ESS and capital gains tax
In most cases, ESS interests are exempt from CGT implications until the discount on the ESS interest has been taxed.
When you sell your ESS interests (or resulting shares) they are taxed under the CGT rules (or if you are a share trader, the trading stock rules).
CGT treatment of an ESS interest after the deferred taxing point
For an ESS interest that is taxed upfront, the interest is taken to have been acquired for its market value on the date of acquisition.
For an ESS interest for which tax is deferred, the ESS interest (and the share or right that it forms part of) is taken to have been re-acquired immediately after the deferred taxing point. This resets the cost base of the ESS interest to its market value at this time, and resets the acquisition date, which will be relevant to your eligibility for the 50% CGT discount.
Example 1: Taxed-upfront scheme, CGT treatment of an ESS interest after the taxing point
Tarlee acquires shares in her employer Chi Chi Fashion Ltd under a taxed-upfront scheme. The market value of the shares at the date of acquisition is $4,000.
For CGT purposes, Tarlee is taken to have acquired the shares at market value. Therefore, the cost of the shares at the time of upfront taxation, which is also the time the shares are acquired, is $4,000.
If Tarlee incurs any additional costs in relation to the shares, they can be added to the $4,000 to form the cost base. If Tarlee chooses to dispose of the shares, the cost base will be used to calculate any subsequent gains or losses on the shares.
These gains or losses will be recognised under the CGT rules and recorded on Tarlee's tax return.
End of example
CGT treatment of an ESS interest that is eligible for the start-up concession
In the case of ESS interests eligible for the start-up concession, the discount on those interests will not be included in your income. However, under the CGT rules the ESS interests or resulting shares will be taxed when sold or transferred.
What is the cost base?
If you acquire an ESS interest that is a share under the start-up concession, the cost base of that share is the market value of the share when you acquired it.
If you acquire an ESS interest that is a right under the start-up concession and you sell the right, the cost base of that right will be any amounts that you have paid to acquire and sell the right. If you exercise the right and sell the resulting share, the amount you paid to exercise the right will be added to the cost base.
50% CGT discount
If you acquire a share by exercising a right that was eligible for the start-up concession, the date of acquisition of the share is taken to be the date the right was acquired. When you sell or transfer the share, use this date to work out if the 50% CGT discount is available to you.
Example 2: Start-up concession, sale of shares
Jodie acquires 500 ESS interests that are shares from Whirl Icecream Pty Ltd in the 2016 income year. Whirl Icecream Pty Ltd is a start-up company. Jodie pays $1.70 to acquire each of her shares and the market value of the shares at acquisition is $2.00. Therefore, Jodie acquires the shares at a 15% discount. All of the other conditions for the start-up concession have been met so Jodie is not required to include an amount in her 2016 income tax return in relation to the acquisition of the shares.
During the 2020 income year, Jodie sells her shares. Jodie uses the market value substitution rule and calculates the cost base of her shares to be $2.00, which is the market value of the shares at acquisition. She uses this cost base in the CGT calculation for the sale of her shares.
End of example
Example 3: Start-up concession, sale of rights
Sheila acquires 750 ESS interests that are rights from Mega Salads Pty Ltd in the 2017 income year. Mega Salads Pty Ltd is a start-up company. The exercise price of each ESS interest is $3.70 and the market value of an ordinary share in Mega Salads Pty Ltd on the date the ESS interests are acquired is $3.60. As the exercise price is greater than the market value of an ordinary share and the remaining conditions for the start-up concession have been met, Sheila is eligible for the start-up concession, so she is not required to include an amount in her 2017 income tax return in relation to the acquisition of the rights.
During the 2020 income year, Sheila sells her rights. As Sheila has not paid anything to acquire the rights, she starts with a nil cost base. If Sheila incurs any other costs in selling the rights, these costs are added to the cost base. She uses this cost base in the CGT calculation for the sale of her rights.
Note, if Sheila had exercised her rights and then sold the resulting shares, the exercise price would have been included in the cost base of the shares.
End of example
There may be capital gains tax when you sell or dispose of your shares or rights.
Example 4: Start-up concession, sale of shares acquired on exercise of rights, availability of 50% CGT discount
Tara acquires ESS interests that are rights from Pink Pty Ltd on 1 July 2017, under the start-up concession. Tara exercises the rights on 1 September 2020 and sells the resulting shares on 1 January 2021.
For CGT discount purposes, the acquisition date of the shares is taken to be the acquisition date of the rights (1 July 2017). Although Tara held the resulting shares for less than 12 months, as she has held the ESS interests that were the rights to acquire the shares and the resulting shares for a combined period of more than 12 months, she is eligible to apply the 50% CGT discount.
End of example