The general tax rules relating to the taxation of an employee share scheme (ESS), or an employee share option plan (ESOP) are outlined in Division 83A of the Income Tax Assessment Act 1997 (General ESS Tax Rules).
The General ESS Tax Rules are aimed at taxing participating employees on any discount they receive on the grant of an ESS interest (including shares or options in a company) either:
- upfront – in the income year of the grant; or
- subject to meeting certain conditions – at the earlier of various future events, for example:
- exercise; or
- the 15th anniversary of the cessation of the employment to which the ESS interests relate (known as the deferred taxing point).
Notwithstanding the General ESS Tax Rules, Australia has a concessional tax regime for eligible start-up companies and employees for both ESS and ESOP (Start-Up ESS Tax Rules).
For more information on the General ESS Tax Rules and the Start-Up ESS Tax Rules – see here or check out our Start-Up ESOP Explainer Video here.
Both the General ESS Tax Rules and the Start-Up ESS Tax Rules require that:
- A share plan involves ordinary shares; or
- A rights plan (including an options plan) involves options over ordinary shares.
This is relevant as some founders seek to issue limited-rights shares to employees to maintain total control, such as non-voting shares.
What is an ordinary share?
Neither the General ESS Tax Rules nor the Start-Up ESS Tax Rules define the term, ordinary share and, therefore, we need to look to the common law.
In Norman v Norman (1990) 19 NSWLR 314, McLelland J held:
“The expression ‘ordinary shares’ is [not] defined … in the articles of association nor in the Companies Act 1961 which was in force at the time of incorporation of the company. Counsel was unable to refer me to any authority in which the expression has been defined.
. . .
In my opinion in ordinary usage the meaning of the expression ‘ordinary shares’ is, and was in 1971, “shares other than preference shares.”
Further, in outlining its view as to whether interests in a corporate limited partnership were ordinary shares for ESS purposes, the Commissioner states in ATOID 2010/62:
“Whether a share is an ordinary share in a company for the purposes of the condition in subsection 83A-35(4) of the ITAA 1997 is to be determined by considering the rights attached to the share in relation to distributions of profits and capital and on winding up of the company, as compared to other shares in the company. Shares that have a priority as to dividends or distributions in the event of winding up are preference shares. If shares are not preference shares, they are ordinary shares”
Therefore, non-voting or other special classes of shares can qualify as ordinary shares for ESS purposes provided that they do not have any preference as to the distribution of profit or capital, either during the life of the company or on a winding up.
If you would like to discuss how to design and implement your ESS/ESOP, contact Mosaic Tax Legal at firstname.lastname@example.org or 1300 115 841.