Attracting and retaining talent through employee share scheme concessions

Legislation Update

9 min. read

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In this alert, we outline the recent changes to the Treasury Laws Amendment (Costs of Living Support and Other Measures) Act 2022 (Cth) (ESS Act) and the considerations for companies competing for employees. 

From 1 October 2022, the changes contained in Schedule 4 to the Treasury Laws Amendment (Costs of Living Support and Other Measures) Act 2022 (Cth) (ESS Act) significantly decreases red tape for companies considering issuing options or shares to employees, contractors, or directors as part of an employee share scheme (ESS).

The ESS Act amends the Corporations Act 2001 (Cth) and will replace the ASIC class orders that previously provided some relief from Corporations Act requirements in relation to an ESS.  

This alert considers what roadblocks have been removed and how, in conjunction with the existing tax start-up concessions, companies can more effectively compete in the war for talent.

Based on our experience in putting ESS plans in place, the “magic” is likely to lie in: 

  • being able to require eligible participants to pay as little as possible (or preferably $nil) to participate in the scheme (so that the most complete ESS Act relief applies from 1 October 2022);
  • while, at least for start-ups, satisfying the “market value requirement” within the start-up rules in the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) (so that the most concessional tax treatment applies).

How this can be achieved is touched upon further below.

Current disclosure regime under Corporations Act 2001 (Cth) 

Unless a relevant exemption applies, offers of shares or options to investors or employees in Australia require preparation of a disclosure document (such as a prospectus or offer information statement), which must be lodged with ASIC.

To date, to avoid the application of the requirement to produce a disclosure document, the most common exemptions for offers made to employees have been, at a high level, as follows:

  • the senior management exemption, which is an offer made to an employee who is also a senior manager (i.e., a senior executive in a corporation who is concerned with its overall management); or
  • the small-scale offering exemption, which requires that, in any 12-month period:

(i)    in relation to offers received in Australia (excluding other exempt offers) there are no more than 20 acceptances; and

(ii)    the amount raised (in relation to those offers) does not exceed $2 million in total. 

The obligation to provide a disclosure document is in addition to other obligations associated with fundraising under the Corporations Act - e.g. to hold a financial services licence and restrictions on advertising and hawking financial products - that need to be considered in making offers to employees.

ASIC class orders

ASIC has previously issued class order relief (Class Order 14/1000 for listed companies and ASIC Class Order 14/1001 for unlisted companies) (Class Orders) from the various associated Corporations Act obligations.

From 1 January 2023, ASIC intends to terminate the ability to make new offers of financial products under the above Class Orders (although offers made before the termination date may remain open for 13 months).  

Corporations Act relief from 1 October 2022

At a high level, from 1 October 2022, the following regulatory relief is now reflected in the Corporations Act and available to companies that make offers under an ESS that are eligible for that relief (eligible schemes):

  • the existing disclosure requirements (e.g. the requirement to produce a prospectus) will not apply to offers under the scheme (provided certain requirements are met) and the new disclosure requirements will not apply to offers for nil consideration;
  • the scheme can be operated without an AFSL;
  • general financial advice can be provided in relation to the scheme without an AFSL;
  • the restrictions on advertising and hawking securities and financial products in the Corporations Act will not apply to the scheme; and
  • the design and distribution obligations will not apply to the issue, sale, or transfer of interests under the scheme.

The fact that a company makes an offer for an “ESS interest” under these new laws will not prevent it from also making an offer that complies with the existing (and still in force) disclosure requirement exemptions under the Corporations Act (as discussed further above).

The new ESS regime applies to offers to eligible participants, which has been broadened to include -  in addition to employees and directors – persons who provide services to the company, casual employees and certain relatives of eligible persons. 

If shares or options require payment by the participant, companies must comply with an issue cap (for listed companies, 5% of the company’s issued securities unless a higher limit is specified in the company’s constitution and for unlisted companies, 20% of the company’s issued securities – including prior 3 year period) and a monetary cap (for unlisted companies, $30,000 per ESS participant in a 12-month period). 

Accordingly, companies should take the time to consider whether now is the time to: 

  • implement a modern ESS that takes advantage of the streamlined regulatory requirements; or 
  • update their existing ESS documentation to reflect the amendments made by the ESS Act prior to the Class Orders being phased out in January 2023. 

“No payment to participate” ESS

The ESS Act requirements are the least demanding where no payment is required to be made to participate in the ESS (i.e., a “no payment to participate” ESS).

If the offer is for options or incentive rights, to qualify as a “no payment to participate” ESS, no monetary consideration is to be provided on the exercise of the options or rights. 

The ability to offer a “no payment to participate” ESS, while qualifying the ESS for the ESS tax start-up concessions, which provides the most favourable taxation treatment available for participants, will often require, or be most effectively facilitated through the Net Tangible Assets (NTA) method of valuing the company under the ESS tax rules being available.

Taxation of interests granted under ESS and concessions available

Division 83A of the ITAA 1997 (ESS provisions) governs the taxation of benefits received by employees and similar persons who receive an “ESS interest” under an “employee share scheme”.

An ESS interest in a company is a beneficial interest in:

  1. a share in a company; or
  2. a right to acquire a beneficial interest in a share in a company.

The ESS tax provisions only operate where an employee receives an ESS interest “at a discount” to the market value of that interest.

The ESS tax provisions operate most concessionally where the ESS start-up concession applies (discussed below).

ESS start-up concession

Under the ESS start-up concession and provided certain conditions are met, the value associated with ESS interests granted as rights or options will not be taxed on grant, vesting or exercise. Rather, the taxing point will be deferred until the sale of the shares. For ESS interests granted as options, the 50% CGT discount will apply if the sale of the shares occurs at least 12 months after the grant of the options.

For ESS interests granted as shares, the value of those shares at grant will not be taxed, with the value of the shares only being taxed upon the sale of the shares by the employee. Provided the shares were acquired at least 12 months prior to disposal, there should be an entitlement to apply the 50% CGT discount to reduce the gain, after applying any current or prior year capital losses.

For the ESS start-up concession to apply, each of: 

(c)    the company,
(d)    the ESS, and the 
(e)    employee 

must meet certain eligibility requirements.

Apart from the “market value requirement” discussed in the paragraph below, this Alert does not discuss those eligibility requirements. However, it is noted that the company (and any related group companies) must not be listed on a stock exchange, nor have been incorporated for 10 years or more.

Approved safe harbour, NTA Method to value unlisted ordinary shares 

In relation to an unlisted company, one of the requirements to be satisfied under the terms of the ESS offer is what may be described as the “market value requirement”, being that:

  • in the case of an ESS for rights / options — the exercise price must not be less than the market value of shares in the company at the date of grant of the rights / options; and
  • in the case of an ESS for shares — the shares must not be offered for more than a 15% discount on the market value of the shares at the date of grant.

Note that the ESS interests must be in relation to ordinary shares only.

To not unduly restrict the benefits of the start-up concession to employees who may not have the means to fund a high price to participate and reduce compliance costs, there are two ATO-approved safe harbour methods that can be used (subject to satisfying eligibility criteria) to value ordinary shares for the purpose of applying, and satisfying, the market value requirement.

One of those methods specifically allows the company to value its shares only based on its net tangible assets (NTA). By definition, this excludes any value attributable to goodwill and other intangible assets, so is very concessional for many start-ups.

Notably also, the NTA method statement prescribed for the valuation of ordinary shares requires that the NTA value of the company is reduced by the return required on preference shares. Given that often early-stage capital providers will have preference shares, or shares with “loaded” return entitlements, this will often mean that ordinary shares are valued at $nil under the NTA safe harbour method.

Accordingly, this means that shares or options may potentially be issued for $nil consideration, while still satisfying the market value requirement under the ESS start-up concession and qualifying as a “no payment to participate” ESS, with its attendant benefits from a Corporations Act compliance perspective.

On-sale issue for listed companies

Listed companies should be mindful that relief from the on-sale restrictions in the Corporations Act that was covered by the existing ASIC Class Order has not been brought across to the new ESS regime under the Corporations Act. The effect of this is that listed companies will need to issue a cleansing notice under section 708A(5) of the Corporations Act, or a cleansing prospectus, each time shares are issued or options exercised by eligible participants to ensure their shares are tradeable. 

ASIC intend to grant relief to address this issue following the phasing out of the Class Order in January 2023 but are still consulting on this and other questions received in response to the new regime.  
 

|By Saxon Rose & Lily Robinson

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