Employee share schemes (“ESS”s) encourage equity ownership in employer companies by enabling shares (or rights to obtain shares) to be obtained at a discount to their market value.
Any such discount would, in the absence of the ESS rules, either be taxable income or a property fringe benefit, with capital gains tax rules applying to disposals.
Tax concessions include the discount being wholly or partly tax free upfront, and/or the tax on increase in value being deferred until the release of restrictions or disposal.
The Tax Office has released a ruling reviewing what is a genuine restriction. See Taxation Determination TD 2022/4. The determination applies both before and after the date of issue.
In general, ESS upfront tax free discounts are coupled with capital gains tax rules (including the CGT 50% discount) applying to the subsequent disposal.
An ESS deferral of tax without any upfront discount will generally result in tax on the increase in value as income at the deferred taxing point.
This indicates a possible planning choice in circumstances where the CGT rules with CGT discount might contribute to a better tax outcome.
1 July 2022 Changes To Taxing Point Rules
For deferred tax ESS schemes, cessation of employment as a tax trigger is removed for employees ceasing employment on or after 1 July 2022. This applies to both new and existing schemes.
Employer reporting obligations are adjusted to reflect the change.
The measures were contained in the Corporate Collective Investment Vehicle Framework and Other Measures Bill 2021 which received assent on 22 February 2022.
Removal of the cessation of employment as a taxing point from 1 July 2022 means that tax will otherwise generally be deferred until the earliest of vesting, exercise of options, removal of sale restrictions or the elapse of 15 years from the date of grant.
A further explanation of the measures is set out here. (KPMG Global)
The ESS rules for concessional tax treatment apply to shares, stapled securities, rights and options to acquire shares or stapled securities.
Draft Taxation Determination TD 2022/8 provides that capital expenses incurred in establishing and an Employee Share Scheme qualify as blackhole expenditure, deductible in equal proportions over 5 years.
On this page:
- Current Rules Div 83A
- History of Employee Share Schemes
- Rules from 1 July 2015 – summary
- From 1 July 2009 to 30 June 2015
- Tax return instructions
- Up to 30 June 2009
- See also..
[update 29 Mar 2022] In the Budget for 2022-23 the government has announced its intention to expand access to employee share schemes to employees at all levels, and reduce red tape.
Where employers make larger offers in connection with ESS in an unlisted company, participants can invest up to:
• $30,000 per participant per year, accruable for unexercised options for up to 5 years, plus 70% of dividends and cash bonuses; or
• any amount, if it would allow them to immediately take advantage of a planned sale or listing of the company to sell their purchased interests at a profit.
Regulatory requirements for offers to independent contractors will be removed where they do not have to pay for the interest.
[update 23 Aug 2021] The Federal Parliament has released a report with recommendations on the tax treatment of Employee Share Schemes with aims that include simplifying certain compliance aspects and encouraging greater access by individuals.
See Employee Share Schemes: Supporting new businesses, innovation, and start-ups, links to the Report and further commentary (King & Wood Mallesons)
Current Rules – Division 83A Amendments – 1 July 2015
Applicable from 1 July 2015, the government reversed some of the measures introduced from 1 July 2009 and created new concessions for startup companies.
One of the principal objections to the 2009 rules had been the linkage of the taxing point for options with the “no real risk of forfeiture” condition, the fulfillment of which can sometimes be unclear in practice, and also potentially creates a tax burden before value is realisable, particularly in startup companies.
The 2015 amendments addressed this issue by moving the taxing point for rights to the time of exercise.
ESS Rules from 1 July 2015 – summary
- Unless there is a real risk of forfeiture at the time of acquisition, an employee is taxed upfront, with the first $1,000 of discounts tax free (subject to adjusted taxable income not exceeding $180,000).(1)
- Otherwise the taxing point for the discount is deferred *(subject to salary sacrifice benefits limit of $5,000) until the earlier of:
- For shares:
- when there is no real risk of forfeiture and restrictions on sale are lifted;
- cessation of employment; or
- 15 years
- For rights:
- on exercise of right, and after exercising there is no real risk of forfeiture and restrictions on sale are lifted;
- cessation of employment; or
- 15 years
- For shares:
* The deferred taxing point can be delayed by up to 30 days to the date of disposal, if the disposal of the employee’s interest occurs within 30 days of the original deferred taxing point. (sec 83A.115, 83A.120). This could potentially have the effect of shifting the taxing point into the following financial year.
- The deferred gain is included in taxable income and is calculated as the difference between market value at taxing point and the cost base.
- A tax refund can be claimed in respect to the taxed discount on forfeitures not the subject of:
- an employee choice (except a choice to leave employment); or
- a market value protection scheme condition
- There are annual reporting obligations on employers, and tax withholding requirements for non-quotation of ABN or TFN (no change)
- An employee is limited to 10% ownership or control of voting rights (previously 5%)
- Eligible startup companies: From 1 July 2015 a tax exemption is available for a discount of up to 15% of market value, with capital gains on the shares or rights being taxed under the capital gains tax rules (with access to the CGT 50% tax discount, and the cost base equal to full market value). (For more – see ‘Startups‘ below)
(1) Eligibility for the upfront income reduction concessions requires (Sec 83A-35):
- $180,000 adjusted income test satisfied (except for the startup concessions)
- the scheme is non-discriminatory: offered to at least 75% of the permanent employees who have completed at least 3 years of service (whether continuous or non-continuous) and who are Australian residents.
- there be no real risk of forfeiture
For commentary on the meaning of ‘real risk of forfeiture’ see ATO ID 2010/61 and ATO here.
Div 83A before and after 1 July 2015
|Up to 30 June 2015||From 1 July 2015|
|Deferred taxing point for shares is the earliest of when there is no real risk of forfeiture and restrictions on the sale are lifted, cessation of employment, or 7 years||Deferred taxing point for shares is the earliest of when there is no real risk of forfeiture and any restrictions on the sale are lifted, cessation of employment, or 15 years
|Deferred taxing point for rights is the earliest of when there is no real risk of forfeiture and restrictions on the sale or exercise are lifted, cessation of employment, or 7 years||Deferred taxing point for rights is the earliest of when rights are exercised, after exercising the right there is no real risk of forfeiture of the underlying share and the restrictions on sale of the share are lifted, cessation of employment, or 15 years|
|An employee is limited to 5% ownership or control of up to 5% of the voting rights||An employee is limited to 10% ownership or control of up to 10% of the voting rights|
|The ESS rules generally use ordinary meaning of market value and do not specify valuation methodology. The valuation method can also be specified by regulation.||The ESS rules generally use the ordinary meaning of market value. The Commissioner can approve optional safe harbour valuation methodologies. The valuation method can also be specified by regulation.|
|No startup company concessions.||Tax exempt discount for startup company employee shares granted at a discount of up to 15 per cent, and tax deferred on options granted with an exercise price greater than or equal to the market value of the underlying shares, taxed under the CGT rules with 50% CGT discount applicable|
Concessions aimed at eligible startup companies took effect from 1 July 2015.
For shares issued to startup company employees for less than the market value, a discount of up to 15% is tax free, with capital gains tax applicable (including access to the CGT 50% discount) on disposal.
Rights (options) must have an exercise (strike) price equal to or greater than the market value of the company’s ordinary shares.
Examples of the tax treatment for each of shares and options (drawn from the Explanatory Memorandum):
Example 1.1: Shares
Tracy is issued with 10,000 shares in a small Australian start-up entity under an ESS. The shares at issue have a market value of $1 per share.
Tracy contributes 85¢ per share under the scheme. Tracy and the ESS meet all the rules for her 10,000 shares to be covered by the small start-up ESS tax concession. After 5 years, the Australian start-up entity is sold under a trade sale where Tracy receives $1.50 per share for each of shares.
On acquisition, Tracy receives a discount of $1,500 which is not included in her assessable income (i.e., not subject to income tax). Her shares will then have a cost base for capital gains tax purposes of $10,000.
When Tracy sells her shares she has a discount capital gain of $2,500 this is included in her net capital gain or loss for the income year. If she has no other capital gains or losses for that year, and no capital losses carried forward from a previous year, the $2,500 is then included in her assessable income.
Example 1.2: Rights
Tim is issued with 10,000 ‘out of the money’ options under an ESS operated by his small Australian start-up employer for no consideration. The options allow Tim to acquire 10,000 ordinary shares in his employer after paying an exercise price of $1.50 per right (which is more than the current market value of each share – $1 per share).
Tim and the ESS meet all the rules for his 10,000 rights to be covered by the small start-up ESS tax concession.
After 5 years, Tim exercises each right by paying $15,000. Tim then immediately sells each share for $2.00 with his total proceeds being $20,000.
On acquisition, Tim does not include any amount in his assessable income in relation to the discount received on his options. His options will have a nil cost base for capital gains tax purposes.
There will be no capital gains tax on exercise of his rights and receipt of his shares (due to the availability of a capital gains tax rollover). However, on exercise, the cost base of his shares will be $1.50 per share.
On sale of his shares Tim will have a discount capital gain of $2,500 that is included in his net capital gain or loss for the income year. If he has no other capital gains or losses for that year, and no capital losses carried forward from a previous year, the $2,500 is then included in his assessable income.
What is a ‘startup company’?
A ‘startup’ is an Australian resident company:
- that has been incorporated for less than 10 years (includes all Group companies)
- which is not stock exchange listed; and
- has aggregated annual turnover not exceeding $50 million.
- interests in VC and DGR entities are generally excluded (83A-33(7))
The Tax Office provides the following assistance and and guides:
- examples of conforming documents
- approved valuation methods
The tax concessions for Employee Share Schemes are centered on the tax treatment of shares or options which have been obtained at a discount to market value.
For startups, which by pre-requisite are not listed companies and therefore lack a readily available reference for market value, a calculation method for determining the market value is necessary.
The Tax Commissioner has the power to determine acceptable valuation methods, which have been published as a Legislative Instrument (see also ESS 2015/1).
Alternative valuation methods are allowed to be used, but the Commissioner’s “safe harbour” assurance is not available unless the result is at least that amount calculated under an approved method.
See also: approved valuation methods
The general position is that shares or rights granted before 1 July 2009 with a deferred taxing point falling after 30 June 2009 are automatically brought into the post 30 June 2009 rules, and subject to the real risk of forfeiture test.
Discounts taxed upfront, or reaching a cessation date before 1 July 2009, are taxed in accordance with the pre-1 July 2009 rules.
1 July 2009
From 1 July 2009, Div 13A was replaced by a new Div 83A in the 1997 Act, which introduced restrictions and other modifications to the operation of the tax concessions.
From 1 July 2009 to 30 June 2015
- An employee is taxed upfront by default, but with the first $1,000 of discounts tax free subject to adjusted taxable income no greater than $180,000.
- Alternatively the taxing point for the discount is deferred (salary sacrifice benefits limit of $5,000) to the earliest of:
- when there is no real risk of forfeiture and restrictions on the sale or exercise are lifted;
- cessation of employment; or
- 7 years
- Deferred tax is paid on the increase in value at the deferred taxing point.
- A tax refund can be requested in respect to the taxed discount on forfeitures not the subject of:
- an employee choice (except a choice to leave employment); or
- a market value protection scheme condition
- Annual reporting for employers, plus tax withholdings for non-quotation of ABN or TFN
- An employee limited to 5% ownership or control of voting rights
Div 13A to Div 83A comparison 1 July 2009
|Div 13A - up to 30 June 2009||Div 83A - from 1 July 2009|
|Upfront taxation is the default position with election to pay upfront or defer tax until "cessation time".||Upfront taxation is the default position with deferral of tax for schemes with a risk of forfeiture or provided through salary sacrifice (limit $5,000).|
|An employee may elect between upfront or deferred tax||No election - the eligibility for tax concession is determined by the employee share scheme characteristics.|
|Elect to be taxed upfront and the first $1,000 of discounts is tax free. (No means test),||Upfront tax free $1,000 discount concession is subject to adjusted taxable income being less than $180,000.|
|Tax deferred taxing point is the earliest of when restrictions on sale are lifted, sale or exercise, cessation of employment or 10 years after acquisition||Tax deferred taxing point is the earliest of when there is no risk of forfeiture of the benefits, restrictions on the sale or exercise are lifted, cessation of employment or 7 years after acquisition|
|Tax refund only on forfeited rights (not shares), if the employee loses the right without having exercised it.||Tax refund on shares and rights if forfeiture not the subject of an employee's choice (except a choice to leave employment) or scheme condition designed to protect the employee from a fall in market value|
|No reporting requirements.||Employers have annual reporting obligations.|
|No withholding requirements.||Withholding tax for non-provision of employee TFN or ABN at the taxing time.|
up to 30 June 2009
In 1995, Div 13A was introduced to specifically target the benefits associated with genuine employee share schemes (to the exclusion of overlapping FBT), and provide tax concessions subject to qualifying conditions. Benefits flowing under non-qualifying schemes continued to be taxed under pre-existing rules without tax concession.
Div 13A established a default position whereby all discount benefits are immediately taxable, but with an election available to reduce the taxable discount by $1,000 and be subject to CGT (eligible for 50% CGT discount) in due course.
If no up-front election is made, the “tax-deferred” concession provides for tax to be paid on the increase in value at “cessation time”. The CGT rules, including the 50% discount, only become applicable if the shares are held for at least 30 days after cessation time.
“Cessation time” is the earliest of:
- the sale of the shares or exercise of rights
- cessation of employment
- 10 years after acquisition
- the later of:
- lifting of sale restrictions or
- cessation of forfeiture conditions
A refund of tax on forfeited rights (not shares) is available if the employee loses the right without having exercised it.
There were no employer reporting requirements, and no ABN or TFN withholdings.
History of Employee Share Schemes
The ESS rules had their origins in Sec 26(e) of the 1936 Income Tax Assessment Act which is a widely drawn section capturing benefits in respect of employment for inclusion in assessable income. Sec 26(e) was superseded by Section 26AAC in 1974.
Benefits in the form of discounts provided under an employee share scheme were picked up by the Fringe Benefits rules from 1986, generally as a property fringe benefit (and excluded from potential double taxation).
- 1995: Division 13A – (ITAA 1936) was introduced to cover benefits (discounts) associated with employee share schemes, providing tax concessions and excluding the application of FBT to prevent double taxation.
- 1 July 2009: Division 83A – (ITAA 1997) was introduced, containing a number of limitations and qualifications to the tax concessions, and introducing reporting and tax withholding obligations.
- 1 July 2015: Division 83A was amended to reverse some of the 2009 amendments and introduce new concessions aimed at startup companies
Tax return instructions
- Tax return 2021 instructions are here.
- Tax return 2020 instructions are here.
- Tax return 2019 instructions are here.
- Tax return 2018 instructions are here.
- For the 2017 year see here.
- For 2016 tax returns the instructions and related links for Income Item 12 here reflect the rule changes from 1 July 2015.
- The Individual tax return instructions provide the calculation methods and sequence for correctly entering a taxable discount and concession data in the 2014-15 (i.e. pre 1 July 2015). The instructions for Question 12 are here.
- Commentary [27 July 2021] Time to Revisit Employee Share Schemes for Start-Ups – Cornwalls
- Employee share schemes – ATO
- ATO – ESS Calculator
- Cautionary tale: Tax payable but no value to show for it
Rulings & Determinations
- Taxation Determination TD 2016/17 – How the ESS rules apply where a right to an employment benefit is granted on a conditional basis
- TD 2019/13 Income tax: what is an ’employee share trust’?
- Taxation Ruling TR 2018/7 Income tax: employee remuneration trusts – For the tax treatment of employee remuneration schemes which fall outside the scope of Div 83A
- Taxation Determination TD 2022/4: When are you genuinely restricted from immediately disposing of an interest provided under an employee share scheme?
- Taxation Determination TD 2022/8: Deductibility of expenses incurred in establishing and administering an employee share scheme
This page was last modified 2022-06-07