Employee Share Schemes (ESS) involve an employer giving employees a benefit through the provision of shares in the company that the employee is working for.

This can include giving employees the ability to purchase shares at a discounted price and giving employees options to buy shares in the future. 

While employees are often eligible for tax concessions on the benefit they are given, it is important to be aware of the potential tax consequences that can occur. This is particularly true in situations where a taxpayer can be assessed for taxes on hundreds of thousands of dollars of assessable income, without the cash income being available to them to pay for those taxes.

In essence, unless the ‘start-up’ concessions apply, you are required to include the ‘discount’ on the shares you acquire, with the discount determined by comparing the price you pay for the shares to the market value.

This discount is a benefit that is included as assessable income in your tax return. The terms of when the market value is measured, and whether tax concessions may apply, vary depending on the exact nature of the ESS.

Basic example:

Employer company issues you shares that are worth $100,000
You only pay $80,000 for the shares.
This means you received a discount of $20,000.

You are required to include that $20,000 benefit as assessable taxable income in your income tax return.

Tax Concessions

For concessional tax treatment both the general condition and specific conditions of the particular ESS must be met.

The general condition is: 

That after acquiring your shares through the ESS, you must not:

• Hold over 10% ownership of the company
• Control more than 10% voting rights in the company

(Including ownership/rights held by associates and additional ownership/rights that would be held if any other ESS interests were exercised). 

The specific conditions depend on the type and particulars of the ESS that the employer offers.

Potential tax concessions include:

• Rollover relief
• Start-up concession (where the employer is a start-up company)
• $1,000 discount on taxed-upfront schemes (explained further below)
• Deferred Taxing point (discussed further below)

Taxed-Upfront Scheme

In a taxed-upfront scheme the employee is taxed on the discount that they receive in comparison to the market value at the time of acquisition. In certain situations a very small benefit of $1,000 is available.

Provided your taxable income is under $180,000 (and you meet the general condition ownership/voting rights test), then shares that are acquired under the taxed-upfront scheme are eligible for a reduction in assessable income by up to $1,000.

For example:

Jack has a total taxable income of $50,000.

His employer provides him with $999 worth of shares in the employer company. After receiving these shares Jack will have less than 1% ownership/voting rights in the company.

The $999 value of the shares is required to be reported as assessable income in Jack’s income tax return. However, as he meets the concessional requirements he is able to apply the discount and will not be taxed on the $999. 

If Jack was provided with $1,999 worth of shares then he would be able to discount $1,000 of those shares and only be assessed on the remaining $999.

Tax-Deferred Scheme

Under a tax-deferred scheme the timing of when the employee is taxed on their discount is deferred to a specific “taxing point” in the future, rather than being the time they initially receive the benefit. 

There are a number of different types of tax deferred schemes and specific conditions must be met for each arrangement. 

When it comes to deferred taxing schemes it is important to follow the specific terms of the actual scheme itself, as this will play a big part in determining when the deferred taxing point occurs. 

In general, the deferred taxing point is the earlier of the following events: 

1. The time when there is no risk of the ESS interest being forfeited and there are no restrictions on selling the shares.
2. Where the interests are rights (options), usually the point when the employee exercises those rights and there is no risk that they can forfeit the share and no restriction stopping them from selling that share. 
3. When the employee ceases employment with the employer who provided the ESS.
4. 15 years after the acquisition of the ESS interests.

However, if an ESS interest is disposed of within 30 days of the deferred taxing point, then the date of the disposal becomes the taxing point instead.

For example:

Max’s taxing point occurs on 1 March 2020, when he exercises his rights and acquires shares at a $100,000 discount compared to market value. 

On 15 March 2020 Max decided to sell those shares. By this time the market has dropped and he sells his shares for only $80,000 more than he paid for them.

If he was required to include the discount at the point of acquiring the shares he would have to declare the $100,000 discount as  income in his tax return and then declare a capital loss of $20,000 from the sale 15 days later. 

However, because he has sold them within 30 days of the deferred taxing point, he will only need to include the $80,000 discount that applied at the time of sale. 

However, if Max hangs on beyond the 30 day window and the share price drops he will get a capital loss but will be stuck paying income tax on the higher value.

Capital Gains Tax

Deferred Taxing Schemes

An ESS interest that is acquired under a deferred taxing scheme is taken to have been “re-acquired” immediately after the deferred taxing point.

For example:

Wilma is issued with options to acquire shares in her employer’s company on 1 January 2018. 

On 1 May 2020 Wilma exercised those options and acquired shares with a market value of $500,000. She only paid $300,000 for the shares, which means she included $200,000 of assessable income in her 2020 tax return for the discount realised at her deferred taxing point. 

On 1 December 2020 Wilma sells those shares for $600,000.

The $500,000 market value is her cost base, which means she has realised a $100,000 capital gain. 

Since 1 May 2020 is the acquisition date, she has not held the shares for over 12 months and is unable to apply the 50% CGT discount to that $100,000 gain. This means she will need to declare $100,000 in capital gains in her 2020 tax return. 

Forfeiture or Loss of ESS Interests

If an ESS interest is forfeited or lost then there are provisions to ensure that a person is not stuck with a tax bill, however the rules are highly technical and if you are in this position you should seek further tax advice. but they do not necessarily operate as some people may expect.

Being Prepared with ESS Interests

Managing your tax in relation to ESS interests can become complex and can result in cash flow difficulties.

Understanding and accessing any eligible tax concessions can also help reduce the tax burden. For instance, there can be significant tax incentives for early stage investors.

Because ESS discounts are a tax assessable benefit that is provided in the form of discounts on acquiring shares in the employer company, there is no cash income seen by the employee at the time the income becomes assessable to them. 

Since ESS discounts can see individual taxpayers with hundreds of thousands of dollars in assessable income, it is important that the taxing points are adequately prepared and planned for. 

In the event of termination of employment, this can be a double edged sword. 

Since employment termination is one of the triggers for determining the deferred taxing point, and loss of employment can also mean loss of income, some taxpayers can find themselves being assessed for high levels of tax, with low levels of cash to cover their tax requirements.

It is important to talk to your tax and finance specialists when receiving ESS interests, so you can be aware of contingencies and make necessary plans for tax and cashflow considerations. 

When it comes to tax residency, the six month rule is quite simple to understand: live in a country for at least six months, or 183 days, and you’re considered a tax resident of that country. 

The simplicity in this rule explains why it is a common way of determining when an individual taxpayer is considered to be a tax resident of the country they are living in. In fact, for some countries, this is exactly how they determine tax residency.

For this reason it can be natural to assume that if you live overseas for at least six months then you are a tax resident of that country and no longer a tax resident of Australia. This is particularly the case if that country specifically states that they consider you to be a tax resident when you are living in their country for at least six months.

See here for a brief overview of the key differences between a Permanent Resident and Temporary Resident.

Why You May Still Be Considered An Australian Resident While Living Overseas

If you are an Australian citizen then Australia is your default home country in relation to tax residency. This means that it’s not just about meeting the tax requirements of the other country to be classed as a foreign tax resident for Australian tax purposes.

Under Australian tax laws an Australian citizen, who has been living as a tax resident, continues to be an Australian tax resident until they make a permanent move overseas. A permanent move overseas requires them to effectively cut ties with Australia. Typically the move overseas must be for a minimum of two years, and you must be setting up a permanent home in your new country (not just travelling around, or staying in hotels).

The Impact Of Double Tax Agreements

A double tax agreement (DTA) between two countries may contain provisions that help determine which country has taxation rights when an individual’s tax residency status is not clear cut.

For example, this might happen when an individual goes to a country that treats them as a tax resident after six months living there, however, under Australian tax laws they are also still treated as a tax resident. The DTA, through the tie-breaker provisions, helps determine in which country the individual taxpayer should be treated as a tax resident.

DTA typically gives weight to the country where the person has their permanent home, by virtue of birth or choice. In practice this means there is an expectation that the country in which an individual is a citizen, particularly if they clearly intend to return to their home country, retains more rights than a country they are temporarily living in. Beyond this, DTAs tend to consider where an individual’s personal and economic ties are stronger.

Unclear Situations

Most people find themselves in clear situations. They are either an Australian tax resident or a foreign tax resident, based on the country that they are a permanent resident. However, since individual circumstances can be very unique, there are plenty of situations that are not so clear cut.

Consider a situation where an individual lives in multiple countries, moving from one to another through the year. Or there are situations where an individual moves to one country, intending to remain there permanently, only for an unexpected issue to arise that results in them changing their mind and relocating to another country.

The Pandemic

COVID-19 has resulted in many people staying in countries for significantly longer periods than they ever planned. Conversely, many Australian expats have returned home to Australia to ride out the pandemic, despite previously intending to remain living overseas.

Since each situation is different, it is impossible to give clear, generic advice on these grey areas. The special circumstances of COVID-19 mean that even some Australians who were holidaying overseas have been unable to return home to Australia as planned. Their time overseas does not automatically cause them to become a foreign tax resident, especially where their intent and actions remain to return to Australia as soon as they are able to.

Others who have been living overseas for many years have returned to Australia for a prolonged period due to the pandemic. Their time in Australia does not automatically mean they resume Australian tax residency, however this requires them to be intending to return to the country they consider home as soon as possible. As the pandemic continues, it becomes more difficult to ascertain what “as soon as possible” means, and what actions would indicate a change in circumstances and intent.

Six Months Living Overseas

We cannot treat six months living overseas as automatically resulting in a change of tax residency. It should be understood that a change of tax residency will only occur if an Australian moves overseas for a period no shorter than six months, and a permanent place of abode is established. The subtle difference means that a stay of less than six months can clearly be understood to be temporary and would not change tax residency, while an overseas move that is expected to last more than six months requires review to determine if, and when, there is an actual change in tax residency.