First up an ESOP is an Employee Share [Stock] Ownership Plan and the acronym applies in a number of countries, but particularly the USA. An ESS is an Employee Share Scheme and is Australia’s less than useful (for start-ups and SMEs) version of an ESOP. The ESS scheme does not share the structure and objectives of the S ESOP system in the USA, and additionally Australia has significantly fewer medium-large companies, so the foundations of the S ESOP would not be as effective here.
The ESS rules in Australia mean that if you issue shares to your employees at a discount, or in lieu of wages, then the value of the discount or of the shares is counted as income for the employee at the time of their issue. The horrible result of this is that no cash benefit has been realised by the employee, and they now have a tax liability to pay without any additional cash to pay it. And yes, that means that the employee typically has less take home pay – fantastic result all around.
The other problem with the current scheme is the share valuation methods used for unlisted companies – start-ups and SMEs commonly don’t have market traded securities. The result is that businesses effectively need to seek professional advice to ensure that they have a realistic (auditable) value that is in line with the ATO’s expectations. This type of advice is costly and creates a barrier to involving employees in the capital of smaller companies. The ESS system is too complicated and costly for companies with limited resources, and money can be better spent to increase the prospects of start-ups and SMEs.
Because of this non-sensical arrangement, Australia has been starved of the opportunity to allow employees to share in the risk and reward of business ventures, but particularly start-ups and SMEs. Consequently, it has now been acknowledged by the Government that entrepreneurial people are looking for, and moving their operations to, more friendly jurisdictions.
On 14 October 2014 the Australia Federal Government announced changes to the ESS arrangements with an implementation date of 1 July 2015. The announcement can be found here.
We are very pleased to see the Government taking steps to address this issue. However, we don’t think the announcement or the proposed changes go far enough to achieve the purpose of the changes, which is to allow “small unlisted companies be more competitive in the labour market”.
Conceptually there is only one change of any real consequence – “start-up” businesses can take advantage of a deferred tax liability for employees that fit within the confines of the scheme. This is a good start, but we still have to endure minimum ESS durations, try to value unlisted shares, and use options to frame the arrangements with employees. Each of these items adds complexity to the system, which is unnecessary. It also adds an unrealistic premise of certainty around what the company will be doing and opportunities that may arise, this is particularly so for start-ups. The Government has demonstrated a clear knowledge deficit about start-ups and SMEs in its approach to helping high growth technology companies.
If the Government is serious about helping high growth technology companies to prosper in Australia, we would like to see a crystal clear self contained scheme that start-ups and SMEs can rely on. We would also like to see a guide jointly published by the ATO and ASIC that they are bound to adhere to. The purpose of this guide should be to allow business people to self-assess the arrangements with certainty and get on with running their businesses.
We acknowledge that former schemes have been exploited for unintended purposes in the past, and that the regulators need the power to prosecute in particular circumstances. We are not suggesting that regulators’ hands be tied; but simply that there needs to be a clear and cost effective method of implementing an ESS with absolute certainty.
In addition to the primary change discussed above, we question why the scheme is limited to “start-ups”. There are thousands of businesses in Australia that do not fit within the scope of that definition that could be re-invigorated by bringing in new staff and allowing them to participate in the capital of the company; particularly if they are the catalyst for growth and prosperity in the business.
It shouldn’t matter whether the business is a high technology start-up or not. If your employees are deferring their financial gains through an arrangement with their employer, then they should only pay tax when they receive that gain.