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Guide to tax deferral for employee share schemes

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As a general rule, if you acquire an interest under an employee share scheme (ESS) you will be taxed (at your marginal rate of tax) on any ‘discount’ you receive at the time you acquire the interest under the ESS (ESS interest), unless the ESS qualifies for concession tax treatment such as the tax deferral scheme which allows you to defer the taxing point to a future point in time.

What is a discount?

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.

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 we discuss in our Guide to the start-up concession for employee share schemes.

How do I qualify for the tax deferral scheme?

If you have a discount that is not reduced to nil by any other concessions, 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

Where the ESS interest is a share, 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

Where the ESS interest is an option to acquire a share, 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.

When does the deferral come to an end?

If you qualify for the tax deferral scheme, the date or event on which the deferral comes to an end also depends on whether the ESS interest is a share or an option to acquire a share.

If the ESS interest is a share

Where the ESS interest is a share, 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

Where the ESS interest is an option, 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.

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How we can help

We can assist both participants in an employee share scheme and organisations who wish to establish an employee share scheme by:

  • Preparing a bespoke employee share scheme for implementation in your business
  • Assisting in the administration and management of an employee share scheme
  • Advising you on the taxation implications of participants who are invited to acquire shares or options in an employee share scheme
  • Determining whether the shares or options provided to participants of an employee share scheme qualify for the start-up concession, deferred tax concession or taxed up-front scheme