Often when startups organise the setup of an employee share options plan (ESOP), the legal matters are set in place, but the tax reporting is left by the wayside. Don’t be left out of the ATO compliance loop – read to find out what’s your ESOP tax accounting requirements.
Don’t be left out in the cold with tax, in this article we show you how to meet your ESOP Tax accounting obligations with the ATO. But if you don’t understand how an ESOP works check out our overview.
ESOP NTA Valuation
This is usually a startup’s first piece of work regarding tax and accounting for their ESOP. When determining the exercise price for the ESOP Offer & Plan documents, the lawyer will often ask you about its value.
The exercise price is the amount payable by the employee to convert the options into shares. This is often a figure that many advisors will advise to put a negligible value – after all most employees wouldn’t be in the market to purchase until there is a liquidity event (company sale or listing) to help reimburse the employee with cash to first exercise the options.
It is important to note that choosing a nominal value (say $0.01) for the exercise price isn’t a given. The startup concession criteria in s83A ITAA 1997 and via ESS 2015/1 must be passed to allow a nominal valuation for income tax purposes regarding the shares of the company – based on effectively the net asset value of the balance sheet.
Choosing an exercise price lower than the valuation determined from this procedure could potentially lead to a “taxable discount” for the employee so it is key to get this figure right. If conducted correctly the startup concessions for ESOPs effectively allow for a cashless transaction for the employee (with no income tax applicable on the grant or vesting of the associated shares or options in the startup).
With the help of a seasoned ESOP tax advisor, you can evaluate whether your venture meets the numerous criteria for the startup concession and calculate a value of the ESOP for income tax purposes (via ESS 2015/1).
Balance Sheet Valuation
So you now have an ESOP plan running and incentivising “buy-in” from your staff. Now comes around end of tax year time and you have to account for the value of the option plans on your balance sheet. Amongst bootstrapped founders this is often a forgotten exercise, but when there are other sophisticated stakeholders onboard (such as when a VC requests a statutory declaration from founders on the state of the accounts) that’s when its necessary to get proper figures included for the options.
Whilst there are many different ways to calculate the value of options for accounting purposes, the Black-Scholes method is by far the most popular and takes numerous variables into account including exercise price, risk-free interest rate, volatility amongst many others.
At the end of the financial year, your ESOP accountant can take the basic details for your option plan and convert them with some quite detailed formulas and spreadsheets to arrive at a figure for the equity section of your balance sheet. Being a complex operation, allow your accountant some time to calculate this section properly.
Your auditors will thank you for it!
ATO Annual ESS Report
Aside from external stakeholders, the ATO is also interested in the details for your ESOP tax accounting plan. Whilst no immediate tax is payable under the startup tax concessions, the ATO still needs you to prepare & report annually on your ESOPs via ESS statements. ESS stands for employee share schemes and the ATO often refers to ESOPs by this term instead.
The ESS statements serve the purpose of helping your employees calculate a capital gains event on their shares in the future and are to be provided to both the employee and the ATO.
Your ESOP tax accountant should be able to complete this for you for each employee in receipt of an ESOP with the details on hand.
Payroll Tax Considerations for ESOPs
When implementing an Employee Share Option Plan (ESOP), startups should also consider their payroll tax obligations, which can vary significantly across different Australian states. Generally, the grant of share options under an ESOP may trigger payroll tax liability when the options vest or are exercised, depending on the specific state or territory legislation.
The taxable value for payroll tax purposes is typically calculated as the difference between the market value of the shares and the exercise price paid by the employee. However, certain startup concessions and exemptions may apply, particularly for qualifying startups that meet specific criteria regarding company age, turnover, and others. It’s crucial to engage with payroll tax specialists who understand both the income tax implications outlined in the ESS/ESOP framework and the varying state-based payroll tax treatments, as failure to properly account for these obligations may result in penalties and interest charges.
The NSW & QLD states in particular are known for taking different stances on the “safe harbour” valuation method given by the ATO above and that founders are advised to get independent market valuations for ESOPs regarding payroll tax obligations here.
Tax Planning & Advisory for your Employees
When participating in an ESOP you can be sure that your employees will also have questions around the best practices for tax. They often have queries around tax projections, when to sell or exercise, what concessions are available and what structure they should hold the shares in or even a simple tax review of the arrangement.
Ensuring they have access to a tax advisor who can best advise on their ESOP is the key part of help staff feel comfortable with this mode of remuneration.
ESOP accounting is not part of the regular assignments that tax accountants manage so it is key to work with an advisor seasoned in the space. Contact Fullstack about income tax compliance for your ESOP arrangement.
