Employee Share Scheme (ESS)
The Australian Taxation Office describes the Employee Share Scheme (ESS) as a “scheme under which shares, stapled securities or rights to acquire them (ESS interests) in a company are provided to an employee or their associate in relation to the employee’s employment at a discount. Special taxation rules apply to this discount.
The importance of ESS in Australia
ESSs play an important role in helping startups establish their business in the marketplace. By complementing cash remuneration and making salary packaging appear more substantive and attractive, they help attract high-quality employees and give employees a vested interest in the company’s success.
The advantages of ESSs are amplified in the life science sector, where the pre-revenue phase is typically extended by the need to clear regulatory hurdles before revenue can be earned, which can exceed a decade.
If Australia’s tax system does not provide a conducive environment with competitive incentives, these new ventures will be undermined and take their life science innovations to other economies.
Background: 2009 changes to the Employee Share Scheme (ESS)
The 2009 changes to Australia ESS taxation provisions reduced the incentive to employee, increased administrative costs and discouraged companies from using the Scheme. As a result, many startup companies in the life science sector have been compelled to choose alternative and insufficient methods to retain, incentivise and reward their employees.
Industry’s concerns were substantiated, as
- Over 90% of all plans suspended during the first year, and 30% suspended for up to two years (the majority were not reinstated five years after the changes were originally made).
- The number of employees participating in, and the amounts they’ve invested in, employee share ownership plans substantially diminished since 2009.
A reversal of the 2009 changes could potentially boost the Australian economy by more than $1.4 billion in the long term, according to the ‘Employee Share Schemes – Their importance to the Economy Report’ (Employee Ownership Australia & New Zealand, 2014). The report claimed that repealing the changes to salary sacrifice plans and options plans could increase tax revenue by over $215 million per year and supported AusBiotech’s call for a reversal of the 2009 policy.
Broadening the definition of ‘startups’
AusBiotech maintains that the definition of a ‘startup’ in the proposed ESS legislation is unhelpful for a large number of life science companies, excluding the companies it is designed to assist. The draft legislation stipulates that startups must be:
- An unlisted company
- Have an aggregated turnover that does not exceed AU $50 million
- Incorporated for less than 10 years
Life science companies often do not meet all these three requirements. Those who list on the ASX early in their life cycle do so to raise capital for their research programs. While it is assumed that listed companies are liquid or have ready access to capital, this is not the case for the life science sector.
The 10-year age limit is restrictive for life science companies. Few would have reached the point of sales revenue by the time, as the development of a new therapy can take 15 years to reach market.
AusBiotech’s submissions
AusBiotech made two submissions since the 2009 changes were implemented. In these submissions, AusBiotech asserted that the changes inappropriately targeted small, rapidly-growing companies that often lack the ability to provide financial rewards to their employees. To support the growth of Australian innovation, it is essential to encourage startups and implement beneficial taxation provisions.
AusBiotech’s submission to the Treasury’s review of the ESS in February 2014 stated that:
- The 2009 change introduced a distinctive to staff by moving to compulsory taxation of shares and options prior to the realisation of any value.
- The requirement for valuations of pre-revenue technology companies provides an unnecessary impost on small business and is almost meaningless for R&D companies.
While AusBiotech’s response to the review of impediments facing small business acknowledged that there are challenges with determining the market value of employee share scheme benefits, it recommended that this could be addressed by taxing shares at the time of liquidation or realisation.
In 2015, AusBiotech made two submissions to the Federal Government to broaden the eligibility for ESS to allow extra benefits planned for startup companies to extend to listed companies eligible for the refundable R&D Tax Incentive.