When looked at on a global scale Australia is known to have a very backward approach to the taxation of Employee Share Schemes (ESS). There were some positive recent changes in 2015 but they were only slight tinkering around the edges and didn’t bring forth any meaningful change.
I completely understand why at first glance some politicians have been sceptical of granting concessions here, but in the points that follow I will show how supporting a more favourable approach toward ESS benefits all Australians and politicians on both sides of the political spectrum.
The tax system has a few main functions:
- Revenue raising: Bringing in money so the government can then spend it on providing services to the community
- Redistribution of income/wealth: Taxing the rich and giving to the poor
- An incentive system for the private sector to do what the government/public sector can’t: Tax breaks for specific industries politicians want to support and additional taxes for those they don’t want to support
One of the main objections to granting more favourable treatment to ESS is that it is seen as a way for the rich to get richer through insiders offering themselves more equity in the companies they work for and already own. This is misplaced angst when one actually looks at the way ESS impact a company’s shareholders and employees. There are a few very limited instances that an ESS will have an undesirable effect (making already wealthy shareholders richer) and these are easily solved while not at the same time kneecapping regular employees from sharing in the success of the companies they work at.
The current Australian system offers minuscule concessions to ordinary companies and a few more, but relatively insignificant, minor concessions to what are deemed startup companies.
Ordinary companies are capped at granting $1,000 per year in tax free shares, but only to employees who earn less than $180,000 per year
Startup companies have to satisfy the below to gain access to the additional concessions outlined further below:
- Employee owns less than 10% of the company
- Only available to Australian companies
- The company needs to be less than 10 years old
- The company needs to have a turnover less than $50 Million
- The company can’t listed on an exchange (ASX etc)
If the employer and employee satisfy these conditions all the company can do is shares at up to a 15% discount. Most employers give shares to employees at NIL cost as a reward for high performance, so this is a pointless concession. If employees are required to pay for the shares it makes no difference from buying the shares on the open market, and is therefore no real incentive for the employee to work harder to earn them as reward.
Max 10% ownership rule
This is the only rule I believe is achieving its intended outcome, and the only one I think should stay. The reasoning for this is simple. If someone like Elon Musk is issued shares in his company it makes him, the already wealthiest shareholder, even richer. We want ESS to be used to increase the wealth distribution of the shareholders, by making the richest shareholders less rich and the poorest shareholders richer.
If someone already owns more than 10% of the company they are already in the richest 10 shareholders so should not be able to receive tax concessions on their ESS grants.
Having concessions that only apply to Australian companies is completely counterproductive, we want Australians to be able to realise their full potential regardless where they work, and if they work for an overseas company that wants to offer shares to them they should be able to take full advantage of this, free of any punitive taxes that would make the company reconsider or choose not to offer this to them. For example if an Australian software developer is working for facebook, and is issued shares as part of their employment and hard work, they are not ‘the rich getting richer’ by receiving these shares and should not be treated as such. Our current ESS system doesn’t penalise facebook’s wealthiest shareholders, it disadvantages our employees who work there. When looked at accurately, the dilution effect of facebook issuing shares to employees for no cost decreases Mark Zuckerberg’s net worth and increases the net worth of all the Australian employees receiving them. It is a way that companies share wealth by issuing shares to employees. ESS are a type of wealth redistribution the government should be encouraging, not taxing unnecessarily.
Less than 10 years old
This rule also boggles the mind when looked at through a lens of ‘how do we look out for ordinary Australians’ and ‘how do we share the wealth of our country to deserving hard working Australian's’. What potential gaming of the system is this rule trying to prevent? If CBA wants to offer tax free employees shares they are not allowed, so instead of giving a high performing employee shares they issue none, and the existing shareholders (who are already very wealthy) benefit most through there being no dilution to their shares.
Every time a new employee is granted shares it increases the wealth distribution in the value of the company. Let’s say for example you have a company that has been around for 100 years, is worth $1 Billion, has 1,000 shareholders and 1,000 employees. If all shareholders own equal shares they all own $1 Million of equity, but if you issue shares to the employees as well, for the same amount then they all only own half that $500,000 in equity.
Issuing shares to employees is a way of increasing wealth distribution, and companies want to do it, the only thing that is getting in the way of this is our stifling tax laws.
Less than $50 Million Turnover
I can see how this was used as a simple way to gain political brownie points without actually doing anything of value, but this rule is not having the effect it was intended to have. Blanket banning large companies from offering concessionally taxed ESS to employees just means that they stop sharing the wealth they create once they reach this arbitrary milestone.
If politicians actually cared they would want to actively encourage more aggressively handing out ESS to employees after they reach this point, spreading the wealth with their employees more, now there is considerable wealth to give.
The only time I can see this being a net positive is when it is not used as a way of blanket banning whole swathes of businesses in our economy, and is instead paired with other rules that achieve productive aims. For example my suggestion would be to retain the Max 10% ownership rule, and pair it with this rule, but adjust it so that companies with a $100 Million turnover or lower can give tax free ESS to employees owning 10% or less in the company, but those over the threshold can only give ESS to employees owning less than 5% of the company.
This rule also makes no sense and is just an arbitrary one that achieves no specific aims. It helps the government score political points because it is seen to disadvantage the big end of town, but has no tangible benefits. Why should an engineer of BHP not be able to receive a concessionally taxed ESS, but an identically trained engineer at a small consultancy be able to?
Companies want to spread the wealth they create, but it is the legislation that is preventing this from happening. These laws as they stand make things more unequal. They are having the exact opposite effect they should be.
One final point i want to make is the granting of shares to senior executives and how this while coming across as the rich getting richer is actually not always the case, and shouldn’t be viewed with black and white polarity. Say for example you have a senior executive working for amazon and they are offered $10 Million in new shares at no cost. Many people would think that it is not desirable for this person to get these shares tax free (They’ll never be totally tax free because when they sell them there will always be CGT. What we mean here is tax free when issued) But if you were to look at the share register at Amazon and see the impact on Jeff Bezos net worth as a result in giving this senior executive these shares his net worth would decrease by $1 Million (currently he owns just over 10% of amazon). Yes this executive is someone in the top 1% of wealthy people but he is taking from someone in the top 0.01%. So this is directionally correct in that it is taking from the rich and giving to the less rich.
By this i’m not implying we should create a free for all where anyone can get any amount of tax free shares granted to them. But I do want to bring to people's attention the fact that there is quite a lot of nuance around these issues and that we could stand to have some more refined concessions that provide positive outcomes without unnecessarily handicapping deserving employees of great companies.
- ESS are almost always, except in the most extreme cases, a mechanism of re-distribution of wealth away from the wealthy
- These extreme cases can easily be prevented from being granted concessional taxation treatment without handicapping deserving employees, allowing all companies to offer ESS, not just a handful of very small companies.
- Companies want to do this, but it is the government and their inhospitable tax environment that prevents them from offering this to more employees
What are my recommendations:
- Scrap the current ESS tax regime for all companies, including the startup concessions and replace them with a single system applying to all companies, Australian and foreign
- If a company has a turnover greater than $100 Million then it can offer tax free shares and options to employees such that they own less than 5% of the shares in a company after the shares are issued
- If a company has a turnover less than $100 Million then it can offer tax free shares and options to employees such that they own less than 10% of the shares in a company after the shares are issued
- Employees will pay no tax when the options are granted, vest or exercised, they will pay no tax on shares when they are granted or vested.
- They will still pay CGT on these shares when they ultimately sell them
- Those not eligible for the tax free concessions will pay tax at marginal rates only where the options are exercised or shares vest