Employee share schemes: How they work

An employee share scheme (ESS) enables firms to attract and retain talent while connecting employee interests with corporate performance. Organisations that give company shares or share options develop a sense of ownership, which leads to increased engagement and productivity. According to Australia HR Institute research, organisations that use ESS have lower employee turnover — 29% against 32% for non-ESS firms in Australia, which shows its value for employers.

However, careful structuring, tax planning and compliance are necessary for the implementation of an ESS. In Australia, though still underutilised, the total annual ESS payments reached $2 billion in 2014–15, which also reflects their growing role in employee compensation. For business owners, the challenge is ensuring compliance while maximising tax benefits. Employees must understand ownership rights, vesting and taxes to make wise judgements.

In this article, we'll go over how ESS works, how to set it up and what factors to consider for long-term success.

Learn how Wilson Porter simplifies tax and compliance for Employee Share Schemes.

Understanding Employee Share Schemes

The idea behind ESS is that workers should be able to purchase shares in their employer at any time, whether immediately or at a later date. A company's financial status and long-term objectives determine the structure of an ESS. Some businesses issue direct shares, while others provide share options that let employees buy shares at a fixed price in the future. There are also phantom share schemes, which don't involve actual equity but instead offer cash bonuses tied to company performance.

ESS adoption is increasing in Australia, notably among mid-sized businesses (40%) and big corporations (58%), due to their importance in attracting and keeping key employees. Moreover, organisations with ESS report 5% higher revenue per employee than those without, which indicates a direct relationship between employee ownership and productivity.

Given these benefits, businesses must carefully choose the right type of share scheme. The decision between an ESS and an Employee Stock Option Plan (ESOP) depends on such factors as company size, liquidity and tax relief opportunities. An ESS typically grants immediate ownership or share options with tax concessions, whereas an ESOP provides employees with the right — but not the obligation — to purchase shares in the future.

Common ESS structures include:

• Direct share schemes — Workers get ordinary shares upfront.
• ESOPs — Employees can buy shares later at a set price.
• Loan-funded share plans — Employees use business loans to buy shares.
• Phantom equity plans — Employees receive cash bonuses linked to share value.

Explore Wilson Porter's Business Support Services for help structuring ESS efficiently.

Setting up an ESS: A step-by-step approach

It's important to plan ahead when implementing an ESS to make sure it benefits the company and its workers. Follow these steps to get started:

Step 1: Define your goals

Before you can design your ESS goals, you need to define them. Are you aiming for a more engaged workforce, better employee retention rates or something else entirely? The scheme's objectives will dictate its architecture, which includes eligibility criteria, vesting conditions and tax advantages.

Newer companies, for example, may want more flexibility to avoid immediate tax problems, while more established companies may choose stricter vesting timelines to retain important staff. To achieve these goals, businesses can guarantee that their ESS is supporting these wider strategic goals by identifying specific objectives.

Step 2: Choose the right ESS structure

The structure of an employee share scheme has a significant impact on its effectiveness. Some corporations issue company shares directly to employees, giving them immediate equity share ownership. Others choose share option schemes, which provide employees with the right to buy shares later at a fixed price.

Companies must balance incentives with equity compensation and corporate governance considerations. Loan-funded share schemes allow employees to buy ordinary shares with employer-provided loans, while share incentive plans provide bonuses tied to the company's success.

Choosing the right structure requires balancing employee incentives with corporate profitability, as each model has distinct tax and administrative implications.

Step 3: Understand tax and compliance obligations

Taxation is one of the most complicated components of operating an ESS. Startups may be eligible for tax breaks that allow employees to defer tax payments, whereas larger enterprises must carefully examine capital gains tax (CGT) implications. Companies must comply with Australian Taxation Office (ATO) reporting obligations, such as providing ESS Statements to employees and submitting ESS Annual Reports.

Step 4: Establish vesting conditions

Employees get complete ownership of their shares according to vesting schedules. With a cliff vesting structure, employees get all of their shares when a certain amount of time has passed — usually four years.  Some choose a method of graded vesting, in which they receive their shares in stages — say 25% per year for four years.

Vesting conditions should align with business objectives. If the goal is retention, a longer vesting period may be appropriate. However, companies must also plan for cases where employees leave before shares fully vest and decide whether to reclaim or reallocate unvested shares.

Step 5: Address shareholder agreements and voting rights

A major aspect of an ESS is whether employees will be able to vote on their shares. In certain circumstances, employees have full shareholder rights, whereas in others, shares are restricted. This decision impacts control over the company and governance, so businesses must balance the benefits of employee participation with the requirement to maintain decision-making authority.

Dilution is something else to consider. As employees receive shares, current shareholders may see their ownership percentage go down. Companies should carefully handle this process to keep the balance of equity while still giving rewards that are worth taking advantage of.

Step 6: Implement administration and reporting systems

Maintaining adherence to an ESS calls for constant monitoring and control, including accurate tax reporting, real-time share allocation tracking and current personnel records. Being thorough with these processes is crucial, as making an error could result in unforeseen tax obligations or administrative hassles.

Beyond compliance, businesses must also be able to adapt to new situations. The ESS should change along with the needs of the business. Companies should be ready to introduce changes to the plan to keep it in line with their goals. This could mean changing the qualifying requirements, the timing of when shares vest or the availability of buying back shares. A well-run ESS makes sure that the plan continues to help both the company and its workers in the long run.

Maintaining and optimising your ESS

An ESS isn't a set-and-forget plan — it needs regular oversight to stay effective and compliant. Tax obligations shift, business needs change and employee engagement fluctuates. To keep it valuable, companies must review tax responsibilities, monitor participation and adjust structures as needed.

Every year, employers are required to file the ESS Annual Report with the ATO by August 14 and submit ESS Statements by July 14. Frequent company valuations assist in guaranteeing that shares are reasonably priced, lowering the possibility of tax problems for the business and its employees. It's important to keep an eye on payroll tax and fringe benefits tax (FBT) obligations so you don't have to pay more than you expected. Also, make sure your employees know about the capital gains tax (CGT), when their shares will be taxed and any deductions they may be eligible for. Keeping employees informed helps them make better financial decisions and prevents misunderstandings about tax obligations.

As businesses evolve, their ESS should adapt to reflect changing workforce needs and company goals. Modifying vesting schedules can enhance employee retention by incentivising long-term commitment. Introducing buyback options can assist in managing liquidity and keep shares in the proper hands. The system should also be adaptable enough to include remote or part-time employees, providing equitable participation. And finally, clear standards must also be in place for employee exits to ensure that unvested shares are handled consistently and per corporate policy.

Companies should pay attention to four main areas to keep an ESS working smoothly:

• Compliance: Ensure tax reporting, payroll tax and shareholder agreements are up to date.
• Valuation & adjustments: Regularly reassess share pricing and modify vesting schedules as needed.
• Employee engagement: Inform workers of the potential tax implications, buyback choices and participation perks.
• Liquidity planning: Plan how you will handle share buybacks and staff shares that haven't been vested yet.

Tax implications of Employee Share Schemes

Taxes are one of the biggest concerns for employees in an ESS, and the timing can make all the difference. Depending on the scheme's structure, tax liabilities might kick in when shares are granted, vested or sold. Some ESS arrangements allow employees to defer taxes until they sell their shares, which can ease cash flow pressures. But there's a catch — once those shares are sold, CGT applies. Employees who are aware of these guidelines up front are better able to prevent unpleasant shocks and make wise financial decisions.

Tax implications for employers include corporation deductions, payroll tax requirements and the possibility of FBT payments. In some situations, offering shares at a discount may result in FBT requirements that must be properly managed to minimise needless expenses. All these implications make understanding the tax consequences critical for developing an ESS that benefits both employees and the business.

Managing tax obligations for an ESS can get tricky, but Wilson Porter's taxation services make it easier to stay compliant and get the most out of available tax benefits for your business.

Key takeaways

Employee share schemes are powerful ways to incentivise employees and drive long-term engagement, but they require thorough planning and ongoing compliance. From tax obligations to shareholder agreements, every aspect must be structured correctly to maximise benefits for both the business and its employees.

A well-managed ESS ensures tax efficiency, regulatory compliance and alignment with business goals. Whether you're implementing a new scheme or optimising an existing one, expert guidance can make all the difference. Wilson Porter specialises in ESS structuring and compliance — contact us today to ensure your scheme is set up for success.