Your employment package may include interests under an employee stock ownership plan (“ESOP”), such as shares or options.  If so, how will Australia tax you on those interests?

It will depend on the answers to questions including:

• Do your ESOP interests relate to work you did overseas while you were a foreign resident?
• What is your residency status at the time you sell your shares: are you an Australian resident, a temporary resident or a foreign resident?
• Were you promised, or did you receive your ESOP interests before 1 July 2015?
• Does your employer’s group qualify as a “start-up”?
• Are your ESOP interests shares (or, instead, options)?
• Are your ESOP interests the kind that are taxed “upfront” (or, instead, the kind that are taxed on a “deferred” basis)?

Understanding the Australian tax treatment can help you to make choices in relation to your ESOP interests (eg, when to exercise your options, when to sell your shares etc), and also to understand the true (ie, after-tax) value of your interests.

Your employer may have sought advice about the Australian tax implications of the ESOP at the time the plan was established.  However, in our experience, this is not always the case, especially if your employer’s business is headquartered outside Australia and, at the time the ESOP was established, the majority of employees lived outside Australia.

Below we provide some high-level observations about how Australia taxes ESOP interests.  The observations relate only to interests acquired on or after 1 July 2009 where the employer group does not have a substantial landholding in Australia.

1. Overview of ESOP taxation

Australia has a special taxation regime for ESOP interests that are shares, or options to acquire shares, in a company (or, in certain circumstances, in an entity that is not a company, but that is treated like a company for Australian tax purposes).

Under the special ESOP taxation regime,  generally, there will be two taxing points in relation to your ESOP interests:

1. a taxing point when you are deemed to “get” the interests (“Get Tax Point”); and
2. a taxing point when you ultimately sell the shares (“Sell Tax Point”).

(There are some exceptions to this including where (i) you never sell any shares because your ESOP interests are options; and you sell or choose not to exercise the options; or (ii) you cease to be an Australian resident (other than a temporary resident) between the Get Tax Point and the date you sell your shares and you elect to pay tax at that point instead of at the Sell Tax Point.)

• Taxation at the Get Tax Point:  At the Get Tax Point, you will generally be required to pay tax (at your marginal tax rate) on the difference between:
  • the value of the interest at the Get Tax Point; and
  • broadly, the amount, if any, you paid to acquire the interest.

(However, the tax treatment is modified if you were a non-resident, working overseas, for some of the period to which the ESOP interest relates.  Also, tax at the Get Tax Point is eliminated entirely if the generous “start-up” concessions apply; or if the “$1000 concessions” apply).

• Taxation at the Sell Tax Point:  At the Sell Tax Point:
  • if you are a temporary resident, you may have no tax to pay; and
  • otherwise, you will generally be required to pay tax (at your marginal tax rate) on the difference between:
    • the amount you sell your shares for; and
    • broadly, the sum of:
      • the value of your ESOP interests at the Get Tax Point; and
      • in the case where your ESOP interests are options – the amount you paid to exercise your options to acquire the shares.

Significantly, you can reduce the “difference” (on which you are taxed) by 50% if you held the shares for more than 12 months before selling them.  But this 50% discount may be reduced if you sell the shares after you have ceased to be resident (other than a temporary resident) and you didn’t elect to pay tax when you left Australia.

The above tax treatment may be modified if the “start-up” concessions apply.

2. Timing of the Get Tax Point

The date of the Get Tax Point depends on multiple factors including: whether the ESOP relates to ‘ordinary’ shares; whether you were an employee at the time you acquired your interest; whether the predominant business of your employer’s group is investing in other entities; the percentage of other Australian employees entitled to participate in the plan; your total deemed shareholding percentage after acquiring your ESOP interests; whether you have a real risk of forfeiting/losing your ESOP interests; and whether you acquired the interests under a salary sacrifice scheme.

The Get Tax Point can be as early as the date your employer becomes committed to granting you options (even if you don’t receive the options until a later date) and can be as late as 15 years after you were initially granted the ESOP interest.

The advantage of an “early” Get Tax Point is that the value of your ESOP interest may still be low, so tax payable at the Get Tax Point may be low.  If the value of the interest increases after that date, it may be possible to arrange your affairs so that you are taxed (when you sell your shares or leave Australia) on no more than 50% of the increase.

On the other hand, there can be advantages to a “late” Get Tax Point:  no one wants to pay tax today on interests they haven’t yet realised, and don’t intend to realise, until a future date.

3. Start-up Concessions

Highly favourable tax consequences are available if the “start-up concessions” apply to your ESOP interests.  Under these concessions, there is no tax at the Get Tax Point; and at the Sell Tax Point, provided 12 months have passed since you acquired the ESOP interest, you generally pay tax only on 50% of the increase in value since the acquisition date.  (Different consequences will apply for temporary residents and foreign residents.)  To qualify for the “start-up concessions”, your ESOP interests must be in a “start-up” (as defined in the ESOP taxation regime); and multiple other conditions must also be satisfied.

4. Changes from 1 July 2015

Generally speaking, the tax treatment of ESOP interests acquired on or after 1 July 2015 is more favourable than for those acquired or deemed to be acquired before then.  This is due to the introduction of the “start-up” concessions and also of new rules which allow an option-holder to “push back” the Get Tax Point re their options; and to obtain a tax refund if, after paying tax at the Get Tax Point, the options are never exercised.