Start-ups warned over staff equity tax drawback

An expert has issued some advice to start-ups who plan to offer stock options to employees, after players in the technology industry highlighted the drawbacks of Employee Share Option Plans.

An Employee Share Option Plan (ESOP) is a defined contribution plan that provides a company’s workers with an ownership interest in the company.

In an ESOP, companies provide their employees with stock ownership, typically at no cost to the employees. However, unlike in the US, Australian businesses have to pay tax on the stock option as soon as it is issued.

Shares are given to employees and are held in the ESOP trust until the employee retires or leaves the company, or earlier diversification opportunities arise.

For cash-strapped start-ups, stock options can complement wages and secure highly-skilled workers.

Gary Fitton, a director of Remuneration Strategies Group, says start-ups should consider implementing an ESOP on a contribution basis via a trust.

“We do options for some very big listed companies and some start-ups. Obviously, the start-ups can’t afford to pay what a big listed company pays, so we need to base it on the value of the equity,” Fitton says.

“When you use a trust, contributions are based on the value of the equity.”

“Equity has to be valued anyway and has to be expensed in the profit and loss account, so we normally base our fees on those valuations.”

Fitton’s comments come on the back of a report by The Sydney Morning Herald, which describes employee stock options as “a cornerstone of the Silicon Valley entrepreneurial culture”.

In the United States, the tax is paid when the option vests. But in Australia, companies must pay the tax when the stock option is issued or acquired by the employee.

According to Joris Luijke, vice president of human resources at Australian tech company Atlassian, this can be limiting for companies with small revenues.

“To do that across the organisation will cost you too much. That’s why so many [companies] don’t do it,” he told The Sydney Morning Herald.

But for many start-ups, Fitton says an ESOP is an ideal option.

“Start-ups usually try and compress their expenses and spend the money on their technology – their basic asset,” he says.

“The beauty of stock options is you can compress your [employees’] base salary and you’re giving employees a share in the future capital of the business.”

“People are often quite happy to make the sacrifice of accepting a lower wage, with the expectation they share in the value of the assets… in years to come.”