Employee Share Schemes: Pros, Cons and Tax Implications

Velocity Legal

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Key Insights

Employee equity is a control decision, not just a remuneration decision. Issuing shares or options can help motivate and retain key people, but it also affects the company’s ownership structure. Even small equity interests can carry rights that matter in practice, including voting rights, minority protections, access to information and rights that may affect a future sale or capital raise. The commercial structure should be settled before equity is issued.
The tax outcome can make or break the incentive. If employees receive shares or options at a discount, the default tax position may produce an upfront tax liability before the employee has received any cash. Deferred taxation, the startup concession, valuation methodology and real risk of forfeiture conditions need to be considered at the design stage. A scheme that looks attractive commercially can fail as an incentive if the tax treatment is not workable.
The documents need to work together. An Employee Share Scheme should not sit separately from the company’s constitution, shareholder agreement and funding arrangements. Leaver provisions, drag along rights, restraints, share classes, voting rights and loan terms all need to align. This is especially important for loan-funded schemes, where Division 7A, Fringe Benefits Tax and shareholder approval issues may also need to be considered.

Contents

Can employee equity motivate key staff without creating tax and governance problems?

Employee Share Schemes can be a powerful way to align incentives, preserve cash and reward employees who contribute to business growth. But they are not simply an HR tool or a standard incentive template. If the structure is not properly considered, an Employee Share Scheme can create upfront tax exposure, shareholder dilution, voting issues and future exit complications.

In this episode of Explain That by Velocity Legal, Andrew Henshaw is joined by Edward Hart and Archana Manapakkam to discuss the commercial and tax realities of Employee Share Schemes, including when they work well and what businesses need to resolve before issuing shares or options to employees.

The discussion covers:

why businesses use Employee Share Schemes to align incentives and support retention;
how equity incentives can help startups and growth businesses preserve cash;
the tax treatment of discounted shares and options;
upfront taxation, deferred taxation and the real risk of forfeiture;
the startup concession and when it may be available;
valuation issues for private companies;
dilution, voting rights and minority shareholder protections;
why ESS documents need to align with the constitution and shareholder agreement;
good leaver and bad leaver provisions, drag along rights and restraints of trade;
loan-funded Employee Share Schemes and related tax risks; and
the strategic questions businesses should ask before offering equity to staff.

A practical discussion for founders, business owners, directors, executives, accountants and advisers considering employee shares, options, loan-funded arrangements or other equity incentive structures.

For advice on structuring, reviewing or implementing an Employee Share Scheme, contact Velocity Legal’s Commercial and Tax teams.

This podcast in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this podcast.

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