Employee share schemes: What you need to know

Flexible work arrangements. Free meals. Social activities. Dogs in the office. There's no shortage of non-salary benefits that some Australian companies offer in an effort to retain talent.

Another is employee share schemes.

"The benefit of employee share schemes is that they enable employees and key management people to take an ownership stake in the business," says Craig Butler, a private wealth adviser at Shadforth Financial Group.

"As the business grows and the share price increases in value, they're able to participate in that appreciation. So, for a lot of our clients, it's a really genuine way for them to accelerate their wealth creation and put them in a better position to eventually stop working."

While it might be natural to think that employee share schemes belong more in the domain of listed companies, that is not the case.

Peter Bardos, a tax partner at HLB Mann Judd, says any company can offer an employee share remuneration scheme, though in his experience they tend to be more common in certain sectors.

"You certainly see a fair bit within the tech space. It's perhaps more prevalent in industries that require significant investment and perhaps have less cash as a result, but there's a number of companies in other industries that offer them."

How do employee share schemes work?

The idea at the heart of employee share schemes is simple: employees can access equity in the company which - all things going well - will increase in value, while employers can retain talented employees and ensure that they have a real interest in helping the business perform.

The reality is that share schemes can be quite complex, though. In part, because there are various ways that they can be implemented:

Employee share purchase plans

Employee share (or stock) purchase plans are among the most common in Australia and are typically offered to a wider group of employees within an organisation, according to Butler.

"The benefit of that particular program is that it allows you to buy shares at a discount to the market price and build an equity stake within the business," he says.

"So, from an employee's perspective, that could be receiving a number of shares each year as part of a remuneration package. We also see it quite regularly in share match programs, where the employee buys shares and the employer will purchase some additional restricted shares that vest after a number of years."

Employee share option plans

Employee share option plans, which are popular in Australia, give employees the opportunity to purchase shares down the track.

"With options, essentially it's the right to acquire shares in the future. The benefit is if the share price appreciates over time above the strike price that you have to pay to purchase the shares. Then the employee can exercise those options and acquire those shares for - hopefully - a substantial profit.

"The danger is that the share price doesn't exceed the strike price at the time they vest. In that instance, the employee would obviously just elect not to exercise those options. So, in that case, there's no benefit, but there's not any detriment other than a lost opportunity."

Restricted stock unit plans

Restricted stock unit plans are often provided by international companies operating in Australia.

"Essentially, it's an award of shares that are given to an employee that have some sort of genuine risk of forfeiture," says Butler. "So, it could be time-tested where you're unable to sell the shares for a period of, say, two or three years.

"The other thing that we see more in senior management roles is performance-tested shares. Again, it's not a share that's being given to them immediately, but at a certain point in time if performance metrics are met."

What are the tax implications?

Another complexity comes with tax. HLB Mann Judd's Bardos notes that share benefits can attract tax at different times and in different ways, but broadly speaking there are three schemes worth highlighting: taxed-upfront schemes, tax-deferred schemes and start-up concessions.

The taxed-upfront scheme may apply in situations where people are given, or offered the option to buy, discounted shares - for instance, through an employee share purchase plan.

"Any discount that employees get on the value of their shares - that they don't have to pay full market value on - is included in their assessable income. Just like any other type of income like their salary or the interest they earn," says Bardos.

"Then there's the question of when that's included. The default position is upfront. So, whenever your employer offers shares, it's included in your assessable income at that point.

"There's an obvious timing issue here, though. You may have shares but you don't have the cash yet, but you do have to pay tax on that receipt so, as a result, there's a deferred taxing point that is available."

Under a tax-deferred scheme, employees can delay paying tax on that discount until a deferred taxing point occurs. For example, with shares, Bardos notes that this could be when there are no longer any restrictions on the shares being sold.

Then there are special tax concessions for employees at unlisted Australian startups that are less than 10 years old and have a turnover of less than $50 million. As Bardos explains, eligible employees can avoid having their discounted shares assessed as taxable income.

"With the startup concession, it basically means that you're in capital gains territory from the start. So, whenever those shares are granted to you, you're not assessable on the discount - on a future sale it will only be a capital gain."

On restricted stock unit plans in particular, Bardos says employees who are working for overseas companies need to be mindful of any additional tax implications.

"From an Australian perspective, these are generally subject to deferred taxation. But a lot of the time these can be structured by overseas companies. For example, an employee might be working directly for an overseas company and they will have been set up with foreign jurisdiction rules in mind.

"So, you might get some unintended tax consequences from an Australian point of view, for example, where you have performance criteria and not be able to sell your shares but have to pay tax upfront."

Example: When a share scheme punt pays off

Ali works at a tech company with an employee share purchase plan. She decides to make use of the 15% discount available with the plan to purchase 400 shares at $4.25 each (their market value is $5).

All up, Ali has paid $1700 for $2000 worth of shares. They have a three-year vesting period (until she can exercise her rights).

Because Ali is eligible for a tax-deferred scheme, that $300 discount she has obtained isn't assessed as part of her taxable income straightaway.

After five years, Ali decides to sell her shares, which are now worth $8 each ($3200 in total). At this point the $300 discount that was deferred initially will be included in her taxable income.

Ali will also need to pay capital gains tax on the profit she has made ($1200), though because she's held them for more than 12 months she may be eligible for a 50% discount.

It's worth noting this is an example meant for illustrative purposes only though, and that individual circumstances (and tax implications) will apply in each situation.

Get stories like this in our newsletters.