Home Business & Company Employee Share Schemes for Small Companies: Have the 2022 Reforms Made Things Easier?

Employee Share Schemes for Small Companies: Have the 2022 Reforms Made Things Easier?

The short answer is yes, but only up to a point. From a corporate law perspective, the reforms have made things significantly easier for many small companies. However, that does not automatically mean the company or its employees will qualify for the most favourable tax treatment.

In March 2022, the Australian Government announced reforms aimed at making employee share schemes (ESS) easier and less costly for companies to implement. Those reforms commenced on 1 October 2022.

So what does that mean for small proprietary companies, often referred to as closely held or family companies? Have the reforms actually made it easier to put an ESS in place and take advantage of the available tax concessions?

The short answer is yes, but only up to a point.

From a corporate law perspective, the reforms have made things significantly easier for many small companies. There is now a clearer and more practical pathway for offering shares or options to employees without the same level of disclosure burden that previously applied.

However, the tax position remains a separate issue. While it is now easier to implement an ESS, that does not automatically mean the company or its employees will qualify for the most favourable tax treatment.

Benefits of ESS

Employee share schemes help align the interests of employees with the employer and existing shareholders.

This can be a very effective way for employers to retain and motivate key staff.

It can also improve productivity and workplace cooperation, as employees often feel more invested in the performance and long-term success of the business when they have a direct ownership interest.

For small companies, an ESS can also be a useful succession planning tool. It can provide a structured pathway for bringing senior employees into ownership over time, without requiring an immediate transfer of control.

There can also be tax advantages available under the employee share scheme rules. But it is important to understand that those tax outcomes depend on how the arrangement is structured and whether the relevant requirements are met.

Depending on the circumstances, an employee may receive concessional treatment, a deferral of tax, or be taxed upfront on any discount received.

Employee share schemes help align the interests of employees with the employer and shareholders.

This can be a good way for employers to retain and motivate their employees.

It can improve productivity and workplace cooperation as employees feel that they have a direct interest in the performance of the company.

Tax Concession Requirements for an Eligible ESS

If a company wants employees to access the start-up ESS tax concession, a number of conditions must generally be satisfied.

Broadly speaking, these include the following:

  • the company must not be listed on a stock exchange;
  • the company must have been incorporated for less than 10 years;
  • the company must not have aggregated turnover exceeding $50 million;
  • the company must be an Australian tax resident;
  • in the case of shares, the discount must generally be no more than 15% of market value at the time of acquisition;
  • in the case of options, the exercise price must generally be equal to, or greater than, the market value of an ordinary share at the time the option is acquired;
  • the ESS interests must relate to ordinary shares;
  • there is generally a minimum holding period of 3 years, although that period can end earlier in some cases, such as cessation of employment;
  • a participant must not, immediately after acquisition, hold more than 10% of the shares in the company or control more than 10% of the voting rights; and
  • in some cases, participation must be available on a broad basis to at least 75% of permanent employees with the required period of service who are Australian tax residents.

It is important to be clear about what these requirements mean.

These are not the conditions for every employee share scheme.

They are the kinds of conditions that must be met if the company wants employees to access particular tax concessions under the ESS tax rules.

A company can still put in place an ESS even if one or more of those conditions are not met. The result is usually not that the scheme is invalid, but that the relevant tax concession may not be available.

Disclosure Requirements for an ESS

This is where the 2022 reforms have made the biggest practical difference for small companies.

Before 1 October 2022, the disclosure and compliance requirements were often a major obstacle for proprietary companies wanting to offer shares or options to employees. In many cases, the cost and administrative burden made an ESS impractical.

That has now changed.

Since 1 October 2022, the Corporations Act has contained a specific ESS regime designed to make these offers easier and more accessible.

In many cases, an eligible ESS offer can now be made without the need for a prospectus or offer information statement, provided the statutory requirements are met.

For small proprietary companies, this is a significant improvement. It reduces both the cost and complexity of implementing an ESS and removes one of the main barriers that existed under the previous regime.

That said, the process still needs to be handled properly. A company must ensure that the offer falls within the current statutory framework and that the plan documentation is prepared carefully. The fact that the regime is simpler does not mean the arrangement should be put in place informally.

The most common issues for small companies

Targeted participation

Most small companies do not want to offer shares to all employees.

Instead, they usually want to target the offer to a small number of key employees who have demonstrated value, loyalty and leadership potential.

That is still possible.

In particular, option-based arrangements may offer more flexibility than direct share offers when it comes to satisfying the tax concession rules and managing ownership outcomes.

So while broad-based participation can still be relevant in some cases, it is no longer accurate to say that a small company must always run a general employee-wide scheme in order to implement an ESS.

The 10% ownership threshold

Many business owners want to use equity as part of succession planning and may want a key employee to acquire more than 10% of the company over time.

That can still be done.

However, if the employee exceeds the 10% ownership or voting threshold, the relevant ESS tax concession may no longer be available.

This is therefore better understood as a tax limitation, rather than a prohibition on issuing or transferring the shares.

Cost and administration

The cost and administration involved in implementing an ESS have improved significantly since the reforms.

The old assumption that a small company would necessarily need an offer information statement and audited accounts is no longer a reliable starting point.

Even so, there is still legal, valuation, tax and compliance work to be done, particularly where the company wants the arrangement to fit within the concessional tax rules and work effectively alongside its constitution and shareholder arrangements.

How then can Small Companies bring on Employees as Shareholders?

Just because a particular tax-concessional ESS may not be available does not mean a small company cannot bring employees into ownership.

A small company may still be able to:

  • issue shares to an employee;
  • grant options or rights to an employee; or
  • transfer existing shares to an employee.

The important point is that the transaction should be structured carefully from the outset.

If shares or options are provided to an employee at a discount in connection with their employment, the arrangement may still fall within the employee share scheme tax rules even if the documents are called something else.

Whether the shares are issued or transferred to an employee, it is important that the transaction is documented correctly. This will usually involve:

  • a Share Subscription Agreement or Share Sale Agreement with the employee; and
  • a Shareholders Agreement between all shareholders of the company.

When it comes to the Shareholders Agreement, we generally recommend the inclusion of good leaver and bad leaver provisions, together with a well-drafted Employment Agreement, to give the best protection to the business and its owners.

Final Comments

The 2022 ESS reforms have made it materially easier for small proprietary companies to implement employee share schemes from a corporate law perspective.

That is good news for business owners who want to reward, retain and incentivise key employees through equity participation.

But the tax position still requires careful attention.

For many small companies, the real question is no longer whether an ESS can be implemented at all. The real question is how to structure the arrangement so that it works commercially, fits within the current legal framework, and achieves the best available outcome for both the company and the employee.

If you are considering issuing shares or options to employees, it is important to obtain advice on the structure before any offer is made.

Need advice on putting an ESS in place?

If you are thinking about bringing a key employee into ownership, whether through shares, options or a staged succession strategy, careful planning at the start can save considerable cost and difficulty later.

Roberts Crosbie Mortensen Lawyers can assist with the legal documentation and structuring required to help small companies implement employee equity arrangements properly.

Contact us to discuss whether an ESS, share issue or share transfer is the right approach for your business.

Corporate Commercial Lawyers for Sydney & Newcastle

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The information in this article is not legal advice and is intended to provide commentary and general information only. It should not be relied upon or used as a definitive or complete statement of the relevant law. You should obtain formal legal advice specific to your particular circumstance. Liability limited by a scheme approved under Professional Standards Legislation.

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Author
Amanda Crosbie
Partner
Accredited Specialist (Business Law)