As a small business or an unlisted company, it is usually harder to attract, retain and motivate employees compared to that of a sizable corporation or listed company. One effective way to achieve employee retention and promote employee motivation is for a small business or unlisted company to offer an employee share scheme (ESS) to its employees, allowing them to invest in and share in the growth and success of the business or company.
An ESS generally has a life span of two to 15 years. It aligns a company and its employees’ interests by creating ownership of company shares by employees. It is offered in addition to salary and wages and only for certain groups of employees (such as senior managers and directors) and their related persons. The ESS offer to employees may also have potential tax efficiencies.
The Corporations Act 2001 (Cth) (Corporations Act) governs a company’s obligations in offering an ESS to its employees, including requirements on disclosure, licencing, advertising, hawking and the on-sale of financial products. Exemptions to these regulatory requirements are available to eligible companies but they are restrictive.
Types of ESS
There are many types of ESS including the most commonly distinguished restricted share plans and broad-based share plans.
Restricted share plans are reasonably popular. They involve offering to an eligible employee (on a discretionary basis, e.g. offering to senior executives of a company or non-employee participants) a specific number or monetary value of ordinary shares in a company. Such an employee is restricted from, during a specified restriction period, selling, transferring, or dealing with the ordinary shares, but is entitled to receiving dividends and vote in a general meeting of the company. The restriction is lifted at the end of the specified restriction period and the ordinary shares will then vest in the employee.
Broad-based share plans are non-discretionary. They must be operated on a non-discriminatory basis, i.e. the plans must be offered on the same terms to at least 75% of a company’s permanent employees who have at least three years of service and who are Australian residents for Australian income tax purposes. The plans must have no real risk of forfeiture and the participating employees must hold their shares for a minimum holding period of three years (subject to some exceptions). An eligible employee is offered ordinary shares in the company at a discount of up to $1,000 in each financial year, usually for nil consideration.
Tax Concessions
The type of ESS generally determines its tax treatment. The tax treatment can be either concessional or non-concessional.
If a company and its employees follow special tax rules, tax concessions can apply to ESS interests. An ESS interest is either a beneficial interest in a share of a company or a right to acquire a beneficial interest in a share of a company.
To gain the benefit of tax concessions, including tax deferral on the issue of options, performance rights and share appreciation rights, salary sacrifice tax deferral for acquisitions, a tax-free discount, and start-up tax concession for certain grants of shares and options to eligible start-up companies, an ESS must be set up in such a way to ensure that the conditions of Division 83A of the Income Tax Assessment Act 1997 are met.
Vesting Conditions
Generally, the vesting conditions of a restricted share plan require a participating employee to remain in employment with the company for a specified period and to achieve an acceptable level of individual performance.
As broad-based share plans cannot be forfeited, they are not subject to any performance-based vesting conditions.
Disclosure Relief
Division 1A of Part 7.12 of the Corporations Act provides disclosure and licensing relief for ESS offer which does not require monetary consideration to participate, except for making a statement that the offer is made pursuant to Division 1A of Part 7.12 of the Corporations Act. Such relief is particularly useful for companies that wish to offer ESS interests for no monetary consideration, with minimal disclosure requirements when making the offer.
For ESS offer that requires monetary consideration to participate, the historical ASIC disclosure requirements still apply, including provision of an offer document, financial information, valuation of the interests being offered, and a directors’ solvency statement. Certain relief may be offered to an unlisted company, if, among others:
(1) the total number of securities issued under the ESS over the previous three years does not exceed 20% of the company’s issued capital, unless otherwise specified by regulations or the company’s constitution; and
(2) there is a monetary cap of $30,000 cash per participant outlay under the ESS offer in a 12-month period (from the day the ESS participant accepts the offer under the ESS), plus an additional 70% of any dividends and 70% of any cash bonuses received in that year. The cap includes money expended or loans taken out on offers.
Reporting and Withholding Obligations
The company offering ESS to its employees has reporting and withholding obligations.
The reporting obligations include providing ESS statement to an employee by 14 July after the end of a financial year (taking account of the 30-day rule), reporting eligible start-up concession and ESS interests provided to an associate of an employee, and lodging ESS annual report with the Australian Taxation Office.
Withholding is not payable if an employee has given their TFN declaration for their employment. However, where no TFN has been provided, the company must pay tax on the discount at the highest marginal rate.
Criminal Liability
There are several offences under Division 1A of Part 7.12 of the Corporations Act including misleading or deceptive statements offences and offences relating to holding ESS participant’s money. It is important that any offer document and any supporting documents do not contain any misleading or deceptive statements or omissions, and the company offering an ESS does not breach any of the requirements for ESS offering, the monetary cap, issue cap and disclosure timeframe. Regulatory relief can be revoked in case of any of these breaches.
Shareholders Agreement
Last but not least, changes may be required for a company’s shareholders agreement if an ESS participant will become a shareholder of the company. Any changes to the shareholders’ agreement must set out the rights and obligations of shareholders, whether existing or new.
Early Legal Advice
The process of offering an ESS involves careful consideration and analysis of a company’s objectives and a weighing up of the various pros and cons. An ESS not properly set up may lead to non-compliance with the Corporations Act and unnecessary disputes with employees. For these reasons, it is crucial for a company to consult a lawyer and obtain legal advice early on before planning to offer an ESS.
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