Employee incentive schemes: Updated class order relief and proposed tax changes

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1 Ashurst Australia 16 December 2014 Company Law & Governance Update Employee incentive schemes: Updated class order relief and proposed tax changes WHAT YOU NEED TO KNOW On 31 October 2014, ASIC updated its guidance on employee incentive scheme relief and issued two new class orders which apply to listed and unlisted bodies. ASIC's expanded and modified relief for employee incentive schemes should, on the whole, facilitate the current practices of listed bodies (and eligible foreign entities). Expanding the relief to allow unlisted bodies to make annual offers of up to $5,000 worth of shares, options or incentive rights to each employee may also provide some increased flexibility to unlisted employers wishing to provide equity incentives to their employees. The federal government has also announced proposals to improve the tax treatment of employee share schemes. These proposals will predominantly impact executive option plans and employee share schemes offered by start-up companies. WHAT YOU NEED TO DO Consider whether ASIC's updated relief provides your organisation with an opportunity to adopt a more flexible employee incentive scheme structure. Watch out for further details on the proposed changes to the tax treatment of some employee share schemes. In 2003, ASIC issued Class Order 03/184 Employee share schemes (CO 03/184) which facilitated employee incentive schemes by permitting companies to make offers of certain financial products to particular employees without needing to comply with certain provisions in the Corporations Act 2001 (Cth), including disclosure obligations, licensing obligations, on-sale restrictions, advertising prohibitions and hawking prohibitions. More recently, ASIC has become concerned that CO 03/184 does not reflect current market practice, and required updating to reflect legislative changes. On 13 November 2013, ASIC released Consultation Paper 218 Employee incentive schemes (CP 218) which sought feedback on proposed extensions to its employee share relief. (For our coverage of CP 218, and much of the background to ASIC's changes, see our Company Law & Governance Update dated 4 December 2013). On 31 October 2014, ASIC updated its guidance in Regulatory Guide 49 Employee incentive schemes (RG 49), and replaced existing CO 03/184 with two new class orders: Class Order 14/1000 Employee incentive schemes: Listed bodies (the Listed Body Class Order); and Class Order 14/1001 Employee incentive schemes: Unlisted bodies (the Unlisted Body Class Order). Separately, the federal government announced on 14 October 2014 that it proposes to improve the tax treatment of some employee share schemes, particularly for start-up companies, from 1 July This update summarises the key terms of the new class orders, and the key tax reforms. AUSTRALIA BELGIUM CHINA FRANCE GERMANY HONG KONG SAR INDONESIA (ASSOCIATED OFFICE) ITALY JAPAN PAPUA NEW GUINEA SAUDI ARABIA SINGAPORE SPAIN SWEDEN UNITED ARAB EMIRATES UNITED KINGDOM UNITED STATES OF AMERICA

2 OFFERS BY LISTED BODIES Who can make offers? Who can receive offers (generally)? Former position (CO 03/184) Listed bodies and their associated bodies corporate Relief limited to offers to: full-time employees part-time employees New listed body relief (CO 14/1000) No change Relief extended to include offers to: contractors (40% FTE) casual employees (40% FTE) directors non-executive directors prospective participants (on condition that they accept the position) What "eligible products" can be offered? Relief restricted to offers of: fully paid shares quoted on ASX or on approved foreign markets units in those shares Relief extended to include offers of: depositary interests, including Australian CDIs, UK CDIs and certain ADRs units in registered schemes able to be traded on ASX options for the issue or transfer of these shares fully paid stapled securities quoted on ASX (at least one being a share) fully paid stapled securities able to be traded on ASX, even if the stapled components do not include a share options over depositary interests, units in registered schemes and fully paid stapled securities incentive rights (including cash-settled rights) What structures can be used? Direct issue of eligible products Trust structures, where shares are held on trust for specific participants on an allocated basis Contribution plans in relation to the issue or purchase of shares Direct issue of eligible products Trust structures, where eligible products (other than options and incentive rights) are held on trust on an allocated or an unallocated basis (5% holding limit; trustee may exercise voting rights in its own discretion if it is not the listed body or an associate) Contribution plans other than in relation to the acquisition of options and incentive rights Loans (no conditions) Loans other than in relation to the acquisition of options and incentive rights (no recourse or limited recourse; no interest or fees payable) What general conditions apply to the relief? 12 month quotation period; no suspension > 2 days 5% issue limit (current offer and offers over past 5 years) 3 month quotation period; no suspension > 5 days 5% issue limit (current offer and offers over past 3 years) Copy of offer documents must be given to ASIC within 7 days Offer documents must be clear, concise and effective Notice in prescribed form must be given to ASIC within 1 month after first relying on the Class Order ASIC can exclude a body from Class Order relief Ashurst Company Law & Governance Update 16 December

3 Who can make the offers? The Listed Body Class Order permits offers made under an employee incentive scheme by bodies listed on ASX or an approved foreign market. The relief also applies to offers by "associated bodies corporate" of listed issuers, being a related body corporate of the issuer, or a body corporate that has voting power in the issuer of not less than 20% or a body corporate in which the issuer has voting power of not less than 20%. Associated bodies corporate do not, themselves, need to be listed. Who can receive the offers? The Listed Body Class Order permits offers to be made to "eligible participants", being: full-time and part-time employees (including executive directors); non-executive directors (NEDs); certain contractors and casual employees; and prospective participants. Under the Listed Body Class Order, each of these eligible participants can renounce the offer in favour of an immediate family member, a family company or a self-managed superannuation fund. Non-executive directors The Listed Body Class Order does not include any restrictions on the conditions on which offers can be made to NEDs. Rather, RG 49 highlights some guidance on corporate governance concerns relevant to NED schemes, including that schemes with performance based conditions should not be offered to NEDs. (The proposal in CP 218 was far more limited. In particular, the offer to NEDs could only relate to quoted shares, depositary interests or stapled securities and the acquisition of these products could not be subject to a performance condition (as this might compromise their independence). CP 218 also envisaged that NEDs should be required to contribute their own funds to acquire the products, but that no loan or financial assistance could be provided.) Contractors The Listed Body Class Order permits offers to be made to certain contractors provided the contractor is contracted to work the pro-rata equivalent of 40% or more of a comparable full-time position. (The terms of the Listed Body Class Order is less onerous than CP 218, which proposed that the contractor must have worked under the contract for 12 months before the offer and worked a number of hours in that period equivalent to 80% or more of a full-time position, and there be an ongoing intention to continue engaging the contractor on an equivalent basis for at least the next 12 months.) Casual employees The Listed Body Class Order permits offers to be made to casual employees provided that the employee is (or might reasonably be expected to be) engaged to work the pro-rata equivalent of 40% or more of a comparable full-time position. (The terms of the Listed Body Class Order is less onerous than CP 218, which proposed that the casual employee must have been employed for 12 months prior to the offer). Prospective participants The Listed Body Class Order permits offers to be made to prospective participants provided that the offer is conditional on acceptance of an offer of engagement as an employee, contractor or casual employee. What products can be offered? The Listed Body Class Order permits listed bodies to offer a range of "eligible products", including: fully paid ordinary shares able to be traded on ASX; fully paid ordinary shares or stocks able to be traded on an approved foreign market; Ashurst Company Law & Governance Update 16 December

4 depositary interests able to be traded on ASX or an approved foreign market where the underlying interest is fully paid shares or stocks; fully paid units in registered managed investment schemes able to be traded on ASX; fully paid stapled securities able to be traded on ASX (even if the stapled components do not include a share); options over any of the above products; and incentive rights relating to any of the above products (other than options). Depositary interests The Listed Body Class Order permits offers by listed bodies (or their associated bodies corporate) of depositary interests able to be traded on ASX or an approved foreign market, where the underlying security is a fully paid share or stock (and not debt). This includes: CHESS Depositary Interests (Australian CDIs); CREST Depository Interests (UK CDIs); and Level II and III American depositary receipts (ADRs). The Listed Body Class Order also permits offers of shares or stocks (whether or not they are quoted) which can be converted into these depositary interests. Options The Listed Body Class Order now extends to offers of options over all "underlying eligible products", which means all eligible products other than options or incentive rights. As a result, listed bodies can now offer options over depositary interests, units in registered schemes and fully paid stapled securities. The options themselves do not need to be quoted on ASX or an approved foreign market, so long as the underlying eligible product is quoted. If, however, the options themselves are not quoted, RG 49 provides that they must be offered for no more than nominal monetary consideration. Incentive rights The Class Order extends to offers of incentive rights, which are defined as conditional rights to acquire (by issue or transfer): underlying eligible products (ie excluding options and incentive rights); certain cash amounts, where the value of those amounts relates to the financial value of the underlying eligible product (eg VWAP, ROE etc); or a combination of the two. RG 49 provides that the incentive rights must be offered for no more than nominal monetary consideration. (Unlike the proposal in CP 218, the Listed Body Class Order does not require that the incentive rights vest automatically for no monetary consideration upon the satisfaction of performance conditions relating to a period of service by the recipient and/or the performance of the recipient, the issuer or an associated body corporate.) What structures can be used? The Listed Body Class Order permits listed bodies to make offers using a range of structures, including: direct issue; trusts; contribution plans; and loan agreements. The Listed Body Class Order extends the circumstances in which trust structures and contribution plans can be used by listed bodies and their associated bodies corporate in connection with their employee incentive schemes. ASIC has also placed restrictions on the terms of any loan or financial assistance which may be provided. Ashurst Company Law & Governance Update 16 December

5 Trusts The Listed Body Class Order permits trust structures to be used to accumulate underlying eligible products such as shares, foreign shares, stapled securities, units in registered schemes and depositary interests (but not options or incentive rights). ASIC still permits a trustee to hold underlying eligible products on an allocated basis (where products are recorded against the name of specific participants). Depending on the design of the trust, the beneficiaries may have no particular entitlements, or the beneficiary may have the right to direct the trustee how to vote and have a right to receive dividends. The Listed Body Class Order also permits the trustee to hold underlying eligible products on an unallocated basis (where the products are held in a pool for participants generally). The specific conditions which apply to this relief include that: if the trustee is the listed body or an associate, the trustee is prohibited from exercising its discretion in relation to voting rights that attach to the underlying eligible products; if the trustee is permitted to exercise its discretion in relation to voting rights, the trustee must do so in accordance with its fiduciary duties; the trustee cannot hold more than 5% of the ordinary voting share capital of the listed body on trust in reliance on ASIC's employee incentive scheme relief; the trustee is not permitted to charge any fees for operating the trust that are payable by the beneficiaries or out of the assets of the trust (other than reasonable disbursements such as brokerage and certain taxes). Contribution plans The Listed Body Class Order broadens the terms on which contribution plans can be used in relation to employee incentive schemes. In particular: contribution plans can be used for the acquisition of all eligible products (other than options or incentive rights) and are no longer restricted to the acquisition of shares; and participants are entitled to make monetary contributions using either before-tax or after-tax funds and are not restricted to contributions out of wages and salaries (after-tax contributions must, however, be held in a dedicated trust account with an Australian authorised deposit-taking institution). The beneficiary must have the right to direct the trustee how to vote (if there are voting rights) and a right to dividends in respect of underlying eligible products acquired with the contributions. If a participant wishes to discontinue participation in the contribution plan, 45 days' notice must be given. Loans The Listed Body Class Order imposes limitations on the terms of any loan or financial assistance which is offered to facilitate participation in an employee incentive scheme. In particular, loans or similar financial assistance must: not be provided to acquire options or incentive rights; be interest free and fee free; and be provided on a basis that is without recourse or with recourse limited to forfeiture of the eligible products that are acquired under the loan. The Listed Body Class Order permits dividends to be used to pay down loans. What general conditions apply? There are a number of general conditions which apply to Listed Body Class Order relief. Period of quotation Under the Listed Body Class Order, the product (or the underlying eligible product, in the case of options or incentive rights) must have been quoted on ASX or an approved foreign market for at least three months without Ashurst Company Law & Governance Update 16 December

6 suspension for more than five trading days in the shorter of the period in which the product has been quoted or the 12 months before the offer is made. 5% issue limit The Listed Body Class Order applies a 5% issue limit to offers by listed bodies. This means that the listed body or its associated bodies corporate must have reasonable grounds to believe that that the number of underlying eligible products that may be issued under the current offer, together with all underlying eligible products which have been or may be issued in reliance on ASIC relief in the previous three years, will not exceed 5% of the issued capital of the listed body. Proposal for 12 month holding abandoned ASIC has abandoned its proposal in CP 218 that a participant must hold onto at least 25% of their cash or share entitlements for at least 12 months. Disclosure The offer documents must include or be accompanied by the terms or a summary of the terms of the employee incentive scheme, and provide associated documentation relating to any special features (eg contribution plans, loans or trust structures being utilised). Offer documents must be worded in a "clear, concise and effective manner" and must contain a general advice warning and disclosure about the risks of acquiring and holding the products. Lodgement with ASIC The Listed Body Class Order reduces the administrative burden on issuers by replacing the requirement that all offer documents be provided to ASIC with an obligation for the listed body to notify ASIC using the prescribed form within one month (compared with 7 days under the previous class order) after first relying on the class order. A notice of reliance can cover a particular employee incentive scheme that is intended to operate for many years. Further notification to ASIC will only be required if the body establishes a new employee incentive scheme. Excluding a body The Listed Body Class Order gives ASIC the power to exclude a listed body from relying on its new class order (eg if there is "substantial, systemic or repeated non-compliance" with the terms of the relief, the Corporations Act or corporate governance failure). The exclusion notice may be withdrawn by ASIC if its concerns are adequately addressed. Ashurst Company Law & Governance Update 16 December

7 OFFERS BY UNLISTED BODIES Former position (CO 03/184) New unlisted body relief (CO 14/1001) Who can make offers? Who can receive offers (generally)? Unlisted bodies, but only in limited circumstances Relief limited to offers to: full-time employees part-time employees Relief extended to include wholly-owned subsidiaries of unlisted bodies Relief extended to include offers to: contractors (40% FTE) casual employees (40% FTE) directors non-executive directors prospective participants (on condition that they accept the position) What "eligible products" can be offered? Relief limited to offers of options over fully paid shares Relief extended to include offers of: fully paid voting ordinary shares; units in fully paid ordinary shares; incentive rights relating to fully paid ordinary shares Offer limit of $5,000 per participant per year Offers must be for no more than nominal monetary consideration Payment of monetary consideration on exercise or vesting of options or incentive rights in certain circumstances What structures can be used? Direct issue Direct issue of eligible products Trust structures, where fully paid voting ordinary shares are held on trust on an allocated or an unallocated basis (20% holding limit; trustee may exercise voting rights in its own discretion if it is not the unlisted body or an associate) What general conditions apply to the relief? Effectively, options could not be exercised until the underlying shares had been listed on ASX or an approved foreign exchange for at least 12 months No listing requirement 20% issue limit (current offer and offers over past 3 years) Offer documents must be clear, concise and effective 5% issue limit (current offer and offers over past 5 years) Copy of offer documents must be given to ASIC within 7 days Prominent warning about illiquidity and realisation value and disclosure of certain financial information Notice in prescribed form must be given to ASIC within 1 month after first relying on the Class Order ASIC can exclude a body from Class Order relief Ashurst Company Law & Governance Update 16 December

8 The Unlisted Body Class Order expands ASIC's employee incentive scheme relief for unlisted bodies by permitting offers of ordinary shares, options or incentive rights valued at up to $5,000 per participant per year. This relief will provide some increased flexibility to unlisted employers wishing to provide equity incentives to their employees. ASIC's relief is, however, more limited than the relief provided to listed bodies. This is because unlisted bodies are subject to a lower level of supervision and disclosure and, in the absence of a disclosure document, it may be difficult for participants to assess the value of an offer by an unlisted body. As a result, the risks for participants may be higher. Who can make offers? The Unlisted Body Class Order permits offers to be made by unlisted bodies and their wholly owned subsidiaries. It does not extend to associated bodies corporate or related bodies corporate that are not wholly owned subsidiaries. The Unlisted Body Class Order recognises that the unlisted body may have other classes of shares on issue, however it is only products referable to fully paid ordinary shares that can be offered to participants under the terms of the relief (see further below). Who can receive the offers? Offers can be made by unlisted bodies to the same eligible participants described in the Listed Body Class Order (see page 3 above). What financial products can be offered? The Unlisted Body Class Order permits offers of: fully paid voting ordinary shares; units in fully paid voting ordinary shares; options over fully paid voting ordinary shares; and incentive rights (being conditional rights to acquire fully paid voting ordinary shares, certain cash amounts relating to ordinary shares or a combination of the two). Offers of these products must be made for no more than nominal monetary consideration at the time of the offer. Vesting of options and incentive rights The Unlisted Body Class Order does not prescribe the circumstances in which options can be exercised or incentive rights can vest. ASIC has abandoned its proposal in CP 218 that the exercise or vesting requirements should depend on: the length of service of the participant or the performance of the body; and the unlisted body preparing a disclosure document or being the subject of an IPO or trade sale. ASIC now recognises that there are a range or circumstances in which participants may be required to pay additional consideration in order to exercise an option or for incentive rights to vest: (IPO) the fully paid voting ordinary shares have been quoted on ASX or an approved foreign market for at least three months without suspension for more than five trading days during the shorter of the period in which the shares have been quoted or the 12 months before the rights vest or the options are exercised; or (independent valuation) one of the following valuation documents is given to the participant at least 14 days before the exercise or vesting: an offer information statement or prospectus; an independent expert's valuation; or an executed agreement which specifies the value of shares to be acquired by a third party (who is not an associate) on arm's length terms. (This differs from CP 218 which proposed that no more than nominal monetary consideration should be payable on the vesting of incentive rights or exercise of options). Ashurst Company Law & Governance Update 16 December

9 What structures can be used? Listed Body Class Order permits unlisted bodies to make offers to eligible participants either directly or through a trust structure. (The terms of the Unlisted Body Class Order differ from CP 218, which proposed that unlisted bodies be prohibited from utilising trust structures.) ASIC's relief is granted on similar conditions to those imposed on the use of trusts by listed bodies, except that the trustee cannot hold more than 20% of the issued capital of the unlisted body on trust in reliance on ASIC's employee incentive scheme relief (compared with 5% for listed bodies). Unlisted bodies cannot use loan structures or contribution plans in connection with their employee incentive schemes. General conditions There are a range of general conditions applying to employee incentive scheme offers by unlisted entities. Offer limit of $5,000 per participant per year The aggregate value of all offers of shares, units in shares, options and incentive rights offered cannot exceed $5,000 per participant per year. The offer document must disclose the directors' methodology for determining the value, which must have been resolved less than 12 months before the offer and must have a reasonable basis. (The terms of the Unlisted Body Class Order differ from CP 218, which proposed that offers of ordinary shares be capped at $1,000 but contained no cap on offers of options and incentive rights. CP 218 also provided that the value of the share offers must be calculated by reference to the company's net tangible assets (NTA) (as shown in the company's audited accounts) or an independent expert's valuation.) 20% issue limit In addition, a 20% issue limit is applied to offers by unlisted entities, which is calculated in broadly the same manner as the 5% issue limit which applies to listed bodies (see page 6 above). Disclosure Among other requirements, the offer document must: be accompanied by audited financial statements or a special purpose financial report; include a copy of a directors' solvency resolution made no later than one month before the offer; contain prominent front page warning statements indicating that, depending on future events, the products offered under the offer document may not have any value which is capable of being realised by the participant; and be presented in a clear, concise and effective manner. Ashurst Company Law & Governance Update 16 December

10 PROPOSED CHANGES TO TAX TREATMENT OF SOME EMPLOYEE SHARE SCHEMES Background Employers offering financial products such as shares or options will also need to take into account the relevant tax treatment of the relevant scheme, which can vary considerably depending on the type of financial product being offered and the structure of the offer. The tax treatment may influence the attractiveness of the scheme to employees. Current tax rules The tax rules apply to schemes which involve the issue of "shares" or "options" to acquire shares to "employees" (collectively, "employee share schemes"). For tax purposes: "shares" include interests in shares (such as depositary interests over foreign shares), shares issued by foreign companies and interests in stapled securities which include a share; "options" can include rights which may become a right to acquire a share; and "employees" include directors, office holders, certain individuals providing services who are not common law employees, associates of an employee and past or prospective employees. The tax rules seek to tax the employees on the "discount" or value of the share or option, either at the time the share or option is issued or at a later time (and in some limited cases, the discount or value may be exempt from tax up to $1,000). The ability to defer taxation or obtain an exemption is partly intended to make relevant employee share schemes more attractive. In 2009, the Rudd government introduced significant changes to the tax treatment of employee share schemes. Under the current tax rules: the tax on the discount associated with a share or option issued to an employee can only be deferred if there is a "real risk of forfeiture" or under a limited salary sacrifice arrangement; for shares, 75% of eligible employees need to be offered participation for the deferral concession to apply and the tax generally becomes payable on the earlier of cessation of employment or the seventh anniversary of the shares being issued; for options, the tax generally becomes payable on the earlier of cessation of employment, the options becoming exercisable (rather than the options being exercised) or the seventh anniversary of the options being issued. As a result of these conditions, employee share schemes have become less attractive, particularly when compared with their tax treatment in countries like the US and the UK. The conditions have had a particular impact on executive option plans and on start-up companies, which rely on employee shares or option schemes to attract key individuals. Proposed tax changes As reported in our recent Tax Alert dated 15 October 2014, the federal government has proposed changes to the tax treatment of certain employee share schemes which involve the issue of shares or options at a discount, including some of those that are covered by the new class orders. Offers of options In broad terms, one of the proposed tax changes should make it more attractive for all companies to offer share options to their employees at a discount. Under the proposed changes it would no longer be necessary for there to be a "real risk" that the options, or the shares acquired on exercise, will be forfeited or lost in order for the employee to defer taxation of the options. Share options issued to employees should only become taxable on the earlier of cessation of employment, the exercise of the option or the seventh anniversary of the option being issued. Ashurst Company Law & Governance Update 16 December

11 Offers by start-up companies In addition, extensive changes are proposed to the tax treatment of share and options schemes offered by certain "start-up companies" to their employees. These changes will make it easier for start-up companies to offer shares or options which qualify for deferral of tax. Provided the options or shares are held for at least three years, the tax could be deferred to the fifteenth anniversary of the options or shares being issued unless an earlier taxing point occurs first (such as sale of the shares or options). In addition, some schemes will be exempt from tax. As noted in our Tax Alert, a limited range of companies will qualify as "start-up companies", including that they must be unlisted, have been incorporated within the last 10 years and have an aggregated turnover of less than $50 million. Given that the Unlisted Body Class Order will only allow unlisted companies to offer up to $5,000 worth of options or shares to participants without a prospectus or other disclosure document, access to the proposed tax concessions for shares and options offered by start-up companies could be limited. In particular, the potential costs involved in preparing a prospectus or disclosure document is likely to be a factor for start-up companies, which commonly face difficulties in raising capital. Where next? Details of the federal government's reforms to the tax treatment of employee share schemes are yet to be released and will be subject to consultation. Developments in this area should be monitored. FINAL OBSERVATIONS ASIC's expanded and modified relief for employee incentive schemes should, on the whole, facilitate the current practices of listed bodies (and eligible foreign entities). Expanding the relief to allow unlisted bodies to make annual offers of up to $5,000 worth of shares, options or incentive rights per employee may also provide some increased flexibility to unlisted employers wishing to provide equity incentives to their employees. Changes to the tax treatment of employee share schemes should continue to be monitored, and companies should consider whether tax reform combined with ASIC's updated relief will facilitate a more flexible employee incentive scheme structure. Contacts John Sartori Partner Melbourne T: E: john.sartori@ashurst.com Ian Kellock Partner Melbourne T: E: ian.kellock@ashurst.com Lisa d'oliveyra Senior Associate Melbourne T: E: lisa.d'oliveyra@ashurst.com Jason Hewitt Senior Associate Melbourne T: E: jason.hewitt@ashurst.com Marcus Ryan Senior Associate Sydney T: E: marcus.ryan@ashurst.com Lauren Harris Lawyer Melbourne T: E: lauren.harris@ashurst.com This publication is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to. Readers should take legal advice before applying the information contained in this publication to specific issues or transactions. For more information please contact us at aus.marketing@ashurst.com. Ashurst Australia (ABN ) is a general partnership constituted under the laws of the Australian Capital Territory and is part of the Ashurst Group. Further details about Ashurst can be found at Ashurst Australia No part of this publication may be reproduced by any process without prior written permission from Ashurst. Enquiries may be ed to aus.marketing@ashurst.com. Ref: 12 December 2014