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Employee Share Schemes (ESS) are an attractive option for many startups and small businesses. As a result of changes to the Tax Act in 2015 – with subsequent updates reflecting market and regulatory shifts up to 2025 – employers can now offer enhanced tax benefits to employees who participate in an ESS. In today’s competitive environment, an ESS not only incentivises your team to perform at their best but also aligns their interests with the long-term success of your company.
If you’re thinking about establishing an ESS for your company, read on to learn:
- What is an ESS?
- How to value your shares
- How are options offered in an ESS taxed?
- How to set an ESS up and;
- The pros and cons of an ESS
What Is An Employee Share Scheme?
An ESS gives your employees the option to buy an interest in your company. Whether you operate as a sole trader or a registered company (read more on the Sole Trader vs Company debate), an ESS can be structured in various ways to suit your business model. Many employers also refer to our in‐depth guide on shareholders agreements for additional advice on aligning employee interests with your business goals.
Some methods of buying shares under an ESS include:
- Salary sacrifice
- Loans from an employer
- Full up-front payment; or
- Remuneration for high performance
There are three kinds of Employee Share Scheme interests offerable under a scheme:
- Shares
- Stapled securities
- The rights to acquire shares and stapled securities (options)
An important distinction to be aware of with ESS is that schemes are classified as either non-concessional or concessional. This classification determines whether your employees receive a tax concession on the options they purchase.
How Are Interests Offered Under Employee Share Schemes Valued?
There are two recognised methods for valuing the interests offered under an ESS. Depending on the approach, your company may be able to offer ESS interests at below market value, thereby creating an even greater incentive for employees.
Option 1: Net Tangible Valuation Method
The first option available to many startups is the net tangible assets valuation method. For updated details on this method, consult the ATO ESS guidelines under ‘Method One’. Essentially, this method involves dividing the value of your company’s tangible assets by the number of ordinary shares in issue. Because most startups have limited tangible assets, this approach often allows you to offer shares below their current market value.
The eligibility criteria for using this valuation method have been revised for 2025 and include:
- No anticipated change of control in your company within six months of the valuation date.
- Your company did not raise more than $12 million in the year prior to valuation.
- Your company qualifies as a small business or has been incorporated for no more than 7 years.
- A financial report for the relevant year must be prepared.
If you don’t meet the above criteria, you’ll need to use the second valuation method.
Option 2: Official Valuation
This method involves a comprehensive valuation performed by your CFO or a qualified professional. Detailed under ‘Method 2’ in the ATO ESS guidelines, this approach takes into account a range of factors, including:
- The value of both tangible and intangible assets – including intellectual property (learn more about our intellectual property services).
- The present value of anticipated cash flows.
- The market values of similar businesses (for further insight, see our Business Sales advice).
- Consideration of control premiums, lack of marketability, and key person risk.
In summary, most startups are eligible for the net tangible assets method, enabling you to offer ESS interests at a discount to market value, which provides a substantial incentive for your employees.
How Are Options Offered In An Employee Share Scheme Taxed?
Updated tax concessions continue to apply in 2025. Changes to the Tax Act mean that, if your ESS meets specific criteria, the tax on the options purchased by employees is deferred until the sale of the shares. Moreover, when the shares are eventually sold after a qualifying holding period, employees may benefit from additional tax concessions.
There are two key tax advantages for employees:
- Tax on the option is deferred until the sale of the shares, easing cash flow for employees.
- If the shares are sold after being held for at least 12 months, employees are eligible for a 50% capital gains tax discount.
How Do I Create An Employee Share Scheme That Receives The Startup Tax Concession?
To create an ESS and secure the startup tax concession, your company must meet the eligibility requirements set out by the ATO. It’s essential to ensure that your scheme is structured properly from the outset.
To help you determine if you’re eligible, consider the following questions:
- Are you a company incorporated in Australia? (Learn more about company set-up.)
- Is your main business activity something other than investing?
- Are your shares or options in the company private, ensuring they are not publicly traded?
- Does your company earn less than $50 million a year?
If you answer yes to all these questions, your ESS is likely to qualify for the startup tax concessions. To maintain eligibility, additional requirements include:
- Employees holding more than 10% of the company’s shares cannot be granted options or shares under the scheme.
- If offering options, the exercise price must be at least equal to the fair market value at the time of grant.
- If offering shares, the price must not be less than 85% of the current market value.
- All ESS interests must be ordinary shares, not preference shares.
- ESS interests must be held for a minimum period of three years from the date of acquisition.
Are Employee Share Schemes Worth It?
ESS have both advantages and disadvantages. They can strongly incentivise employees by aligning their interests with the company’s performance, but they also involve practical and administrative challenges that require careful consideration.
Pros
- Aligns the interests of employees and the company, driving enhanced performance.
- Can reduce the need to offer high salaries when attracting top talent.
- If employees pay upfront for shares, an ESS provides immediate cash flow benefits to the business.
- Encourages long-term employee retention by fostering a sense of ownership and loyalty.
- Tax deferral on options and potential for capital gains tax discounts make ESS a very tax-efficient incentive tool in 2025.
Cons
- ESS can incur significant administrative and start-up costs.
- If the company’s value declines, employee morale and motivation may suffer.
- Distributing shares inherently reduces control for existing owners.
- The complexity of ESS may mean employees do not fully appreciate the benefits until a liquidity event occurs.
Will I Need Legal Assistance/Advice When Creating An ESS?
Setting up an ESS is a complex process. Although the ATO provides detailed guidance to reduce administrative costs, any mistakes can be costly in the long run. Securing professional advice from both a lawyer and an accountant will help ensure your ESS is structured correctly and complies with the latest 2025 requirements. For instance, our online lawyer service is available to help tailor an ESS that meets your company’s needs.
Need Help?
We can help with this! If you need assistance establishing your ESS, we’ve got you covered. You can reach out to us at team@sprintlaw.com.au or contact us on 1800 730 617 for an obligation-free chat.
For more detailed insights into setting up and optimising an ESS, check out our other resources such as our guide on Registering a Business in Australia and explore the comprehensive advice available on our Sprintlaw Guides page. Staying informed about the latest regulatory updates in 2025 will ensure your ESS remains both compliant and a valuable tool for growth.
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