Following on from our first article we are going to go through the eligibility criteria to implement an employee share scheme under the Startup Concession.
In designing and implementing an Employee Share Scheme under the Startup Concession the following conditions need to be met:
- The general eligibility criteria for all ESS.
- The Startup Concession company criteria.
- The Startup Concession offer criteria.
General ESS Conditions
Employment requirement: The taxpayer must be “employed” by the company that issued the ESS interest or its subsidiary at the time of acquiring the interest. Employees can include current, past or prospective employees and their associates. For the purposes of the ESS rules, directors and independent contractors are also treated as employees.
Ordinary share requirement: when your employee acquires the interest, all ESS interests available for acquisition under the scheme must relate to ordinary shares.
10 per cent maximum shareholding and voting power: the employee and their associates (generally family members and controlled entities) must not have greater than 10 per cent ownership or voting rights in the company in which the ESS interests are granted (including vested and unvested options).
Broad availability requirement: if the scheme relates to shares (as opposed to options), the scheme will also need to satisfy the existing broad availability condition. This condition requires that at least 75 per cent of the permanent employees of the employer who have completed at least three years of service and who are Australian residents are, or at some earlier time had been, entitled to acquire ESS interests in the employer (or a holding company) under an ESS.
Practically, this test has no application in circumstances where a company has been operating for less than three years (and therefore has no employees who have completed at least three years of service).
Startup Company Eligibility Conditions
The ESS interests you provide must be in a startup company. A company is a startup company where it meets the following conditions:
$50 million turnover limit: the ESS interests must be in a company that has an aggregated turnover not exceeding $50 million for the income year prior to the income year in which the ESS interests are granted. The concept of ‘aggregated turnover’ includes connected and affiliated entities but ignores certain eligible investments;
The not-listed requirement: no equity interests in the company in which the ESS interests are granted (or its corporate group) can be listed on an approved stock exchange at the end of the company’s most recent income year before the ESS interests are granted;
The 10-year incorporation limit: the company in which the ESS interests are granted (and all other companies in its corporate group) must have been incorporated for less than 10 years before the end of the company’s most recent income year before the ESS interests are granted; and
Australian residence requirement: the employing company (which may not be the company in which the ESS interests are granted) must be an Australian resident taxpayer.
Startup Concession Offer Eligibility Conditions
Minimum exercise price condition (for option concession): the exercise price of an option must not be less than the market value of an ordinary share in the company at the date of grant of the option.
Maximum discount condition (for share concession): the discount provided on the share must be no more than 15 per cent of the market value of the share at the date of purchase.
Minimum holding requirement (three years): the scheme must be operated so that at all times during the ‘minimum holding period’ every acquirer of an ESS interest under the scheme must not be permitted to dispose of their ESS interest (or share acquired as a result of the ESS interest). The ‘minimum holding period’ commences on acquisition of the ESS interest and ends on the earlier of:
- when the employee ceases relevant employment, and
- the third anniversary of the date of acquisition or such earlier time as the Commissioner allows;
There are exceptions to the minimum holding requirement where:
- all membership interests (not some) in the company are sold under the same scheme and the Commissioner of Taxation exercises a discretion to allow the 3 year holding requirement to be waived; or
- under a scrip for scrip transaction, participants receive ESS interests in the “new company”. s.83A-130(3)
So, Shares or Options?
The Startup Concession provides for either the issue of shares or options. Practically the issue of options is the best for startups as no monetary consideration is required to obtain an interest in the company. As per the eligibility criteria above If a company issue shares under the Startup Concession the employee is required to pay 85% of the market value of the shares otherwise the Startup Concession cannot be used.
In a high growth, early stage startup the aim is work toward an exit event such as an IPO or trade sale. Practically an employee who is issued options does not need to exercise their options until just prior to an exit event if at all. Effectively, buying shares (exercising their options) one day and selling them the next in the exit event (or otherwise being compensated for the purchase or cancellation of their options), thereby receiving the capital gain with no need to outlay funds to purchase the shares for any length of time.
This series of articles therefore deals with setting up an Employee Share Option Plan.
Use our instant pre-assessment tool below to find out if your company is eligible for the Startup Concession.