The changes made to the taxation of employee share schemes in 2009 meant that employee share schemes were no longer a viable strategy for private businesses. The tax cost of traditional arrangements became excessive for the employees and the costs to design tax effective arrangements were prohibitive. Unwinding the 2009 changes is welcome, but needs to be undertaken in the context that the pre-2009 rules weren’t perfect. The government should use this as an opportunity to improve the overall treatment of employee share schemes, not just re-implement the old rules replete with their flaws.
For shareholders in private companies, taxing discounted options when they are converted to shares rather than when they are issued is merely moving the issue. Shares and options in privately owned businesses are not readily convertible to cash. There is no market for shares in private companies, as opposed to public companies where the shares can be traded on the applicable exchange. The concession should defer the taxing point until the employee share is sold. This would overcome the unfunded tax liability issue, which is the primary issue impeding the implementation of employee share arrangements by private companies.
The announced concessions for start-ups is welcomed, but we (and others) have been calling for this for a long time now, so we need to see action not announcements.
The proposal to defer taxation until sale is a very positive move and the indicative eligibility criteria are generous enough that they should capture most start-up style businesses. We’d called for a $20 million threshold in submissions to treasury, so a $50 million threshold is better than had been hoped for.
I would only question the “being incorporated for less than 10 years” condition because the lives of companies are such that some small-scale companies may exist for years before a change leads them to becoming start-up in nature.
A key issue is going to be addressing the rate of taxation applying to the gains made on the employee shares – essentially, should it be taxed as income (at full rates) or a capital gain (and benefit from the 50 per cent discount)?
Treating the gain as a capital gain is appropriate as:
– The gain represents a growth in the capital value of the business and so is inherently capital in nature. It can be distinguished commercially from a bonus paid out of profits and the tax treatment should reflect this
– The gain arises in a single income year although the gain has accumulated over a number of income years. Due to the marginal tax rates, taxing the whole gain as income in a single year will result in an artificially high effective rate of tax applying to the gain
Other countries – such as the UK, Singapore, Canada and Israel – apply a concessional rate of tax to employee share scheme related gains. Australia competes against these countries for innovative and entrepreneurial business and we need to recognise this reality in designing the revised tax rules.
In implementing these changes the government needs to ensure that it does not impose unnecessary compliance costs. If the rules could be designed so that valuation requirements were removed for start-ups, that would be a very positive step. This can be achieved by taxing the gain made on employee share as a capital gain with tax being imposed in the year in which the shares are sold.
Greg’s tax expertise and 20 plus years’ experience as a Chartered Accountant enables him to work with clients to deliver practical, commercially focused outcomes, whether it’s a technical tax matter or a broader business issue. Recognised as one of Australia’s leading tax advisors, Greg has assisted countless businesses, individuals and families to deal with complex and significant tax issues. He is a published author and regular conference presenter.