Tax Insight – Employee Share Schemes in the COVID-19 Pandemic

02 April 2020

The COVID-19 pandemic has created an unprecedented economic crisis. As many companies find themselves unable to continue to pay full wages for a period of time, companies are increasingly turning to the use of employee share schemes to supplement reduced salary levels in order to retain and incentivise employees during the COVID-19 pandemic.

With the Government’s recently announced employee share schemes tax review unlikely to be a priority in the months ahead, companies are left with the existing tax settings to implement share plans that are tailored for the pandemic.
HWLE is working with clients to prepare new employee share schemes that are designed specifically for implementation during the COVID-19 pandemic, where existing plans may not have sufficient flexibility. Where there is flexibility within an existing plan, HWLE is working with clients to prepare tailored offer documentation.

We set out below some of the key issues for employers to consider at this time.

  1. Salary sacrifice performance rights plans may emerge – In consideration for an employee agreeing to reduce their salary and wages, employers may consider making special grants of performance rights equal in value to the amount of salary foregone. If such rights are satisfied with new issue shares (or existing unallocated shares already held in an employee share trust), this would not require the company to incur any additional cash expense to satisfy the awards. With stock prices having fallen significantly, employees may see potential upside in a grant of performance rights priced at today’s share price. Minimum services conditions linked to the normalisation of business conditions after the pandemic (and perhaps other qualitative performance conditions) should also be considered. Companies could look at structuring the plan to qualify for the $5,000 salary sacrifice tax deferral concession (and the $1,000 tax exemption), subject to complying with the strict conditions associated with accessing those concessions. Compliance with the ASIC Class Order for listed companies (14/1000) would also need to be considered, including the 5% issue limit rule. If these conditions are unable to be met, we would suggest considering applying to ASIC for specific relief (it may be more inclined to grant relief in these exceptional times). Consideration also needs to be given by listed companies as to whether a new issue would be deducted from its Listing Rule 7.1 capacity, or whether it could be made within the employee share scheme exemption (where a plan has previously been approved by shareholders). From an employment contract perspective, any reduction to salary or wages would require the employee’s consent. Any salary sacrifice arrangement should not reduce salary levels to below minimum entitlements;
  2. Loan funded share plans will continue to be popular for private groups wishing to retain key management.  With market values potentially having fallen sharply, the plan may be able to be operated with a smaller loan component. In addition to standard service based vesting conditions, companies may also wish to include leadership, effective team management and health and well-being as key performance metrics during the pandemic;
  3. Existing share option grants may be dead in the water – ASX companies that have granted premium priced options over the last 12 months may find that management now perceive their existing share options to have no retention value. When replacing existing incentives with new incentives, companies need to take care to ensure that they do not inadvertently trigger a taxing point in respect of the disposal of the old awards. Under existing ASX rules, the replacement of out of the money incentives will require shareholder approval, and potentially a waiver from ASX Listing Rule 6.23.3. It remains to be seen whether ASX may relax these approval requirements in the current climate;
  4. Non-financial performance conditions are likely to be more popular – Given economic uncertainty and high stock market volatility, we expect performance conditions to focus on qualitative factors such as leadership in a crisis and managing workforce health and well-being;
  5. Review cessation of employment clauses in plan rules. With an increasing number of companies standing down employees, companies should consider the impact of that action on existing employee share scheme interests. For example, would it constitute a cessation of employment under the plan rules? (it shouldn’t in most cases if it doesn’t constitute a technical cessation of employment). What is the impact on the vesting period and performance conditions? (if any)  What happens to employee share matching plans? (do the rules provide for employee contributions to be paused during the stand down period?);
  6. Employee share trusts to be revisited (again) – On 6 December 2019 the ATO published its final guidance on employee share trusts in TD 2019/13 (the Determination) (you can read our commentary on the draft and final determinations here). In short, the ATO has taken a restrictive approach to the application of the ‘sole activities’ test, combined with a view that once a EST fails the ‘sole activities’ test, it loses its concessional status as a EST forever. In this time of unprecedented economic crisis, companies may be considering the extent to which their ESTs can help the company survive. First, some of the trust administration expenses that the company may have historically paid for might now be able to be paid for by the EST (which would appear to be permissible under the Determination). Second, trustees of ESTs with significant cash reserves may be tapped on the shoulder by companies looking to assist with the payment of various employee entitlements. The first step would be to consider whether the trust deed permits such payments (and some older deeds that haven’t yet been updated for compliance with the Determination might indeed permit the trustee to make such payments). However, a trust that does so will almost certainly lose its status as an EST (according to the ATO view). The potential adverse tax consequences for the trust and for the company in using the cash reserves in that way would carefully need to be considered. If there is a silver lining to the stock market crash, it may be that non-qualifying share trusts with unallocated shares may now be able to roll-over those shares into a new EST without triggering a net capital gain in the trust; and
  7. Impact of capital raisings on employee share scheme interests. There is likely to be an increase in rights issues as existing large shareholders get called on to support the company in order to avoid fire sales, restructurings and/or insolvencies. Ordinarily, employee share rights are not adjusted for rights issues, but if the scale of the rights issue is significant, Boards should be considering adjustments in accordance with the applicable plan rules.

This article was written by Shaun Cartoon, Partner, Dave Filov, Partner and Jamie Restas, Partner.

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