Employee Share Schemes (ESS) are one of the effective tools to attract, retain and motivate talents. But when it comes to payroll tax, the rules can catch employers off guard, especially when an ESS that looks favourable for income tax purposes still triggers a payroll tax liability.
Here’s what you need to understand, and how to stay ahead of any surprises.
What is an Employee Share Scheme (ESS)?
An ESS is an arrangement where a business offers shares, or rights to acquire shares (commonly called options), in the company. It is an effective way to align employee interests with business goals, so everyone is working towards the same outcome: growth and success.
For income tax purposes, ESS arrangements can attract generous concessions, particularly for start‑up businesses. But for payroll tax purposes, the treatment can be quite different.
Why ESS and payroll tax do not always align
Payroll tax is a state‑based tax, and while the rules are largely harmonised across Australia, each state and territory has its own legislation. Under those rules, shares and options granted to employees under an ESS are specifically included as taxable wages, even if no cash is paid at the time.
Importantly, payroll tax applies regardless of whether the ESS qualifies for favourable income tax concessions. So even if your employees receive tax benefits, you still face a payroll tax liability as the employer.
Choosing your ‘relevant day’: timing is everything
Employers can generally choose when payroll tax is triggered, known as the ‘relevant day’, which is usually either:
- the date the share or option is granted; or
- the date it vests.
Payroll tax is then calculated based on the market value of the interest on that day. The choice of relevant day can have a significant impact on employer’s cashflow because of the risk of unexpected payroll tax costs.
Valuing ESS interests for payroll tax purposes
Valuations are one of the most complex parts of ESS and payroll tax. Revenue offices generally accept a market valuation under ordinary valuation principles, or a method prescribed under Commonwealth Regulations.
For start-up businesses, for income tax purposes, it is acceptable to use the Net Tangible Asset (NTA) method to value ESS interests (subject to certain conditions). For payroll tax purposes, only the Victorian State Revenue office currently accepts this approach, the other revenue offices do not allow valuations based on NTA for payroll tax purposes. This means that the ESS interests may be valued higher for payroll tax than for income tax, creating an unexpected cost if you haven’t planned for it.
What employers should be doing
ESS arrangements can create real payroll tax exposure if they are not carefully managed. To stay on top of your obligations, we recommend:
- Reviewing payroll tax implications when designing or updating an ESS, not just the income tax outcomes
- Choosing your ‘relevant day’ deliberately, with both valuation outcomes and cashflow in mind
- Tracking all ESS grants, vesting events and valuations alongside payroll tax obligations
The key takeaway
ESS arrangements are a powerful way to attract and keep talents. But the interaction with payroll tax is often misunderstood, and the consequences of getting it wrong can be costly.
