It has been a little while since I have had an opportunity to blog about interesting things I encounter when helping clients. The year goes quickly and despite the arctic vortex freezing us there is some heat in business activity right now.
It seems that there is a bit of political football going on with major policy decisions but there is one small glimmer of hope for those business owners wanting to give further incentive to key employees. Take a look at the recent amendments to the Income Tax Assessment Act 1997 which will mean that many small companies can offer tax effective incentives to employees under an employee share scheme (ESS).
What are the new rules?
The new rules operate from 1 July 2015, for companies that are:
- Not listed;
- Comprising turnover below $50 million per annum; and
- Incorporated for less than 10 years.
This will appeal to many of our small to medium business clients. If shares in the company are issued to a key employee, it is not counted in the employee’s assessable income on one big condition.The discount on the price of shares cannot be any more than 15% of the market value of the shares in the company. This would require an accountant to do a valuation of the shares as at the date of issue.
Options to acquire shares at a later time, require different rules. If the exercise price of the option is equal to or more than the market value of the shares at the time that the options are granted, it is not assessable to the employee. This is great news for employer companies wanting to secure the management team and to broaden the risk profile of the business. It provides a good platform to give added incentive to important employees and allows the key to a better succession plan for the shareholders.
It means that the employees identified as able to add significant value to the business are not penalised in getting taxed on the new shares and a business owner can provide some additional security for the growth that an employee will generate over the next few years. The new rules apply regardless of whether there is a risk of an employee forfeiting their shares or options, provided the offer is broadly available to at least 75% of full time employees with at least three years’ service.
There are rules and conditions that must be satisfied to access these concessions. Careful drafting of the offer documents must be undertaken and also need to comply with requirements for share issues under the Corporations Act 2001. Think how the minor shares can be dealt with and the rights of access to financial information first.
New market valuation rules what is a safe harbour?
It is frustrating for a fledgling company to be restricted as to how shares can be issued or transferred to core employees when access to other capital is so hard to obtain. The banks talk about wanting to lend money but the reality is that it is extremely hard to get good funding without a set of numbers from a solid trading history. The chicken and the egg argument comes to mind.
To make the start-up concession easier to access, the amendments also introduced a secure method or “safe harbour” which bind the ATO to accept a company’s valuation using the ATO published guidelines.
The first published method appears to be based on a straight calculation of net tangible assets and most companies seeking to access the new concessions should be able to apply this method. This will save start-up and administration costs (insert “accounting costs”).
A couple of Key Points
As always there is a bit of a catch. You cannot do this share scheme without thinking about all other impacts on the business. Remember these are existing employment arrangements and as such must be though about carefully. You must get advice on the commercial shareholder perspective (for instance the right to buy back the shares if an employee leaves or tries to compete with the company). Do not forget the employment law aspects of any employee incentive arrangement, both from a Fair Work Act 2009 basis and a Contractual basis. Be careful about any representations made as sure enough they may come back to bite you. The beauty of a shareholding is you never know if it is going to produce dividends and it is up to the Director to exercise their discretion whether they declare a dividend or keep the money in the company for further growth. How about these other things to think about :
- Will the terms of the share scheme provide a real incentive?
- When will employees be able to cash out their shares and is there a guaranteed buy back option?
- When will employees be liable to forfeit their shares?
- Does the scheme give rise to any claim on termination of employment?
- Will the share scheme have any Division 7A loan implications?
- Do the documents comply with the fund raising requirements under the Corporations Act 2001.(less than 20 investors and less than $2 million in any one year?)
- Does the share scheme trigger a requirement for an Information Memorandum or a limited prospectus?
Minor shares have ‘oppression’ provisions or rights to a claim in set circumstances and possibly rights to wind up the company. Heavy stuff to think about before you act!
Please contact a member of our team if you would like further information and how we can assist with advice and documentation required to establish this type of share scheme.