Australia’s national innovation agenda – what does it mean in terms of business and tax incentives?

The following article originally appeared in the December 2015 edition of WTS Tax News Australia. I encourage you to read it and other useful articles in previous editions at the WTS Australia website.  The article should be read in conjunction with the disclaimers published on this website and the WTS Australia website. 

Prime Minister Malcolm Turnbull and Innovation Minister Christopher Pyne recently announced the flagship National Science and Innovation Agenda (Agenda), which is made up of a suite of business and
tax initiatives targeting innovation.
The Agenda, which is made up of a suite of proposed initiatives, represents perhaps the most significant policy announcement thus far of the new Turnbull Government. This article will briefly outline the initiatives that are of most relevance to entrepreneurs and investors.
Increasing access to company losses
Currently, in order to claim prior year tax losses, companies must satisfy either the ‘same business test’ or ‘continuity of ownership test’. The government proposes to relax the same business test, replacing it with a ‘predominantly similar business test’ that companies will be able to satisfy where their business, while not the same, uses similar assets and generates assets from similar sources. It is hoped that this will allow loss making companies to pivot and seek out new business opportunities to return to profitability. Legislation is expected to be introduced in the first half of 2016 and will apply to losses made in the current and future income years.
Insolvency reform
The government is proposing to change insolvency laws by reducing the bankruptcy period from three years to one, introducing a safe harbour for directors from personal liability for insolvent trading if they appoint a restructuring adviser and by making ‘ipso facto’ clauses unenforceable if a company is undertaking a restructure. An ipso facto clause allows contracts to be terminated solely due to an insolvency event. The government will release a proposal paper in the first half of 2016 with a view to the introduction of legislation in mid-2017.
Reforms to employee share schemes (ESS)
Earlier this year the government introduced tax concessions for ESS interests issued by start-ups (broadly those companies with an aggregated turnover not exceeding $50 million and incorporated for less than 10 years). Now it intends to pass a new law to limit the potential for disclosure documents given to employees under an ESS plan to be made available to the public (and therefore competitors). While ASIC has already published class orders providing partial relief from disclosure requirements, these do not apply in all circumstances. The legislation is expected to be introduced in the first half of 2016.
Intangible asset depreciation
Businesses will be provided the option to self-assess the effective life of acquired intangible assets (currently fixed by statute), thereby bringing the treatment of statutory intangible assets in line with tangible assets. It is hoped that this will decrease the cost of investment in these assets and enable smaller innovative companies to better market their intellectual property. The new arrangements will apply to intangible assets acquired from 1 July 2016
Tax incentives for early stage investors
New tax concessions will be provided for investors in unlisted companies that: undertake an eligible business (to be determined), were incorporated in the last three years and have expenditure and income of less than $1 million and $200,000 respectively. Where the investment qualifies, the investor will be eligible for a 20% non-refundable tax offset on investments, capped at $200,000 per investor per year, and a 10 year exemption on capital gains tax, provided investments are held for three years. The scheme is modelled on the UK’s Seed Enterprise Investment Scheme. The new arrangements are expected to apply from 1 July 2016.
Making it easier to access crowd-sourced equity funding (CSEF)
New laws will be introduced to enable companies to access crowd-sourced equity funding. Unlisted Australian public companies with turnover and gross assets of less than $5 million will be able to raise funds online (up to $5 million per year) from a large number of individuals. Companies that become public to access CSEF will receive up to a five year exemption from obligations to hold Annual General Meetings, produce audited financial statements and provide an annual report to shareholders. It is hoped that this will provide small innovative businesses with a more diverse range of funding options.
New arrangements for early stage venture capital limited partnerships
(ESVCLPs)
ESVCLPs are tax-effective investment vehicles in innovative companies at the early & growth stages of the start-up life-cycle. Under new arrangements, partners in new ESVCLPs will receive a 10% non-refundable tax offset on capital invested during the year. Furthermore, the maximum fund size for new ESVCLPs will be
doubled to $200 million and ESVCLPs will no longer be required to divest from a company when its value exceeds $250 million. It is hoped that this will make ESVCLPs more competitive internationally and attract greater levels of venture capital investment. The new arrangements are expected to commence from 1 July 2016.

 

WTS Comment

The proposed measures are encouraging but, as they say, the devil is in the detail.   At the time of writing, the Exposure Draft to the regulation to the CSEF regime (Corporations Amendment (Crowd-sourced Funding) Regulation 2015) only contemplates ‘ordinary shares’ and not other types of share instruments.   This may present a limitation for new economy innovation projects.  WTS will continue to provide updates as more information becomes available.

To read more about the Agenda business and tax incentives click here. (Tax News Australia 2015/6).

 

Contractors and employees – Beyond the common law distinction

It is so important for employers/principals to get the distinction between employee and contractor correct. Misclassifying a worker can have severe consequences, not least because if you get it wrong for one area (e.g. PAYG withholding) it is likely that you will be wrong for another (e.g. super guarantee or payroll tax).

However, each area of the law is a little different and it is important to look at each separately. That is what this article is about – a very brief look at the different and/or expanded definition of employee (compared to the common law meaning) under different state and federal taxes.

Starting Position – The Ordinary Meaning (Common Law Definition) of Employee

The key question is – is it a contract of services or a contract for services? The key factors to consider are;

Control Own account Results
Delegation Risk Tools
Business expenses Uniform Other

These questions have been considered in numerous cases. However I would like to focus on other areas in this article.

PAYG Withholding

PAYG withholding obligations extend to;

  • Directors fees
  • Payments to members of parliament, the defence or police forces
  • Payments to religious practitioners
  • Return to work payments
  • Payments covered by voluntary agreements to withhold
  • Payments to labour hire firms

If you’d like to go straight to the source and see the complete list, refer to Subdiv 12-B of Schedule 1 to the Taxation Administration Act 1953.

Superannuation Guarantee

The expanded definition of employee for SGC purposes, found in section 12 of the SGAA 1992 expands the definition of employee to

  • Directors
  • Members of parliament, local councils, the police or defence forces
  • Performing artists
  • A person who works under a contract that is wholly or principally for their labour
    • Renumerated (wholly or principally) for their personal labour and skills
    • Must perform the work personally (cannot delegate)
    • Is not paid to achieve a result

Paragraph 15 of SGR 2005/1 (SGR is a superannuation ruling issued by the ATO) states “where an individual performs a work for another party through an entity such as a company or trust, there is no employer-employee relationship between the individual and the other party, either at common law or under the extended definition of employee”.

However, this isn’t necessarily the end of the matter. For example, in Roy Morgan Research some of the contractors were engaged through an interposed entity. This didn’t stop the court from determining that SG did apply to the workers. Another example is the AAT case of SR & K Hall Family Trust v FC of T.

The key issue is whether the business is engaging the individual or the interposed entity . If it is truly the individual that is being engaged then the fact that the payments are directed to the interposed entity may not be sufficient to prevent SG obligations from arising.

Payroll Tax (Victoria)

There are provisions in state and territory legislation which deem payments to certain contractors to be liable for payroll tax. Generally, the aim is to impose payroll tax where a contractor works exclusively or primarily for one business and the contract is for their labour.

In Victoria section 34 of the Payroll Tax Act 2007 says that a person who performs work under a ‘relevant contract’ is taken to be an employee. Section 32 defines relevant contracts widely. It includes a contract where a person, in the course of carrying on a business, supplies services for or in relation to the performance of work. However, there are numerous exceptions such as;

  1. Where the supply of services are ancillary to the supply of goods
  2. Where the contractor ordinarily provides the same services to the public generally and   the services are not ordinarily required by the payer
  3. Where the services are ordinarily required for less than 180 days
  4. The services are provided for 90 days or less
  5. The Commissioner is satisfied that the services are performed by a person who ordinarily performs services of that kind to the public generally in that financial year.

Where an agreement is made with an interposed entity and the effect of the arrangement is to reduce or avoid payroll tax then the Commissioner has the power (in section 47) to disregard the agreement and determine that the payments made are taken to be wages.

Remember that whilst payroll tax legislation has been harmonised there are still differences between the states and these should not be forgotten.

WorkSafe (Victoria)

Remuneration includes payments made to a natural person performing work which is not part of a business conducted by the person and a person supplying services, unless an exception applies. The exceptions are very similar to the payroll tax act.

There are special rules dealing with particular industries e.g. owner drivers, outworkers, municipal councillors, jockeys, taxi drivers, door to door salespeople, timber contractors, students on work experience, parliamentarians, judges and religious leaders.

FBT

For FBT to apply benefits must be provided to an employee or their associate. FBT does not have its own definition of employee, it refers you to the PAYG withholding rules.

ABN/GST

Employees are not eligible for an ABN but independent contractors are. However, just because a worker has an ABN doesn’t mean they are an independent contractors.

Employees cannot be registered for GST but independent contractors may be.

Want to go deeper?

ATO/SRO guidance

Recent and important cases

  • ACE Insurance Ltd v Trifunovski [2013] FCAFC
  • Dominic B Fishing Pty Ltd v Commissioner of Taxation [2014] AATA 205
  • FC of T v De Luxe Red and Yellow Cabs Co-Operative [1998] FCAFC
  • Floorplan Pty Ltd v Commissioner of Taxation [2013] AATA 637
  • Hollis v Vabu [20001] HCA 44
  • On Call Interpreters and Translators Agency Pty Ltd v FCT (No 3) [2011] FCA 366
  • Roy Morgan Research Pty Ltd v Commissioner of Taxation [2010] FCAFC 52
  • Xvqy v Commissioner of Taxation [2014] AATA 319

The Employee Share Scheme rules have changed. Should you be taking advantage of the new concessions?

Recruiting and retaining high-quality staff is essential to the success of almost any business. Research suggests that companies in which employees have an ownership interest are more productive than those that do not. In this article I ask – do the new employee share scheme rules provide an opportunity for the savvy employer?

Background

An ESS is a scheme under which shares, stapled securities or rights (e.g. options) to acquire them (ESS interests) in a company are provided to an employee or their associate in relation to the employee’s employment. If these ESS interests are provided at a discount to market value the discount is taxable in the hands of the employee.

Recently the laws surrounding the taxation of ESS interests have changed. These changes apply to ESS interests acquired on or after 1 July 2015. The intention of the new law is to make employee share schemes easier, cheaper and more attractive and by doing so;

  • Facilitate better alignment of interests between employers and their employees, thereby leading to more productive relationships, higher productivity and reduced staff turnover.
  • Allow Australian businesses to be more competitive in recruiting and retaining talented employees in the international labour market and
  • Stimulate the growth of start-ups (which are often cash-strapped)

As an employer, now is a good time to consider whether an employee share scheme should be part of your organisation’s remuneration mix.

The previous state of play (i.e. prior to 1 July 2015)

The default position is that the discount is assessable in full in the year that the ESS interests are granted. However, if conditions are met, one of two concessions may be available;

  • A $1,000 reduction or
  • Deferral of the taxing point.

In my experience schemes that defer the taxing point are typically the most attractive and so the remaining of the article will focus on them. Deferral will be available when all of the following apply;

  • The employee has a genuine risk of losing the interests (e.g. by failing to meet performance criteria or being required to continue employment for a certain period)
  • The scheme is made broadly available – i.e. it is available to at least 75% of Australian employees with at least three years of service
  • After acquiring the ESS interest the employee does not hold an interest in the company of more than 5%.

Note that the second requirement only applies to shares and therefore employers who wish to target key personnel are advised to issue rights (i.e. options), rather than shares.

Where such conditions are met no tax will be payable until the earliest of one of the following times;

  • When the employee ceases employment
  • When the risk of forfeiture has been removed and there are no genuine restrictions on the disposal or exercise of the interest and
  • Seven years after acquisition

What has changed?

The new legislation introduces a number of significant changes;

  • The maximum period of deferral has been extended to fifteen years
  • In the case of rights the deferred taxing point is extended, from when the right can be exercised, to when it is actually exercised
  • The maximum level of ownership has been increased to 10%
  • Access to deferred taxation will be available in a broader range of situations
  • The circumstances where employees are entitled to a refund of tax previously paid on forfeited ESS interests has been broadened
  • New valuation rules have been introduced

The additional concessions for ‘start-ups’

The new rules also introduce further concessions for small start-up companies. Both ‘small’ and ‘start-up’ are defined very broadly and many employers will qualify. Under the concession an employee does not need to include a discount on ESS interests in their assessable income if certain conditions, beyond the general conditions that apply to all ESS concessions, are satisfied;

  • The employer must be an Australian company, it, and all companies in the group, must have been incorporated for less than ten years, it must not be listed on an exchange and the combined turnover of the group must not exceed $50m.
  • The employee must hold the interests for three years or until they cease employment
  • If the scheme relates to rights, the exercise price (i.e. strike price) must be at least equal to the market value of the share at the grant date and
  • If the scheme relates to shares, it must be made broadly available (see above) and the discount cannot be more than 15%

For capital gains tax purposes shares are deemed to have been acquired for their market value and rights for the employee’s cost of acquiring them. Furthermore, the exercise price of rights will form part of the cost base of the resulting shares. When a resulting share has been sold the tax on any gain can be halved if the rights were acquired more than 12 months earlier.

New valuation rules

Calculating the assessable discount requires the employer to determine the market value of the company, possibly at multiple points in time during the year. In the case of unlisted companies this can place a prohibitive administrative burden on the employer.

The regulations to the 97 Act contain safe harbour valuation methodologies. However, these are highly complex and, having not been updated since the 1990s, are based on outdated estimates.

New valuation methodologies have recently been issued by the Commissioner. It is expected that these will be simpler and will result in the value of most options being lower than the previous regulations.

Example

Employer Pty Ltd was established on 1 July 2007. On 1 July 2015 it was not listed, had a turnover of $40m and was not part of a corporate group.

At this time Employer granted, for no consideration, 10,000 options to Bob, an important employee. In three years time, if Bob continues to work for Employer, he may exercise the options for $2 each, being the market value of a share in Employer at 1 July 2015.

On 1 July 2018, with the value of Employer’s shares being $5 each, Bob does in fact exercise all of his options. Immediately afterwards he sells the shares. Effectively, Bob has made a gain of $30,000 but he will not be taxed on this gain under the employee share scheme rules. Instead he will make a capital gain of $15,000, being half of $50,000 proceeds less an exercise price of $20,000.

Conclusion

Recent changes have made issuing ESS interests to employees more attractive, particularly for options. I would encourage all employers to consider if an employee share scheme is consistent with their overall business strategy and their strategy for retaining and recruiting key staff. If so it may be a good idea to include them in your remuneration mix.

Of course not all employee share schemes are created equal and, if you are considering implementing an employee share scheme, I recommend you contact a professional adviser for assistance in formulating the ideal scheme for your business.

Disclaimer

This post is intended to be a broad overview for information purposes only. It does not constitute advice. I urge you to seek professional advice that is tailored to your personal circumstances.

ESS