Tax concessions can apply to your ESS interests if you and your employer have followed special tax rules.
These depend on the type of ESS and when you acquired the interests.
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If you do not acquire your ESS interests at a discount, the ESS tax rules do not apply. However, other parts of the law, such as capital gains tax can still apply.
An ESS provides employees with a financial share in the company where they work. Through share ownership the employees benefit financially when the company performs well.
ESS can take many forms, depending on the company size and type, and the organisation’s reasons for introducing the plan.
In deciding which ESS will best suit your company, you need to think about things like:
- the company's aim in introducing an ESS
- fitting the ESS into a broader employee participation or remuneration plan
- the conditions that will be attached to the plan.
What are the benefits of ESS for employees?
Employees can benefit from ESS in a number of ways. Some of the main benefits may include:
- a sense of commitment and a stronger relationship with their workplace
- greater job satisfaction through receiving tangible rewards for their performance
- a feeling of ownership of the company – a degree of participation in the company and a voice in the company as a shareholder
- increased flexibility and choice when negotiating workplace arrangements
- a tax efficient way of acquiring shares and the opportunity for capital growth of their shareholding
- a greater understanding of the stock market and factors that influence the performance and prosperity of the company.
When would I want to use an ESS?
An ESS is a long-term incentive. They are generally plans that have a life span of 2 to 15 years, and are specifically aimed at creating ownership of company shares by employees. The plan itself need not be related to performance targets, but where performance targets are used, they can be related to broader company or financial targets.
Shares are primarily used because share ownership aligns employees' interests with those of shareholders’ and with company performance. If an employee owns shares in the company, they are more likely to focus on the company's profits and success, which are factors that will impact on the value of shares they hold.
If you answer yes to the following questions, an ESS may be what your organisation is looking for:
- Are you looking to retain staff in the long-term?
- Is it important that employees' interests are aligned with those of the company and other shareholders?
- Are you looking for a longer term outcome?
- Are you looking to increase productivity and staff motivation?
- Are competitors in your industry offering shares as part of their remuneration packages for staff?
- Are you looking for a platform from which to launch broader organisational change?
What sort of company can use an ESS? Do I need to be a large or listed company in order to implement a plan?
Companies of all sizes and types can use an ESS to improve their business outcomes. There are ESS available to suit companies that are both publicly listed on the stock exchange, and privately owned. Unlisted companies often use similar types of plans as listed companies.
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 (the Tax Act) are met.
Reasons why a company may want to consider implementing an ESS
Maintain/gain competitive advantage
For example, if most companies in your industry offer an ESS to their employees or no company in your industry has implemented an ESS.
To align employee/shareholder interests
Getting employees interested in the success of the company
Improve organizational competitiveness, productivity and efficiency
By making an employee a shareholder, their focus is aligned with that of other shareholders
This focus can drive behaviours, e.g. there is greater concern about the success and profitability of the company. As a result, an employee has greater focus at work on how to ensure their work contributes to the company’s profit. The information they receive as a shareholder means they are more informed about the company’s performance and issues that affect the company's success.
Sense of belonging to one company with common goals
If the ESS is offered to all employees, in all locations, and there is a good communication program employees can develop a stronger sense of belonging to a single organisation and sharing in its success.
Every employee has shares in the parent company and receives the same benefits.
High staff turnover
Reduce staff turnover
Share benefits that vest on completion of a defined period of service may provide a financial incentive for employees to stay.
If the strategy is part of a wider benefit program that is effectively communicated to employees, and utilises forums to engage employees and gain their input, it can cause a substantial positive shift in culture and morale.
As a complement to other human resource initiatives, shares may encourage a sense of belonging and make employees feel that their voice is important and heard. If this is a key issue for an organisation, they need to consider the ESS as part of an overall change program. Other human resource initiatives might include improved training and development, individual recognition programs, improved workplace environments, and rewards and benefits such as cash, team competitions or outstanding service awards.
Tax concessions may increase net after tax value of a benefit compared to cash or other non-concessional benefits.
In order for tax concessions to apply, the plan needs to comply with the conditions of Division 83A of the Income Tax Assessment Act 1997 (the Tax Act), i.e. if the plan is a tax deferred plan or tax exempt plan.
Improved individual, team and/or organisational performance
May encourage improved and sustainable organisational performance, especially if the quantity of shares allocated is linked to individual or group performance.
Trade off in Enterprise Bargaining Agreement
Benefit received is greater than cost of providing the ESS benefit
Provision of free or discounted shares may be cost effective.
Retain employees - if the employee leaves, the shares may be forfeited.
Shares can be offered subject to vesting conditions. If the employee is likely to lose a substantial benefit if they resign, there is an incentive to stay.
Understanding the difference between short-term and long-term incentives
The first step is deciding whether you want to introduce an ESS plan, or a short-term incentive plan (STIP), or both.
Many companies operate both an ESS and a STIP as they do not need to be exclusive. The reason for having either, or both, depends on the short-term or long-term focus of your remuneration strategy and what your company is trying to achieve.
Employers should think about ESS and STIPs in the context of their total remuneration strategy. There are three components to a balanced remuneration strategy: fixed remuneration (including base salary and benefits), short-term incentives, and long-term incentives. STIPs form part of the short-term incentive strategy and ESS form part of the long-term incentive strategy. An ESS works best if it's developed as part of an overall human resources and remuneration strategy, in association with the business goals of the organisation.
When would I want to use a short term incentive plan (STlP)?
STIPs, as the name suggests, are an incentive that has a short life span (usually 6 to 18 months). These types of plans take the form of cash payments and the most common form of STlP is an annual bonus. STIPs are generally used where a company is trying to achieve a result in a relatively short period of time. Also, these plans are more easily adapted to setting targets that are specific to an individual or a business unit. STlPs can be less effective than ESS at driving alignment between employee and shareholder (or employer) interests.
If you answer yes to the following questions, a STlP may be what your organisation is looking for:
- Are you looking to achieve a specific, measurable result in less than two years?
- Are you targeting a change in behaviour or motivating employees in a specific way that relates to personal traits or productivity of a business unit?
- Are you looking to reward outstanding performance or drive motivation?
- Are you looking to target a specific group of people in order to improve or increase the output of that group?
- Are you trying to increase sales?
Once you have examined the different types of STlPs and considered which is the most suitable for you, you should seek professional assistance in designing and implementing the plan. This information is specifically designed for ESS and will not guide you through the STlP design and implementation process.
What factors are relevant to employers considering an ESS?
If high participation rates are important, then the key factor is effective communication of the plan to employees. In addition, if the offer involves little or no cash to be outlaid by participants, then the company is more likely to achieve high participation rates. Plan design is also a critical aspect of any ESS strategy and it is important to spend time considering this aspect of implementation, in detail.
Aims of organisation
Employers may want to design their ESS to reinforce the aims of the company.
It is vital to effectively communicate the design and progress of the ESS to employees. Employees need to know:
- why they are receiving shares
- the benefits of participating in the plan
- the link between their participation and the company’s wider strategy
- how their performance will affect their shares (if employees perform well, will they receive more shares? lf the company becomes more successful, how will that affect the share price?)
- how they can track the progress of their shares
- how the value of the shares is determined
- how and when they can realise the value of their shares (that is, sell them)
- When do they forfeit the shares
- This information needs to be communicated in a clear and easy to understand manner because, for many employees, the ESS may be their first experience with share ownership. It is also important to continue to communicate with staff after the initial offer and information presentations are made.
Designing the right ESS for your company
There are many different types of ESS available to companies in Australia. Set out below is a guide to step you through the questions that you need to consider when designing an ESS.
For those companies who wish to implement a qualifying plan (i.e. a tax-deferred or tax exempt ESS), standard forms are available on our website. Companies considering these types of ESS will also find a detailed explanation of tax exempt and tax-deferred plans in this document, including the conditions that need to be met under Division 83A of the Tax Act.
Step 1 – Company's aims
The most important part of the design process is considering what you want to achieve by introducing an ESS. Here are some questions that will help in this process.
Should you introduce a broad-based plan or a select employee plan?
Your company might consider offering a broad-based ESS (i.e. offering the plan to all employees), if the plan is being introduced for the following reasons:
- to gain competitive advantage or to be an employer of choice, in an industry where other organisations offer all their employees an ESS
- to improve morale
- to align employee and shareholders' interests
- to engage employees’ interest in the growth of the company.
Select employee plans
Your company might consider offering a select plan if the plan is being introduced for the following reasons:
- to give the company a competitive advantage in recruiting the right people (including compensating employees for shares/options that are lost due to employment change)
- to retain key talent
- to give a reward for specific performance or company performance
- to drive a specific group to be more efficient/productive
- to target or reward senior employees.
Generally, companies having the objectives described above use a long-term incentive plan (LTIP) or Employee Equity Plan. This is type of plan is primarily used by listed companies to encourage their senior executives to build up a shareholding, thereby aligning their interests with those of their shareholders.
In a LTIP or employee equity plan, free shares are provided to participants subject to the fulfilment of specified conditions. These shares are held in trust and once the specified conditions are fulfilled the trustees release the shares to the senior executives.
LTIP or employee equity plan requirements are normally subject to forfeiture if conditions are not met and include:
- shareholder approval
- an employee benefit trust is normally set up to administer the plan.
The benefits of LTIPs or employee equity plans include:
- flexibility – plans can be designed to meet the corporate needs of a company, its employees and shareholders
- executive benefits from the full value of the shares – unlike other company share option incentives where the participants benefits from the growth of the share value through the duration of the exercise period.
There are many different types of LTIP or employee equity plan such as:
- a restricted share plan – this is a tax-deferred plan that uses free shares. It offers employees shares at no cost provided certain performance targets are reached. This plan uses the tax deferred plan structure by placing restrictions on the shares until targets are met, with the shares being forfeited if the targets are not met
- an option plan – this grants the employee a right to convert their options into shares at an agreed price and on an agreed date. Again, the plan has performance conditions and forfeiture of the options if the conditions are not met. Option plans are generally offered to select employees, rather than to all employees, because of dilution issues, and the complexity of the taxation requirements associated with these plans
- a cash LTIP or employee equity plan – this plan mimics the option plan or restricted share plan but instead of granting shares, the plan pays cash when the performance conditions have been met. The cash benefits are linked to the growth in the share price
- a rights plan LTIP or employee equity plan – being a plan that provides a right to acquire fully paid ordinary share for no consideration.
The plan design for select plans (including any performance, vesting and forfeiture conditions) needs to be specifically targeted at the company’s goals. External professional advice is recommended for companies that wish to introduce more complex plans of this type.
Are tax concessions important?
Is your company interested in offering shares that qualify for tax concessions? Is it important to you that employees are able to get a certain amount of shares tax free, or are able to invest now and pay tax later?
If the answer is yes, then your company might immediately be considering a tax exempt plan, a tax-deferred plan, or a plan that takes advantage of the ESS start-up concessions.
If the answer is no, your company may want to consider an alternative type of ESS. These alternative types of ESS are often used where tax concessions are not important and where there are specific company preferences.
Specific company preferences
Some companies have specific preferences about the plan that they want to operate, depending on their particular circumstances.
For example, take a case where:
- many of a company’s employees are financially astute
- the company would like the cost of the plan to be funded through a loan
- the company would like a plan that operates for longer than 10 years
- the company wants employees to focus on capital growth rather than the tax concessions
- the company is comfortable with employees receiving no income stream from the dividends.
In this situation, a loan plan may be your company’s preference.
As another example, some start-up and technology companies may favour option plans for the following reasons:
- the initial outlay impacts on the company’s issued capital rather than cash
- the focus is on share price growth
When selecting your preferred employee share plan design, you should make your decision based on your company’s employee group, company aims and specific company factors.
Do you want to attach forfeiture conditions to the plan to improve retention rates?
If you have made the initial decision that a tax exempt plan is the plan for you, there is one final question before considering the plan specifics. Are forfeiture conditions required?
One of the reasons for having forfeiture conditions may be because shares are being offered to employees for free and the company wants to use the free shares as a tool to retain employees. In this situation, the best way to retain employees is to impose a condition that the shares can be forfeited if the employee leaves the company. As the tax exempt plan does not allow for forfeiture conditions, it may be a sufficient reason to consider another plan design.
When making this decision, you should consider how important forfeiture is to the company. You also need to consider whether the tax free amount under the tax exempt plan is more important to you and your employees than having forfeiture conditions. If the free shares are going to be offered once only, and the grant is of a low level, e.g. $100, then the plan is unlikely to successfully retain employees even if there are forfeiture conditions attached to the shares.
If you have decided that tax concessions are important and $1,000 is a meaningful amount, then the tax exempt plan conditions require a forfeiture condition under the tax legislation. Most companies use the $1,000 plan for the tax exemption. However, if forfeiture conditions are necessary, then a tax deferred plan may be the better option for your company.
Step 2 – Design considerations
The second and final step is to consider the design features of the plan. A tax exempt plan can offer free shares, or salary sacrifice shares, or both. Free shares will generally only be offered if the company’s aims are to link the grant to company success, and any grant may be conditional on those targets being met each year. Companies often have both free shares and salary sacrifice shares as part of the plan rules to allow flexibility about what they offer each year.
A tax-deferred plan can be funded via salary sacrifice, bonus sacrifice, or provided through an issue of free shares.
Practical considerations for employers
What does your company want to achieve through an ESS?
As explained earlier, the starting point in designing your ESS is being clear about what you want to achieve. You should consider all the relevant factors and make sure they drive the plan's design. Once you are clear about this and have worked out your design, there should be a clear message to employees about the plan, the role it has in the company's remuneration structure and its value as a benefit.
What are the costs associated with establishing an ESS?
There are a number of costs associated with the introduction and ongoing maintenance of an ESS. The table below provides a brief summary of some of the costs that you can incur. These will generally vary according to the complexity of the plan, the frequency of offers, and the number of participants. The costs of the ESS need to be balanced against the benefits you expect your company to gain from the plan.
This information has been provided as a starting point and is designed to reduce the amount of external assistance (and costs) required to establish qualifying plan types. However, you should note that you will still need to seek external professional advice where appropriate to ensure that your plan is robust.
Remuneration strategy & ESS design advice
Whether undertaken internally, or with the assistance of independent consultants, a 'situation and needs' analysis should be completed to ensure the plan implemented is the most appropriate for your company's needs and fits with the overall remuneration strategy.
Plan documentation (plan rules and/or trust deeds)
Once the plans best suited to your needs have been determined, they must be formally documented, usually with the assistance of a suitably qualified lawyer. Standard documents have been created for you to use to assist with reducing these costs.
All companies must comply with the requirements of the Corporations Act in relation to offers made under an ESS. In some circumstances, offers under an ESS may be exempt from certain Corporations Act requirements or may be exempt only if certain conditions are met. Listed companies must also meet the exchange's listing rule requirements and approval of an ESS may be required for shareholders.
You should obtain legal advice on your company's compliance with these regulatory requirements.
Offer documentation should generally include at least some or all of the following:
- plan information booklet and Q&A
- offer letter and acceptance/application form.
The offer documentation may also need to include additional information if your company wishes to rely on the disclosure exemption in ASIC Class Order 14/1001.
Some of the information in your offer documentation may be driven by the legal requirements associated with the plan. If your company cannot rely on a disclosure exemption in the Corporations Act 2001 or ASIC Class Order 14/1001, a prospectus or offer information statement will need to form part of the offer documentation.
Communication and implementation
Aside from the offer materials, a comprehensive and clear communication strategy should be developed for the first and subsequent offers. Communication materials should be designed with the participants in mind. It is important that employees are able to understand the offer and that they know where to find more information if they require it. It is equally important that you communicate throughout the life of the plan at key points like vesting, end of restriction, annually for share price or holding information and if they leave the company.
Ongoing plan management and administration
Managing the regulatory and statutory responsibilities, processing the information flows, taxation information and database management requires dedicated internal and/or external resources.
Printing, stationery, postage & other sundry expenses
Offers, sales, transfers, changes to employee details, dividends, notices of meeting, annual reports and other relevant shareholder information needs to be distributed in paper or electronic form and the process needs to be carefully managed.
What legal requirements must an ESS fulfil?
There are many legal and regulatory requirements to consider in implementing an ESS.
ln summary, you must be aware of how the following affect the implementation of ESS:
- the provisions of the Corporations Act 2001External Link relating especially to offers of shares (in particular, sections 706, 708 and 710 – 716) including disclosure requirements and exemptions
- for listed companies, the relevant stock exchange listing rules (ASX listing rules)
- the company constitution
- the provisions of the Corporations Act restricting companies from dealing with their own shares
- taxation law issues, including income tax, capital gains tax, pay as you go withholding and fringe benefits tax
- the provisions of the Corporations Act relating to financial services regulation, and the rules regulating financial advice (unless you have an exemption from this by using section 708 of the Corporations Act or ASIC Class Order exemptions for ESS)
- other provisions of the Corporations Act relating to licensing, advertising, hawking, managed investment schemes and on-sale of financial products
- accounting standards
- privacy legislation.
What disclosure/prospectus requirements are associated with ESS?
Where you make an ESS offer, a range of obligations under the Corporations Act may be triggered.
The disclosure requirement
The Corporations Act requires that if you make an ESS offer, you must also give the employee a disclosure document, unless an exemption in that Act applies or you are relying on the relief in the Australian Securities and Investments Commission (ASIC) Class Order [CO 14/1001]: Employee incentive schemes: Unlisted bodies (ASIC CO 14/1001).
There are limited disclosure exemptions that may apply for offers of Options to employees under the Employee Option Plan, which include (among others):
- offers to senior managers – see section 708(12) and the definition of 'senior manager' in s9 as modified by ASIC CO 04/0899 for more detail
- small-scale offers – offers to up to 20 persons not exceeding $2 million (calculated by reference to the amount payable on both grant and exercise of the option) in any 12 month period (see sections 708(1)-(7) for more detail).
A disclosure document is a term used to describe all regulated fundraising documents for the issue of securities. All disclosure documents must be lodged with ASIC before an offer can be made under the ESS. The simplest type of disclosure document that can be used to make an offer under an ESS is an offer information statement (OIS). A prospectus, which has a more comprehensive content requirement than an OIS, may also be used.
An OIS must include, among other things an audited financial report prepared in accordance with the accounting standards, which covers a 12 month period and with a balance date that occurs within the last six months before an offer is first made under the OIS.
A prospectus must contain all information that investors and their professional advisors would reasonably require to make an informed investment decision. Among other things, it must explain the company's financial position, performance and prospects.
ASIC CO 14/1001 and offer documents
ASIC CO 14/1001 reduces the compliance burden for unlisted bodies in establishing their ESS by providing conditional relief from the disclosure, and other requirements of the Corporations Act. One of the conditions of ASIC CO 14/1001 is, when making an offer under an ESS, the company must provide an Offer Document that complies with the requirements of ASIC CO 14/1001. Each offer must also be valued at no more than $5,000 per employee and for no more than nominal monetary consideration.
For more information on the conditions to be satisfied to rely on the relief in ASIC CO 14/1001, including the content of Offer Documents, see the section G of ASIC Regulatory Guide 49: Employee incentive schemes.
Other requirements of the Corporations Act
The Corporations Act also contains the following provisions that may be relevant, depending on how your ESS is implemented:
- The requirement to hold an Australian financial services licence for the incidental provision of financial services (such as giving general advice, dealing in financial products or providing custodial or depository services) in connection with the ESS.
- The prohibition on advertising an offer or an intended offer where that offer needs a disclosure document.
- The prohibition on the issue of Options or shares arising out of unsolicited contact with investors (which is referred to as hawking).
- The requirement to register a managed investment scheme for an ESS that has a contribution plan.
- The restrictions on the on-sale of financial products issued without disclosure within 12 months of their issue.
If your offer is an 'eligible employee share scheme' (defined in section 9 of the Corporations Act) and is made using a disclosure document, there are some limited exemptions from these provisions. If you are relying on ASIC CO 14/1001, you are generally not required to comply with these provisions.
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When considering the type of plan that is offered to employees, one of the considerations may be the tax concessions that are available if the conditions in Division 83A of the Tax Act are met. The general taxation consequences as well as taxation consequences for the tax exempt and tax-deferred plan are discussed in this document. To understand these issues more completely, you should seek independent taxation advice.
It is also important to make employees aware of the tax consequences of participating in an ESS. This general tax information would usually appear in the offer materials, and be signed off by a tax expert. This material should ensure that employees are clear that they need to seek their own independent advice, based on their personal circumstances.
From a corporate perspective, the company may be entitled to a company tax deduction where shares are purchased on market, or if a tax exempt plan is used. Both new issue shares and shares purchased on market are deductible up to the $1000 limit per employee, per financial year.
What payroll tax issues should be considered?
ESS may be subject to state payroll tax. However, the rules vary between states and you will need to check with your local State Revenue Office to determine how payroll tax may apply to the ESS interests you issue.
Workplace relations and employment law
Workplace relations strategy and relevant employment law should be considered when you are designing your plan. As with any benefit provided to an employee, employers must be aware of the potential impact that this can have on contractual arrangements including any employee awards. Some awards, for example, do not provide for salary sacrifice arrangements.
Information about wages and conditions of employment in Australia, for work that is covered by federal awards and agreements, can be found at fairwork.gov.auExternal Link
Privacy law considerations
In some cases, there may be exemptions from Privacy legislation. However, that depends on the particular situation. It may be safest to assume that the privacy rules apply to your ESS.
If you are uncertain about how the privacy legislation applies to your plan, you should seek professional advice.
Employees may be eligible for tax concessions on their ESS interests.