New Employee Scheme Share Legislation
The prospectus rules in sections 706 and 707 of the Corporations Act prohibit offers of securities without disclosure, subject to various exceptions. Equivalent provisions in Chapter 7 apply to offers of interests in managed investment schemes. Recognising the impediments these rules impose on employee share schemes, ASIC has for many years provided various forms of relief. Currently, the principal forms of relief are found in ASIC Instruments 14/4000 and 14/4001, which provide prospectus relief for public listed companies and trusts, and private companies respectively. These forms of relief are to be brought into the Corporations Act itself, with some variations and additions. The new rules are found in a new Division 1A of Part 7.12 of the Corporations Act, which will come into force on 1 October 2022.
The ASIC Instruments provide relief for offers of securities and interests under employee share schemes (ESS) where certain conditions are satisfied, principally being that the offer is made by a complying offer document and that the offer together with prior offers does not exceed 5% of the securities on issue in the relevant class. The new Division 1A effectively replicates those conditions in legislative form, with some changes. Some minor tax changes will also be implemented.
As is the case under the current rules, the new rules will be slightly different for public listed companies and trusts and unlisted companies, and they will provide comprehensive relief from the disclosure rules, the restrictions on advertising, the requirement to make a target market determination (for listed trusts), the AFSL requirements for advising, offering and management, and the share hawking provisions.
PUBLIC LISTED COMPANIES AND TRUSTS
There is a general exception for offers of ‘free’ securities and offers of options that can be exercised with no exercise price (sometimes referred to as zero exercise price options or ZEPOs). These offers are exempted altogether. This is particularly relevant for schemes that make use of the tax rules that allow offers of up to $1,000 of free shares to employees annually on effectively a tax-free basis.
An offer for monetary consideration will attract the exceptions under the new legislation provided the offer meets a number of requirements, the main ones being:
- The offer is made by a complying offer document (defined in s1100W – summary of terms, information about risks, other required information).
- The offer complies with the issue cap in s1100V (the cap is 5% for listed companies and trusts, but the constitution can increase the cap, and 20% for unlisted companies). or
- If the securities are offered under a contribution plan, the plan must meet the Division 1A requirements (s1100T, which contains various protections for employees).
- If a loan is provided in connection with the offer, the loan must meet the Division 1A requirements (s1100U, which requires that the loan is no interest with no fees, and on default recourse is limited to forfeiture of the securities – so there is no risk to the employee).
The rules for unlisted companies (there are no exemptions for unlisted trusts) are the same as for listed companies and trusts, with the following variations:
- As noted above, the issue cap for private companies is 20%.
- The offer document must be accompanied by financial information about the company and a valuation of the security offered or other assurances as to valuation of the type specified in s1100X(3). or
- The employee must be given a 14-day cooling off period and the offer document must contain specific disclosures required by s1100Y.
- The offer must be within the monetary cap specified in s1100ZA: $30,000 per annum (subject to various adjustments).
The monetary cap is one area where additional relief is provided by the new changes:
- The limit on the size of purchases of shares by employees of unlisted companies will be increased from the current cap of $5,000 per year to $30,000 per year.
- Further, if an employee holds unexercised options, the employee may accrue their yearly cap over a five-year period or to a maximum of $150,000.
- The monetary cap will not apply where the company is sold or listed through an initial public offering shortly after employee securities are issued.
Previously, an outgoing employee holding an ESS interest that was subject to tax would be required to pay tax on their ESS interests if their employment was terminated before taxation of those interests. Often times, this resulted in an unfunded tax liability on vested options or rights.
Since 1 July 2022 however, cessation of employment will no longer be a taxing point. The new amendments establish that outgoing employees will pay tax on their ESS interests at the next relevant taxing time (which generally coincides with the vesting or exercise of the interest, or the lifting of disposal restrictions).
This change applies to both current and future ESS interests that are covered by the ESS rules in Division 83A of the Income Tax Assessment Act 1997 (Cth). These amendments are most relevant to employee share schemes that provide for acquisition of options at a discount. They alleviate the difficulty that employees can be taxed before they are able to realise any cash benefit.
Disclosure and defences
The new Division 1A contains a disclosure regime which is similar to that found in Ch 6D for prospectuses, including liability for misleading statements and omissions and due diligence defences. This suggests that at least a limited due diligence exercise should be conducted on ESS offer documents.
OTHER CORPORATIONS ACT CONSIDERATIONS
The new Division 1A deals only with disclosure; other provisions of the Corporations Act are important – 260C(4) to allow loans, 259B(2) to allow companies taking security over employee shares where there is a loan, and 257B to allow a company to buy back employee shares. There are also various other exceptions to the disclosure/prospectus requirements in s708, and equivalent provisions in Chapter 7 that are often utilised for director and senior executive incentive schemes. An offer of ESS interests is eligible to be made under Division 1A if it could otherwise have been made under section 708, 708AA, 1012D, 1012DAA or 1012DA.
S 708(1) of the Corporations Act provides an exemption for small-scale offerings. Specifically, it provides that personal offers of a body’s securities do not require disclosure to investors if none of the offers results in a breach of both the 20 investors ceiling and the $2 million ceiling. Offers made in reliance on the small-scale offerings exemption must also comply with the trust, loan and contribution plan requirements (if they are offered under an ESS).
SIGNIFICANCE OF THE NEW RULES
The new Division 1A simplifies the task of advisers working on employee share schemes, in particular because the rules are to be found in the legislation rather than in ASIC Instruments. For those familiar with the current rules, there are some subtle changes that must be taken into consideration.
For further information please contact an author or any member of our Corporate & Commercial team(s).
This information and the contents of this publication, current as at the date of publication, is general in nature to offer assistance to Cornwalls’ clients, prospective clients and stakeholders, and is for reference purposes only. It does not constitute legal or financial advice. If you are concerned about any topic covered, we recommend that you seek your own specific legal and financial advice before taking any action.