The Commonwealth has recently passed the Treasury Law Amendment (Cost of Living Support and Other Measures) Act 2022 (Cth) (ESS Act) which gives effect to the second stage of an overhaul of employee share schemes (ESSs) for Australian companies.  Together with the first stage of the overhaul that addressed the taxing of certain ESS interests, the general aim of the changes set out in Schedule 4 of the ESS Act is to make the implementation of ESSs easier for companies and more desirable for participants.  

What is an ESS?

ESSs are, in essence, arrangements for a company to offer securities (e.g. shares in a company) or interests in those securities (e.g. options to acquire shares in a company) to its employees, usually at a discounted price.  ESSs can be an effective tool to attract and incentivise staff.

Barriers to an ESS

However, in order to offer securities for sale, including to employees, companies are generally required to comply with the disclosure requirements under the Corporations Act 2001 (Cth), including by providing a document containing certain prescribed information (e.g. a prospectus or an offer information statement). The disclosure obligations in the Corporations Act are onerous and the cost and time involved in complying can be prohibitive for many SMEs and start-ups.  

There are some exemptions to the disclosure requirements in the Corporations Act, but before the ESS Act, the exemptions available in relation to the issue of shares to employees were narrow and restrictive.  For example:

• The Corporations Act allows an exemption for:
  - offers made to employees who are 'senior managers'; and
  - offers made (in any 12 month period) to no more than 20 persons (including employees) and where the amount raised does not exceed $2 million in total.

• The ASIC class order relief (Class Order 14/1001 (unlisted bodies)) applies only where (among other things):
  - The value of all offers to each participant in each 12 month period is no more than $5,000.
  - The ESS does not involve the employer group making a loan to the participant to fund the acquisition of the securities.

Additionally, companies wishing to implement an ESS have had to contend with the rules that required an operator of certain ESSs to hold an Australian financial services licence, as well as the advertising and hawking restrictions under the Corporations Act.

The new rules

Under the ESS Act (which comes into effect on 1 October 2022), if certain requirements are met in respect of an ESS, then for that ESS (Eligible ESS):

• the existing disclosure requirements and restrictions on advertising and hawking securities under the Corporations Act will not apply; and
• an Australian financial service licence will not be required by the operator (and general financial advice can be provided in relation to the Eligible ESS without an Australian financial service licence).

Requirements for an ‘Eligible ESS’

The requirements that an ESS must meet to be an Eligible ESS are still somewhat complex and largely depend on whether or not the participant is required to pay for the securities (or interests in securities) offered and whether or not the company is listed.  For offers made by unlisted companies that do not require a participant to pay for the securities (or interests insecurities) or borrow funds to pay for them, the key requirements to be an Eligible ESS include (but are not limited to):

• The offer must be for the issue, sale or transfer of:
  - fully paid shares;
  - a beneficial interest in a fully paid share; or
  - a unit in, an incentive right, or an option to acquire, a fully paid share,
  (ESS Interest).
• The offer must be made to a director, employee or service provider of the company (or certain persons/entities related to them).‍
• For an offer of options or incentive rights, an ‘offer document’ must be provided at the point of offer pursuant to Division 1A of Part 7.12 of the Corporations Act. The offer document must include certain prescribed information.

For offers by unlisted companies that do require a payment by participants, the key requirements to be an Eligible ESS include (but are not limited to):

• The offer must be for an ESS Interest.
• The offer must be to a director, employee or service provider of the company (or certain persons/entities related to them).
• The ESS Interest must be acquired by the participant who pays for the ESS Interest.
• The sum of the following two numbers must not exceed 20% (or such other percentage specified in the company’s constitution) of the interests actually issued in the company:
  - the number of interests that may be issued, directly or indirectly, as a result of the offer; and
  - the number of interests that have been issued, or could be issued as a result of previous offers, in connection with an employee share scheme made during the previous three years.
• The participant must not be charged more than $30,000 per annum (plus an additional amount for certain dividends and cash bonuses received and other amounts accrued by the participant).
• Any plan to allow a participant to make regular payments or elect to have regular deductions made from their wages or salary for the purposes of acquiring ESS Interests (Contribution Plan) must satisfy certain requirements, including that the participant must agree in writing to the terms of the Contribution Plan before participating.
• For an offer of options or incentive rights, an ‘offer document’ must be provided at the point of offer pursuant to Division 1A of Part 7.12 of the Corporations Act. The offer document must include certain prescribed information.
• The participant must be provided with a disclosure document 14 days before an offer is made (and, where the ESS Interest is an option or incentive right, before the ESS Interest can be exercised). The nature of the disclosure document required depends on the nature of the ESS Interest offered, but the requirements for a disclosure document are generally less onerous than the existing disclosure requirements.
• Where the company provides a loan to enable a participant to purchase the ESS Interests:
  - the loan must have no interest or fees payable;
  - in the event of default in the payment of the loan, the right of recourse against the participant must be limited to forfeiture of the ESS Interests acquired using the loan;
  - the borrower must be the participant who will acquire the ESS Interests; and
  - the loan cannot be provided to an existing shareholder.

Money received from participants for applications made under an Eligible ESS must be held in trust until the ESS Interests are issued or transferred, or the money is returned to the participant.

There are also new criminal offences introduced by the ESS Act relating to Eligible ESSs, including in relation to circumstances where the offer or disclosure document contains a misleading or deceptive statement or omission.

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