explicitly elect within the ESS that deferred taxation applies pursuant to Subdivision 83A-C of the Tax Act to all holders of options under the scheme.

If you qualify for the Deferred Tax Concession, the date or event on which the deferral comes to an end will depend on whether the ESS interest is a share or an option to acquire a share.

If the ESS interest is a share

If the ESS interest is a share, then the discount will be calculated and become taxable at the earlier of when:

• you dispose of the share;
• you are no longer subject to a real risk of forfeiting the share and the restrictions on your ability to dispose of the share are lifted;
• when you cease employment with your employer; and
• 15 years from when you first acquired the share.

If the ESS interest is an option

If the ESS interest is an option, then the discount will be calculated and become taxable at the earlier of when:

• you dispose of the option;
• if you have not exercised the option, you are no longer subject to a real risk of forfeiting the option and the restrictions on your ability to dispose of the option are first lifted;
• if you have exercised the option, the share is no longer subject to a real risk of forfeiture and the share is not subject to a disposal restriction;
• when you cease employment with your employer; and
• 15 years from when you first acquired the option.