TAX TIP #16: | EMPLOYEE SHARE OPTION PLAN (ESOP)

Tax Tip #15 discussed Phantom Equity schemes for key employees of a company. However, there are alternatives to Phantom Equity schemes that provide better tax outcomes, such as an employee share option plan (ESOP). The key employee is provided with an option to exercise based on:

1. an exit event (similar to Phantom Equity);

2. reaching KPIs (including performance and/or time based); or

3. a combination of A and B.
   

Tax Tip

1. Unlike Phantom Equity schemes, the key employee can acquire the shares upon the vesting event.

2. For (A), the options are either paid out (business/asset sale) or converted to shares (IPO) at the exit event but the share price is based on a share price in an earlier year.

3. For (B), after reaching the KPI, the key employee can convert to shares which is usually based on a share price in an earlier year. Option (B) is more attractive to companies that pay good dividends otherwise there is no incentive to convert to shares (which requires paying the strike price).

4. The tax advantage is that the options are capital assets and not ordinary income because the options must be paid for at the time of the issue (option fee) and therefore not in relation to, or in respect of, employment.

5. The option fee is calculated based on an ATO safe harbour valuation which has several variables (depending on the client’s wishes).

6. The option fee can be:

   1. paid by the key employee;

   2. treated as a fringe benefit;

   3. treated as Division 7A; or

   4. combination of the above.

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