Reform to Australian employee share scheme tax and regulatory rules

Written by Justin Rossetto, Andrew Clements, Jack Hill, Yiwen Chen, Amanda Kazacos and Tim Wells.

On 29 July 2021 Treasury released exposure draft legislation that proposes to amend the tax rules and regulatory requirements relating to employee share schemes (Proposed Amendments).

The Proposed Amendments were announced in May as part of the 2021-22 Federal Budget (see previous alert) and the regulatory aspects of the Proposed Amendments were also subject to public consultation during April 2019.

The Proposed Amendments are designed to make it easier for businesses to offer Employee Share Schemes (ESS) and to remove the taxing point that currently arises for securities granted under an ESS (ESS interests) when the holder of the ESS interests ceases employment.

Key takeaways:

The removal of the taxing point on cessation of employment is helpful because it means holders of ESS interests will only be taxed where they have received an actual benefit that can be used to cover the cost of the tax.
The regulatory changes are likely to result in companies moving away from 'matching' or 'contribution' schemes. That is because under the Proposed Amendments the regulatory regime applying where participants are required to pay monetary consideration for their ESS interests is more burdensome than the regime applying where the participants receive their ESS interests 'for free'.
From a regulatory perspective, the Proposed Amendments are helpful for unlisted companies but are unlikely to have any material impact for listed companies.

1. Consultation process: An opportunity for you to provide feedback

Consultation on the exposure draft is open until 25 August 2021. We will be providing a submission on various aspects of the draft legislation.

2. Removal of taxing point on cessation of employment

The Proposed Amendments will remove the cessation of employment taxing point for the tax‑deferred ESS that are available for all companies.

The taxing point on cessation of employment has been a major focus and area of concern for those involved in employee ownership for many years, owing to the cessation of employment not necessarily aligning with a liquidity event.

Key takeaways:

Applies to shares and rights, the change will require alterations to plan design to maximise the benefits.
Will apply to new interests only, so limited opportunity for existing securities.
At present the start date is not until 1 July 2022.[1]

How will the new changes work?

This change will apply to ESS interests (both shares and rights) issued on or after the first 1 July after the commencement date.

Importantly the commencement date is not until the first 1 January, 1 April, 1 July or 1 October to occur the day after the enabling legislation receives Royal Assent. This means that provided the enabling legislation receives Royal Assent before 1 April 2022, this change will apply to ESS interests issued on or after 1 July 2022. One of our submissions relating to the Proposed Amendments will be that the start date for the regime should not be deferred until the next financial year after the commencement date of the legislation (as is presently the case).

Currently, under a tax‑deferred ESS, employees may defer tax until a later tax year (the deferred taxing point) if certain criteria are met. The deferred taxing point is the earliest of:

cessation of employment;
in the case of shares, when there is no risk of forfeiture and no restrictions on disposal;
in the case of options, when the employee exercises the option and there is no risk of forfeiting the resulting share and no restriction on disposal; and
the maximum period of deferral of 15 years.

This change will result in tax being deferred until the earliest of the remaining taxing points.

This change will also mean the traditional structuring of share plans (to include a release date when there is risk of forfeiture and restrictions on disposal at cessation of employment), will need to change.

A key issue which will need to be resolved is the extent to which an effective restriction to allow for continuing deferral will exist where employees have flexibility as to when they can access shares.

The Proposed Amendments should not impact unlisted companies eligible for start-up concessions, loan schemes with or without a nominal discount and premium priced option arrangements.

3. Regulatory reforms

Key takeaways:

The Proposed Amendments will help simplify the regulatory regime that currently applies to ESS offers.
The Proposed Amendments are based on the existing ASIC class orders for ESS and provide similar relief to those class orders.
To benefit from the relief provided by the Proposed Amendments, more conditions need to be satisfied where the ESS offer requires participants to pay monetary consideration for their ESS interests than where participants get their ESS interests 'for free'.
The Proposed Amendments are particularly beneficial for unlisted companies. That is because a broader range of ESS offers can be made by unlisted companies in reliance on the relief provided by the Proposed Amendments than can be made in reliance on the existing ASIC class order relief.
The Proposed Amendments are unlikely to require companies to substantially re-write their ESS terms and it will still be necessary for offer documents to be provided to participants even where they are not technically required under the Proposed Amendments. The disclosure may be simplified.
It may be necessary for companies to review how those documents are prepared to deal with the changed liability regime.

Background

ESS offers trigger a range of obligations under the Corporations Act, including in relation to disclosure, financial services licensing, advertising, hawking and the on-sale of financial products.

The Corporations Act provides exceptions from certain of those obligations for ESS offers and ASIC has also provided relief from those obligations for certain ESS offers through class orders (refer to ASIC CO 14/1000 for listed companies and ASIC CO 14/1001 for unlisted companies). The broad and fragmented nature of the regulatory regime currently applying to ESS and the limits to the relief provided under the class orders have often deterred or made it difficult for companies to offer ESS in Australia – particularly unlisted companies.

The Proposed Amendments should help demystify that regulatory regime and make it easier for companies to comply with the regime.

The Amendments

The Proposed Amendments significantly reduce the regulatory burden on companies (both listed and unlisted) that offer ESS interests 'for free' compared to the existing ASIC class orders.

The Proposed Amendments also provide greater flexibility for companies (both listed and unlisted) where ESS offers require participants to pay monetary consideration although a number of conditions and restrictions, which are similar to those which apply under the existing ASIC class orders, will continue to apply.

Set out below is a table summarising the Proposed Amendments from a regulatory perspective.

ESS offer	Comparison against ASIC Class Order requirements
1. Listed companies – Offers of ESS interests 'for free'	It is simpler to benefit from the relief than under ASIC CO 14/1000. There is: no requirement to issue an offer document containing prescribed information; no cap on the number of securities that may be issued in any 3 year period; and no requirement to file a notice of reliance with ASIC. It will still be necessary for documents to be provided to participants to give participants information on what they are being offered. The documents can be simplified because they will have no prescribed content.
2. Listed companies – Offers of ESS interests requiring participants to pay monetary consideration	A streamlined form of disclosure will be required in the form of an ESS offer document similar to ASIC CO 14/1000. The offer document will need to include certain prescribed disclosures; ASIC will need to be notified of offers being made and a cap on the number of securities that may be issued in any 3 year period will apply. Where an ESS offer document is required it will be subject to a range of offences, civil penalty provisions and defences that are consistent with those that apply to other disclosure documents required under the Corporations Act (e.g. a prospectus). That is, there will be deemed liability for directors and a due diligence defence. This is different to the current position under ASIC CO 14/1000. Companies should review the processes they undertake to prepare their offer documents.
3. Newly listed companies	Newly listed companies will now have access to the relief under the Proposed Amendments straight away. This will simplify the process for newly listed entities. Unlike under ASIC CO 14/1000, there is no requirement for a company's shares to have been quoted for 3 months before a company can benefit from the relief provided by the Proposed Amendments.
4. Unlisted companies – Offer of ESS interests 'for free'	It will be much easier to rely on the relief than it currently is under ASIC CO 14/1001. These changes are significant. There is no limit on the value of offers that may be made to a participant in any 12 months. This is in direct contrast to the $5k limit under ASIC CO 14/1001. Similarly, there is no requirement to issue an offer document containing prescribed information, no requirement to provide any valuation information and no requirement to file a notice of reliance with ASIC. It will still be necessary for documents to be provided to participants to give participants information on what they are being offered. The documents can be simplified because they will have no prescribed content.
5. Unlisted companies – Offer of ESS interests requiring participants to pay monetary consideration	A streamlined form of disclosure will be required in the form of an ESS offer document that includes certain prescribed disclosures. It is similar to the disclosure required under ASIC CO 14/1001. Importantly, it is not restricted to ESS where shares are provided 'for free'. ASIC will need to be notified of offers being made and a cap on the number of securities that may be issued in any 3 year period will apply. There will also be an increased $30k cap on the value of awards that may be offered to a participant in any 12 month period (up from $5k under ASIC CO 14/1001). Similar offences, civil penalty provisions and defences described above will apply to ESS offer documents required to be prepared by unlisted companies.

4. Where to from here?

The reforms to employee share scheme rules are very welcome, particularly those which allow companies to rely on broad based securities law relief and those dealing with the taxation of ESS interests on the cessation of employment.

The changes to the regulatory regime have the potential to simplify the administration of offers of ESS interests. These changes will streamline the regime and may assist Australian businesses in attracting and retaining talent.

5. What else? Potential for Employee ownership trusts

As an alternative to ESS, a particular area of interest in the Australian market at present is the potential for the introduction of an "employee ownership trust" in a similar form to that which has been used for some time in the United Kingdom and is being introduced in Canada. Unlike the employee share trusts that are currently used to distribute ESS interests to individual employees, employee ownership trusts hold shares collectively on behalf of current and future employees generally. This can provide significant benefits over a conventional allocated scheme arrangement for unlisted companies.

There is very strong market interest in the potential use of employee ownership trusts in Australia as an alternative form of employee ownership.

We believe that there are aspects of the current tax rules which could be amended to improve the opportunity to facilitate employee ownership trusts in Australia and will continue to be involved in this area.

Please do not hesitate to contact a member of the King & Wood Mallesons team if you would like further information regarding the Proposed Amendments or would like to participate in the consultation process.

[1] This will be the starting date provided the legislation receives Royal Assent before 1 April 2022.