Creating a culture of employee loyalty and engagement in the era of side hustles can be a difficult feat. 

One way to do this is to give employees ownership through either an Employee Share Option Plan (ESOPs) or Employee Share Scheme (ESS).

ESSs directly issue employees shares, and ESOPs give employees the opportunity to acquire shares in their own company through a share option plan. 

ESOPs and ESSs are typically used to motivate and reward employees. ESOPs have gained popularity in the US, with over 6600 plans covering over 14.4 million people, and Australia is following suit after the 2015 Tax Reforms (more on that below).

So, if you’re looking to get your employees more invested in the business, an ESOP or a ESS may be the best strategy for you! 

How Can An ESOP Or ESS Be Taxed? 

Employees are taxed on the value of the shares/options that they are issued. The ATO essentially treats these grants as income, and they are effectively then subject to income tax. Unlike with wages (which is subject to PAYG withholding), the employee is responsible for paying the tax.

There are three different ways in which an employee can be taxed on a grant under an ESOP or ESS, as follows:

  1. Taxed upfront scheme: this is the default position where an employee must include in their assessable income in the year that they acquire an ESS interest (either an option or a share)
  2. Deferred tax scheme: this is where the tax payable can be deferred for up to 15 years (subject to certain conditions being met, which you can find here). 
  3. Start Up Concession scheme: this is where the discount is not reported as income, so no income tax is payable upfront or deferred. Instead, the shares are taxed under the Capital Gains Tax provisions.

Here, we’ll be talking about ESS and ESOPs with respect to the Start Up Concession scheme.

Key Factors To Consider 

Employee Share Scheme 

What Is It? 

With an ESS, a company allows their employees to purchase the company’s shares, often at a discount from fair market value. The shares may vest in tranches over a period of time, or based on certain individual or company wide KPIs being met.

If the employee leaves, generally the rights to unvested shares automatically lapse and the company can purchase back the vested shares at either fair market value or a discounted rate depending on the circumstances in which the employee leaves.

How Do Employees Participate?

As part of the Start Up Concession scheme, if you have an ESS, at least 75% of your Australian permanent employees with at least three years of service must be (or have been) entitled to ESS interests in the company.

How Do Employees Engage?

Typically, ESS arrangements are simpler for employees to understand than an ESOP, as most people are familiar with shares as opposed to options to acquire shares. With an ESS, employee engagement is simple.

What Rights Do Employees Get?

If you want to access the scheme, then you need to issue ordinary shares – this allows the employee to have the same rights as other shareholders. They are then entitled to dividends and have the right to attend and vote at the company’s general meetings. 

How Much Will It Cost? 

The employee must pay a minimum of 85% of a share’s market value upfront. 

Things To Remember 

A private company in Australia (any company that is a Pty Ltd) can only have up to 50 shareholders, so bear that in mind when setting up your ESS.

Employee Share Option Plan 

What Is It? 

With an ESOP, the business issues the employees with options to purchase ordinary shares. These too are vested over time. Once the option vests, then the employee can exercise it by purchasing a share. 

How Do Employees Participate? 

There are no participation requirements for ESOPs. They can choose to distribute options under ESOP to as many employees as they want. 

How Do Employees Engage? 

Many employees do not understand the concept of options so they may perceive the value of an option over a share as lower, even though the end result is ultimately the same as an ESS. As such, generally you would need to spend more time explaining an ESOP than an ESS.

What Rights Do Employees Get? 

Only once an option vests and the employee exercises their option, the employee will be issued ordinary shares and at that point will have a right to receive dividends and have voting rights. 

How Much Will It Cost?  

When an option vests, the employee has to pay the exercise price for the option. This price needs to be fair market value of the underlying shares as at the date that the option was granted.  

Things To Remember 

While ESOPs grant the option to receive ordinary shares, shareholder rights only kick in once the options are exercised. 

Reforms to ESS and ESOPs in Australia 

From July 2015, the Australian Taxation Office (ATO) introduced a set of start up concessions for employees participating in ESS and ESOP set up by qualified start ups. 

Under the changes, employees participating in an ESS or ESOP have the ability to defer tax on a share or option that they’ve received from their company. This concession is only available for interests acquired after 30 June 2015

This means that the employee doesn’t have to pay tax until they have vested or exercised the option – that is, when they have received a financial benefit from them.  

There are, however, certain requirements a company must meet for employees to receive the tax and concession benefits. These include:

  • The startup must not be listed on any stock exchange – so it must be a private company
  • Its incorporation date must have been less than 10 years ago  
  • The startup must not have an aggregate turnover over $50 million 
  • The startup must be an Australian resident company 
  • The employees must hold ESS interests for at least three years 
  • The discount on the share given to an employee must not be more than 15% of the market value 
  • If an option is given, it must have an exercise price that is greater than or equal to the market value of an ordinary share in the issuing startup 

On that note – did you know that there is a special startup valuation process that helps companies to help their employees take advantage of the tax and concession benefits? You can see the two valuation methods here

Changes From 1 July 2022

On 1 July 2022, there were some changes to laws around ESS and ESOPs for small businesses.

Firstly, the changes provide that an employee leaving the business will no longer be a tax trigger. This means that employees will only be taxed on their options where they have received an actual benefit that is sufficient to cover the cost of that tax.

Secondly, unlisted companies can now charge up to $40,000 every 12 months for grants where the employee is required to make a payment. This was previously $5,000.

This means that unlisted companies can now attract and retain talent by offering equity packages on par with listed companies.

Talk to a Lawyer 

ESS and ESOPs can be extremely valuable to your company – both for the employee and the employer. If you’re looking for a way to retain your talent and entice people to work for your startup, then an ESS or ESOP can be beneficial.

There are many rules that need to be adhered to, so it’s best to have a chat with one of our lawyers. We’d love to help create a plan for your business that will be rewarding!  

If you need help, drop us a line at!

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