No news is not good news - reform of Employee Share Scheme rules

Despite industry hopes that this year’s Federal Budget would include announcements on the Abbott Government’s plans for the overhaul of taxation on employee share schemes (ESS) in Australia the Government has delayed any announcement until later this year.

It is widely considered across the industry that existing barriers to the use of employee share schemes to reward employees (particularly in Australia’s technology and innovation sector) place companies operating in Australia at a competitive disadvantage to their overseas counterparts and that removing those barriers is critical to development of the industry in Australia. 

An effective employee share scheme regime allows start-ups to attract and retain talent at a time when they are cash poor.  Usually for these types of companies it is simply not possible to reward staff with salary commensurate with that offered by established businesses or industries and offering any salary shortfall in equity both rewards the employee (allowing them to share in the future success) and fosters a sense of ownership and participation. 

The intricacy surrounding the existing employee share scheme regime in Australia is not just a barrier to the use of such schemes for companies in the technology and innovation industries.  Companies in a range of industries all across Australia are hampered by the inherent complexity in the rules.

Overview of the current rules

The default position under the current rules is that each employee who is issued a share or a right to acquire a share (ESS interest) at a discount to market value must include that discount in their ordinary assessable income and pay tax on this amount at their marginal tax rate.

The time at which the ESS interest is taxed may, however, be deferred in certain circumstances – most commonly, where there is a real risk that the employee may forfeit or lose the interest.

The advantage of having a small amount taxed upfront upon the grant of the options is that once this occurs, the ESS tax provisions will no longer apply.  Instead, the capital gains tax (CGT) provisions will operate from that point forward.  This has two benefits:

• where the taxpayer is an individual or individual beneficiary of a trust, the CGT discount can be accessed for future increases in value (i.e. beyond that already taxed upfront under the ESS rules) subject to meeting the normal discount conditions, and
• any future taxing point will only arise when a CGT event occurs (normally when there is a disposal or other ‘cash-out’ event) and if this does not occur, deferral can be indefinite.

This may be contrasted with the deferral position.  When deferral ends (and the discount is potentially much higher, due to growth of the business) the discount is included in the employee’s assessable income and subject to tax at their marginal rate.

Importantly, the current regime does not allow the employee to choose upfront taxation in circumstances where the conditions for the deferral concession are satisfied (although it is possible to structure schemes that take advantage of the benefits of upfront taxation at a time when the value is low).

Barriers to implementation

The current complexity and regulation of the rules is the most significant barrier to the wide adoption of employee share schemes in Australia.  While there are some alternatives that can allow effective remuneration of key employees for start-ups or companies with high growth potential, due to their complexity (and cost) such plans are not effective to encourage broad participation by employees.

Although the rules provide valuation mechanisms, these cannot always be used.  In circumstances where the employer is not listed, the company needs to obtain a business valuation each time it wishes to issue shares to employees.  Obviously obtaining valuations of many start-ups is problematic or, at the very least, expensive.  Further, where incentive arrangements satisfy the conditions for the deferral concession to apply, there can be multiple valuation points, meaning significant compliance costs in obtaining valuations of the relevant interests at each time a deferral period ends for an employee.

The fact that employees are likely to be taxed upfront on the value of their shares, of itself, provides significant disincentive.  Where there is no market for those shares, the employee is stuck with an upfront tax liability in respect of an unrealised (and potentially unrealisable) investment.  Particularly relevant to start-ups is the risk that an employee will be left with an upfront tax liability in respect of a venture that may fail and shares that are ultimately worthless. 

Even in circumstances where the employee is able to sell shares to meet any upfront tax liability the result is equivalent to paying a cash bonus or salary and the executive using the after cash amount to fund an acquisition of shares at market price.  While this may well be the economic goal of the provisions, it is hardly a means to encourage share ownership.

Whilst this scenario is problematic for a listed company, it is even worse for a private company or entity in which there is no liquidity or available market to dispose of the shares.  In either case, the use of employee share schemes to provide significant benefits to employees that do not qualify for the deferral concession are rare.

Although it is possible to structure an employee share scheme around the obvious complexity in the existing regime, this of itself can produce a scheme that is both costly, complex and in certain industries, may not provide employees with the incentive sought by implementation of the scheme in the first place.

Where to from here?

Treasury released a discussion paper in August 2013 seeking input in respect of the application of the employee share schemes for ‘start-up companies’.  While the paper originally had a closing date for submissions of 30 August 2013, the consultation process was put on hold due to the Federal election and there has been no further announcement from the Government as to the proposed time line for reform of the employee share scheme regime.

Arguably, the proposals in the paper remain highly restrictive when compared to international comparisons (with which the measures are designed to compete for attraction and retention of talent).  In any event, the paper focuses only on the use of employee share schemes by start-ups with the concessions proposed restricted to businesses with a turnover of less than $5 million and 15 or fewer employees meaning that concessions are effectively restricted to ‘small businesses’.

If the Government did proceed with the arrangement and sought to implement some or all of the proposals in full, there would still remain a substantive competitive disadvantage of Australia compared to other overseas incentives, such as those in the UK, US and Singapore: 

• in Singapore a 75% exemption is provided for up to SGD$10 million in value received by an employee over a 10 year period
• in the UK, the concession allows up to £120,000 per employee and £3 million per employer to be granted without tax and without National Insurance Contributions paid on exercise, and 
• the US employee share arrangements (which are not limited to start up or speculative companies) provide for options of up to $100,000 a year per employee to be issued and stock purchase plans of $25,000 per year per employee, which are not taxed when granted or exercised.  Taxation only occurs when the stock is sold and, if held for one year from the date of purchase and two years from the date of granting in respect of options, CGT rates are available.

 

It goes without saying that both the current and proposed employee share scheme tax incentives in Australia are substantially more restrictive and less generous than a number of our overseas peers and a full review of the regime is warranted.

 

It is envisaged that the Government will announce proposed changes to the rules later this year.  For companies that do not have the luxury of waiting this long, there are still structures available to optimise the effectiveness of an employee share scheme and tailored advice should be sought prior to implementation.

Melinda Peters, Hayden Bentley

Is crowd funding an alternative means for raising capital?

Crowd funding is a concept that has existed for some time in various jurisdictions, but has only received attention relatively recently from potential stakeholders and regulators in Australia.

It has been identified as an alternative means for raising capital, in particular as a source of ‘scarce’ capital for early stage and start-up companies, from a large number of small investors.  It has been used successfully and most commonly for creative projects such as music, film and mobile apps. 

However, the next stage of crowd funding’s evolution, involving the issue of securities in return for funds and the accompanying regulatory framework, is still in its infancy in Australia.

What is it?

In its guidance released in August 2012, Australian Securities and Investments Commission (ASIC) defined crowd funding as ‘the use of the internet and social media to raise funds in support of a specific project or business idea. Project sponsors or pledgers typically receive some reward in return for their funds. In some cases, the reward expected may be of minor value and is merely incidental rather than the purpose of the contribution’.

Essentially, it involves advertising an idea online through an intermediary crowd funding platform (usually a website) to allow for the dissemination of the idea to a wide audience.  This can result in significant funds being raised, typically in small individual quantities from a large number of participants.

The most common forms of crowd funding in Australia have been donation funding for charitable causes or pre-payment funding (an investment in return for the promise of a product or service that is produced / provided if sufficient funding is raised).

A more complex area now being considered, including in a Corporations and Markets Advisory Committee (CAMAC) paper in September 2013, is the concept of crowd sourced equity funding (CSEF).  As with other means of capital raising, this would involve the issue of securities in return for funds.  It is this that has caused the most concern for ASIC and other regulators.

Regulator concerns

ASIC has indicated that crowd funding is an area that is to come under increased surveillance, having regard to its consumer protection mandate (with concerns that persons may make an investment or payment based on limited or potentially misleading information, or possibly even fraud).

ASIC has also made it clear that various crowd funding arrangements, particularly CSEF, will be caught by the fundraising and/or financial service licensing provisions of the Corporations Act 2001 (Cth), which could give rise to penalties for persons seeking to raise the funds and/or the operators of the crowd funding websites.  Another potential consideration is whether the crowd funding amounts to a pre-purchase arrangement of a product or service (under the Competition and Consumer Act 2010 (Cth)).  

These concerns are potentially exaggerated by the borderless nature of crowd funding, often making it available to investors in any country, so the number of affected persons can be significantly greater than with other means of fundraising.  Retail investors are the most likely target, emphasising the need for proper legal protections.  That said, CAMAC acknowledges that, with modest investments across a range of opportunities, the perceived risk to such investors is likely to be reduced. 

This has been acknowledged in other jurisdictions, such as New Zealand, where new legislation has been introduced to facilitate CSEF, as an initiative to support early-stage and growth companies.

Next steps as an alternative means of raising capital

At this stage, there have been no indications for a change to applicable Australian law (e.g. to modify the relevant fundraising exemptions) to allow for CSEF.

Some other practical considerations in seeking funds through crowd funding include ensuring compliance with the laws of applicable foreign jurisdictions (where the website is accessible) and that a bona fide website operator is used. 

If CSEF does arise as a means of raising funds, a company issuing securities would also need to consider the practical implications of a potentially large shareholder base with unmarketable parcels of shares and the relevant regulatory and administrative costs which may arise.

It may take some time for more varied forms of crowd funding, particularly CSEF, to emerge in Australia, but it is certainly something to continue to watch.

ASX releases new Corporate Governance Principles

Yesterday, the ASX Corporate Governance Council released the third edition of its Corporate Governance Principles and Recommendations.  The new principles will take effect for a listed entity's first full financial year commencing on or after 1 July 2014.

The release marks the first major revision of key Australian corporate governance principles since the GFC and follows the issuing of draft principles and a consultation process examined in an earlier post last August.

The Corporate Governance Principles and Recommendations are available to view at:
http://www.asx.com.au/documents/asx-compliance/cgc-principles-and-recommendations-3rd-edn.pdf.

Whistleblower protection under the Corporations Act

Whistleblower protection has received a lot of media attention recently, following the Senate Inquiry into the performance of the Australian Securities and Investments Commission (ASIC) and its alleged failure to act promptly on information provided by whistleblowers in relation to serious misconduct in Commonwealth Bank’s financial planning arm.

Consistent with ASIC’s commitment to improve communication and handling of information brought to its attention by whistleblowers, it has released a new Information Sheet (Info Sheet 52) which provides guidance on the statutory protections available to those who report misconduct or provide evidence of a breach of the Corporations Act 2001 (Cth) (Corporations Act) to ASIC. 

The whistleblower provisions of the Corporations Act are designed to encourage people associated with a company to alert the company (through its officers) or ASIC, to illegal behaviour.  Information provided by whistleblowers is considered a protected disclosure (provided certain criteria are satisfied), and must be kept confidential.  Both the information provided and the identity of the whistleblower may not be disclosed, unless that disclosure is specifically authorised by law.

Generally speaking, for the purposes of the Corporations Act, a whistleblower is a person who is an employee, contractor or member of an organisation, who reports or ‘discloses’ misconduct or dishonest or illegal activity that has occurred within that same organisation.  The report must be made to either ASIC, the company’s auditor or member of the internal audit team, a director, secretary or senior manager, or a person authorised to receive whistleblower disclosures (such as a Whistleblower Protection Officer).

It is imperative that companies have a whistleblower policy in place to ensure employees know how to report issues, who to report them to, and how they will be dealt with when the company is alerted. 

The policy should also detail the rights of employees to disclose improper conduct on a confidential basis without fear of retaliation.

A whistleblower reporting tool (e.g. a hotline or online portal with analytical capabilities) is also a useful way to detect fraud within an organisation.  

Info Sheet 52 is a useful reference tool, to ensure your policy adequately details the protections available to whistleblowers.  It should, however, be noted that the protections under the Corporations Act only apply to whistleblowers who report breaches of the Act, as opposed to breaches of other laws, or the company’s internal policies.  

To afford the protections under the Corporations Act, the whistleblower must identify their name when making a disclosure, have reasonable grounds to suspect that the information being disclosed indicates that the company, company officer or employee may have breached the Corporations Act and must make the disclosure in good faith. 

Identifying the whistleblower is not typically required under other laws, nor is it under many internal policies.  Therefore, if a matter that would result in a breach of the Corporations Act is reported anonymously through internal channels, the whistleblower would need to be identified before the matter was referred to ASIC to benefit from the protections in the Corporations Act against civil and criminal litigation. 

Further, the provisions of the Corporations Act may be relied on by the whistleblower in their defence if they are the subject of an action for disclosing protected information.  It is important to note that no contractual or other remedy can be enforced against the person on the basis of the disclosure. 

Where a whistleblower’s employment is terminated because of a disclosure made under the Corporations Act, the whistleblower can apply to Court for an order to be reinstated in that position, or in another position at a comparable level. 

The publication of Info Sheet 52 is an important reminder that whistleblowers play a role in detecting serious misconduct within organisations and should be afforded adequate protections. Companies must ensure that procedures are in place so that matters of concern that are raised can be dealt with on a timely basis, either internally or, in the case of a serious breach, by escalating the matter to ASIC or the Australian Federal Police. 

Tiffany McLean, Andrew Poulton, Navina Vijaysegaran

The new Australian Privacy Principles – Is your organisation compliant?

On 12 March 2014, fundamental changes to Australian privacy laws will take effect. The changes introduce new rules about how organisations collect and store personal information.  With penalties up to $1.7 million enforceable for serious breaches, organisations must act now to ensure compliance. 

As part of the privacy law reform process, the Privacy Amendment (Enhancing Privacy Protection) Act 2012 (Privacy Amendment Act) was introduced to Parliament in May 2012  marking significant changes to the Privacy Act 1988 (Cth) (Privacy Act).

The changes to the Privacy Act include a new set of harmonised privacy principles that regulate the collection and handling of personal information called the Australian Privacy Principles (APPs) applying to most organisations who turn over $3 million or more annually, and to Commonwealth Government agencies.  The APPs will replace the National Privacy Principles that apply to businesses and the Information Privacy Principles that apply to Government agencies.

To some extent, the APPs are based on the existing privacy principles but now impose additional obligations on organisations when dealing with personal information.  In particular, the APPs require organisations to provide additional discloses in their privacy documentation and internal procedures and policies ensuring the protection and ongoing quality of personal information that they use and store. 

APPs are legally binding principles and aim to be the cornerstone of the privacy protection framework in the Privacy Act, by setting out uniform standards for dealing with personal information.  The APPs are structured to reflect the personal information life cycle and are grouped into five parts, including:

• the consideration of personal information
• collection of personal information
• dealing with personal information
• integrity of personal information, and
• access to, and correction of personal information. 

Under the Privacy Amendment Act, the Information Commissioner receives new powers to seek civil penalties of up to $1.7 million from organisations who commit serious or repeated breaches of privacy. The Information Commissioner may also conduct ‘own motion’ privacy investigations on organisations without first receiving a privacy complaint from a member of the public.  

The Privacy Amendment Act also implements changes to credit reporting laws, including the introduction of more comprehensive reporting about an individual’s current credit commitments and repayment history information.  The credit reporting changes are also supplemented by a new credit reporting code. 

While the Office of the Australian Information Commissioner has released APP guidelines to assist organisations with the transition to the APPs (which must occur on or before 12 March 2014), it will be interesting to see how and when the Information Commissioner exercises its new powers in relation to privacy compliance.  Under the APPs, it will therefore be important for relevant organisations to consider their existing information policies, review and update their privacy documents and develop internal procedures to ensure compliance by 12 March 2014.

Alex Hutchens, Stephanie Parkin

ASIC takes ‘no further action’ on David Jones’ alleged insider trading

Whilst some commentators have intimated the buying of shares by two company directors just three days before the release of price sensitive sales results was on the limits of insider trading laws, ASIC has decided to issue David Jones with a ‘no further action’ letter.  Despite ASIC’s decision to not take further action, the share trading has still resulted in the resignation of the relevant directors.

On 10 January 2014, less than two weeks after ASIC announced its conclusion of the two month investigation, accused directors, Steve Vamos and Leigh Clapham, and David Jones Chairman, Peter Mason, have announced their decision to resign from David Jones as part of a ‘board renewal process’.  This news comes after significant pressure from shareholders to remove the directors, despite the fact ASIC’s investigation yielded no evidence to prove that the trades were made in violation of the insider trading laws. 

The investigation was sparked after criticism emerged following the alleged approval of share trading by two non-executive directors, just three days prior to the release of unexpected positive sales results, and one day following David Jones receiving a scrip merger proposal from industry rival Myer.  The directors, who bought a total of 32,500 shares were said to have made the trades to illustrate their long-term commitment to the company.  This was said to be because CEO, Paul Zahra, had announced his intention to resign earlier that month under suggestion there were disagreements between various board members.

Peter Mason, who allegedly approved the trading, claimed the directors were not privy to any price sensitive information.  Yet his defence became unhinged after both announcements caused share prices to spike significantly, despite the merger announcement also stating the proposal was rejected.  Mason allegedly still claimed the directors did not previously obtain the quarterly sales data and that the merger was not materially price sensitive.  If it was found the directors did not have the quarterly sales information and the merger proposal did not satisfy the definition of materially price sensitive information, the directors would not have violated the insider trading laws (amongst other possible defences).

For ASIC to successfully prosecute an instance of insider trading, investigators must be able to satisfy four key tests, proving: the directors actually possessed the information at the time of trades; the information was inside information that was not generally available; the information was price sensitive; and the suspected directors knew, or ought to have known, the information was material and not publicly available.

While ASIC has not publicly released any information as to why the investigation was dismissed, it is potentially relevant that investigators may not have formed the view that the directors knew the information concerning the quarterly sales and that the merger offer was price sensitive.  While the announcement of the merger did result in an increased share price, the definitions given in the Corporations Act states that, ‘for information to be material, a reasonable person would be taken to expect that the information would, or would be likely to, influence persons decisions in deciding whether or not to acquire shares’.  As this was a ‘merger of equals’ where David Jones would not have received any premium on their share price, the value of the company  and shares arguably would not have increased, making it difficult to prove the information of the merger was, by definition, material.

Regardless of the findings of the ASIC investigation, the resignations of the directors highlights the ever increasing need for appropriate corporate governance and security trading policies.  Particular care should be taken whenever a company is ‘in play’ or pending release of formal results, if management information is available.

ASX to introduce online processing for certain corporate actions

In an effort to streamline the announcement process for certain corporate actions, for listed entities, the ASX is proposing the introduction of an online straight-through processing (STP) facility, replacing the current practice of requiring corporate actions to be completed on ASX forms and uploaded as PDF documents.  The initiative will require a change in process for listed entities for the announcement of certain events such as the announcement of a dividend/distribution or a reorganisation of capital. 

Once a corporate action is submitted, the system will automatically generate a PDF and release the announcement to the market.  With more than 110,000 corporate actions announced each year, it is hoped the STP facility will improve the efficiency and timely release of the relevant company data.

The proposed implementation date for the STP is 14 April 2014 (with a six-month grace period in which ASX will encourage, but not enforce, use of the online forms).  ASX will also offer listed entities a facility to test the new system in January and February 2014.

For further details, please refer to the ASX website.