Employee Share Schemes

In Australia, companies sometimes reward employees with shares in recognition of their services. These are known as Employee Share Schemes (ESS), share purchase plan, share option, or equity scheme. Such schemes are often used by small start-ups to attract new staff in a competitive market, or by more established businesses to retain their workforce over the longer term. In effect, providing employees with shares in the business should align worker and company interests. 

Employee Share Schemes

Companies operating an ESS may offer shares to all employees as part of their total compensation (contingent on minimum wage obligations under the Fair Work Act 2009). Alternatively, a company can offer shares only to a select group of workers, such as senior managers and directors.

Some ESSs allow employees to buy shares at a discounted rate against the market price. In such cases, participant employees may also be able to take out loans from the employer to purchase the shares, and/or may not have to pay a brokerage fee when buying or selling shares. Some ESSs allow employees to pay for shares through salary sacrifice, or over a period of time.

Larger companies usually offer ordinary shares, which afford an equity investment in the company. A smaller company may give dividends only, meaning the employee does not have shareholder rights, such as the ability to vote in the annual general meeting.

Tax concessions

The Income Tax Assessment Act 1997 provides several concessions under an ESS, including:

• tax deferral on the issue of performance rights, options and share appreciation rights;
• salary sacrifice tax deferral for acquisitions under $5,000 per annum;
• employees with a taxable income less than $180,000 receive a tax-free discount up to $1,000 per annum on the market value of shares; and
• employees of eligible start-up receive tax concessions for certain grants of options and shares.

ESS as investment

An employee buying shares under an ESS should approach the decision as they would any other investment. The same hesitation should apply when deciding whether to agree to receive shares instead of higher rates of compensation. Employees should research the company before committing to the transaction and familiarise themselves with the terms of the share scheme. For instance, employees need to know whether they can freely sell their shares, when they will receive dividend payments, what happens to the shares if they leave the company, and any tax implications.

If the company performs well, the employee should benefit financially from owning shares. However, like any other investment, shares can go down in value or lose their value altogether if the company fails. Additionally, there are likely to be limitations on when the employee can buy and sell shares, and if they are paying for shares over time, the employee may have to pay off the debt before they can sell the shares. There may even be a requirement for the employee to return or sell their shares back to the employer when they leave the company. Also, the share package may come with restrictions, such as performance targets or the requirement to stay on with the company for a number of years to retain the shares.

Employee share trusts

ESS interests are sometimes held in structures called Employee Share Trusts (ESTs). In such cases, the EST is the owner of all shares that are held for the beneficial interest of all participating employees of the company.

There are commercial benefits to ESTs. One of the most obvious is that it allows private companies to maintain privacy by having only one name (the trustee) on the share register, instead of every employee shareholder. The trust structure also allows a given number of shares to be “warehoused” as an ESS interest, and then transferred to employees progressively over time. There are also administrative efficiencies, such as allowing the recycling of shares that would otherwise be forfeit, avoiding dilution of existing shareholders’ equity and removing the need to obtain shareholder approvals.

There are also certain tax benefits to the EST structure:

• the trust is ignored for capital gains tax (CGT) purposes, meaning that the shares are treated as if the employees directly own the shares, potentially making CGT calculations more straightforward;
• capital losses and gains are disregarded for certain CGT events; and
• employer contributions to the trust are exempt from FBT.

Ineligible activities

In 2020, the Commissioner of Taxation implemented a crackdown on ESTs. The crackdown focuses on ESTs that engage in activities that are not directly related to the acquisition, holding, and distribution of shares within the ESS. If a trust carries out such ineligible activities, it is no longer an EST and can never regain that status. The following have been identified as ineligible activities:

• distributing primarily cash payments to participating employees instead of shares or ESS interests;
• providing benefits to participants or employees beyond the delivery of ESS interests or resulting shares, and associated dividends;
• providing financial assistance, such as loaning money, to purchase shares or interest in the company;
• paying income or accrued capital from unallocated shares to a beneficiary or non-beneficiary employee;
• distributing income or capital unrelated to interests or entitlements;
• engaging in trading activities other than purchasing or selling shares to satisfy obligations under the ESS;
• investing in assets other than rights or shares in the employer country;
• borrowing money for purposes other than purchasing rights or shares in the employer company, with security provided by the trust’s assets, or where the interest on the loan exceeds standard commercial rates; and
• relinquishing certain entitlements, such as the right to payment or dividends in accordance with a dividend waiver clause in the governing trust documents.

Go To Court Lawyers can provide advice to a company or employee about the legality of employee share schemes. Please contact the team on 1300 636 846.