Employee share ownership plan tax considerations - a guide for employers
Taxation regulations impact on the provision of all employee benefits, including employee share ownership plan (ESOP) benefits.
This page summarises the key taxation considerations associated with ESOPs covered by Australian taxation regulations. This page does not however provide comprehensive advice and any employer or employee considering implementing or participating in an ESOP should seek independent advice on the taxation implications for their particular circumstances.
The principal taxation reference for ESOPs in Australia is Division 13A of the Income Tax Assessment Act 1936.
Key principles of Division 13A
Division 13A contains taxation concessions designed to encourage the establishment of ESOPs in Australia. The rules in Division 13A apply to shares or rights acquired by an employee in respect of their employment for a price that is less than market value (that is at a discount - market value less price paid). Under this Division a share or right acquired under an ESOP will be either:
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Qualifying; or
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Not-qualifying.
Qualifying share or rights plans
Where a company provides ‘qualifying' shares or rights to employees (subject to certain conditions) such employees may be entitled to one or other of the following tax concessions:
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the discount on the shares or rights of up to $1000 is not taxable (exempt benefit), subject to additional exemption conditions or
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a deferral of tax, on the discount on the shares or rights received, for up to a maximum ten years (deferred benefit).
Division 13A sets out the following conditions for a share or right to be a qualifying share or right
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the shares or rights are acquired at a discount under an ESOP and
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the shares or rights offered to the employee are shares or rights in a company which is the employer or holding company of the employer and
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the shares are ordinary shares or rights to acquire ordinary shares and
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at least 75% of Australian employees, with at least three year's full time or permanent part-time service with the relevant employer, were, or at some earlier time had been, entitled to acquire
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shares or rights under the ESOP or
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shares or rights in the employer, or a holding company of the employer, under another employee share ownership plan.
N.B This fourth condition does not have to be met by option plans – option plans can be selective and
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no employee participant in an ESOP holds, or is entitled to hold, more than 5% of the legal or beneficial interest in shares or rights, or control more than 5% of the voting rights in the company.
The two main types of ESOPs that are designed to take advantage of these concessions are commonly referred to as Exempt Share Plans - which provide exempt share benefits and Deferred Share Plans - which provide deferred share benefits.
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Exempt share benefits
Exempt share benefits are shares or rights provided tax free to participants. No tax is payable on receipt of a discount up to $1,000 on the shares or rights. Employees are able to receive this in each year an offer is made.
Any increase in the value of the shares or rights above the initial $1,000 is taxed on disposal or sale as a capital gain. Only half of the capital gain will be subject to tax if the share has been held for at least 12 months. Where the shares fall in value the employee will realise a capital loss.
To access the $1,000 tax concession, the following conditions must also be satisfied (in addition to the qualifying conditions outlined above)
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the shares or rights acquired must not be subject to forfeiture
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there must be restrictions on disposal of the shares or rights for three years or until employment is terminated for any reason (whichever is the earlier)
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participation in the ESOP is open to at least 75% of all full-time and permanent part-time employees who have completed at least three years service on the same basis (i.e. the plan is operated on a non-discriminatory basis)
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an election for the tax exemption must be made by the employee prior to lodgement of their tax return in the year the shares or rights are received
Where an election is made, and the additional conditions outlined in Exempt Share Benefits are met, the employee will qualify for the exempt benefit and will include the value of the shares only to the extent that this exceeds $1000.
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Deferred share benefits
To access the tax deferred benefit, the ESOP must contain at least one of two key elements – the shares or rights must be subject to forfeiture, or there must be restrictions on the employee’s disposal of the shares.
The taxation concession inherent in the deferred share benefit is that the discount on the shares (or rights) does not need to be recognised as income by the employee for tax purposes until the first of the following occurs:
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the shares or rights are sold or withdrawn from the ESOP
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any restrictions on disposal and forfeiture conditions are removed
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the employee's employment ends
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the employee exercises the right and there are no conditions or restrictions attaching to the resulting shares acquired or
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ten years after the shares or rights were received
A participant can also receive the benefit of any growth in value of the shares or rights and any dividends paid. Additionally, if the value of the benefit falls below the original value, then tax is only payable on the lesser end value amount. This provides some downside risk protection on the investment. Any tax payable on the value of the shares or rights, including any reduction or growth in this value, is deferred until the time mentioned above.
There are no capital gains tax implications unless the shares are held for more than 30 days after the earlier of the times mentioned above. Where this is the case, the employee, on disposal of the shares or rights, will be taxed as a capital gain, or will incur a capital loss, in respect of any increase or decrease in the value of the shares or rights.
An employee who receives qualifying shares or rights may alternatively elect for the deferred benefit not to apply. In these circumstances the employee will be taxed on the value of the shares or rights in the year they are received, and will recognise any growth or reduction in value in the shares or rights as a taxable capital gain or a capital loss at the time the shares or rights are disposed of.
The tax deferred share benefit may be more appropriate where more than $1,000 of shares or rights are provided or received each year where an offer is made.
As special rules apply to rights, independent advice should be sought on their disposal or exercise.
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Not-qualifying plans and plans not governed by Division 13A
There are many reasons why a company may wish to embrace the principles of employee equity participation but, for one reason or another cannot, or does not, wish to comply with the qualifying conditions set down in Division 13A. Some of these reasons may include:
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a company chooses to offer other than ordinary shares (eg. preference shares etc)
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a company does not want to make offers to 75% of employees
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a company wishes to offer more than 5% of its shares to one employee
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a company does not have a ready or liquid market in its shares, and therefore wishes to place liquidity restrictions on the shares
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a company does not want employees to receive dividend rights on shares until all performance and/or vesting restrictions have been satisfied
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a company wishes to ‘fund’ the offer of shares by way of a loan
Companies, in these and other circumstances, will be left to satisfy their ESOP needs using a range of plans, which may include:
- loan ESOP (either with or without downside risk protection)
- not-qualifying option plans
- not-qualifying deferred ESOP
- replicator ESOP (includes Share Appreciation Rights, Phantom ESOP, Synthetic ESOP and/or Shadow ESOP)
The taxation of those benefits is complex and often results in Fringe Benefit Tax (FBT) (other plans not governed by Division 13A), income tax (not-qualifying plans under Division 13A) and Capital Gains Tax (CGT) consequences.
Understanding and assessing the taxation implications of these plans is critical for employers and employees alike, and employers and employees should seek appropriate advice on the taxation implications of establishing or participating in one of these plans.
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Other taxation considerations
Stamp duty
Stamp duty is a state based tax levied on, amongst other things, the transfer of unlisted shares. Generally, no duty is payable on the issue or allotment of shares or the transfer of listed shares.
Fringe Benefits Tax (FBT)
A benefit provided by an employer to an employee, or an associate, in respect of employment, is at first glance, subject to FBT. A fringe benefit, however, excludes such payments as salary & wages, exempt benefits (as defined), Division 13A ESOP benefits, superannuation and eligible termination payments. FBT may arise in respect of certain other plans not governed by Division 13A and employers should seek professional advice on the structure and establishment of these plans.
Capital Gains Tax (CGT)
CGT is a tax imposed on, amongst other things the gain from the disposal or deemed disposal of an asset. CGT is imposed on the net capital gain accruing to the taxpayer. If an asset is held by an individual for at least 12 months, in most circumstances, only half the gain will be taxed. Where a share is acquired from the exercise of a right, the 12 month period commences from the date of exercise.
Payroll tax
Payroll tax is levied on benefits provided to employees under an ESOP in some Australian states.
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Taxation treatment of employee share ownership plans
The Taxation Treatment of Employee Share Ownership Plans diagram summarises the taxation treatment of ESOPs and is adapted from the website of the Australian Taxation Office. Further details can be found at www.ato.gov.au.
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Where can I get further information?
Further information on tax considerations related to ESOPs can be found at:
w: www.workplace.gov.au/eso
w: www.ato.gov.au
p: 1800 181 088 – ESO enquiry line
e: employeeshareownership@deewr.gov.au
a: GPO Box 9879, Canberra ACT 2601
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Important notice
This publication is produced for general information only. It does not represent professional advice given by the Commonwealth or any person acting for the Commonwealth for any particular purpose. Users should make their own further enquiries, (including as to the accuracy, currency, reliability or completeness of any information contained in this publication) and obtain professional advice where appropriate, before making any decision to take action or not take action on any matter which it covers.
To the maximum extent permitted by law, the Commonwealth and all persons acting for the Commonwealth in preparing this publication, disclaim all responsibility and liability to any person, arising directly or indirectly from any person taking or not taking action based upon the information in this publication.
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