In a comment article published in today’s Australian Financial Review, tax partner Shaun Cartoon warns that for employees of start-up companies holding share options, the government’s overhaul of CGT rules threatens to lumber them with massive tax bills on paper gains they can’t actually cash out.
Shaun explains that, until recently, the tax treatment of a start-up option was easy to explain. No tax on grant, vesting or exercise, and the 50 per cent capital gains tax discount would generally apply to reduce any capital gain when the resulting shares were sold, with a maximum effective rate of 23.5 per cent. But that simplicity ended in June when the government legislated its tranche 1 tax reforms.
Shaun poses the example of an employee who is granted a qualifying start-up option today with a 1¢ exercise price. The discount on grant is disregarded and the option is then held as a CGT asset. Assume the market value of the option is $100 on June 30, 2027. The CGT transition rules deem the option to be sold and reacquired at its market value at that time. That preserves the pre-July gain for the 50 per cent discount and establishes the starting point for future indexation. The notional $100 gain is then quarantined until a later “realisation event”.
“Here is the trap. Exercising the options is itself a realisation event that would trigger tax on the $100 notional gain. For example, if the employee exercises the options in September 2027, roughly $100 of deferred gain would be pulled into the employee’s 2027-28 tax return even though the employee has received no cash and still holds an illiquid share.”
While Treasury’s tranche 2 exposure draft legislation, released on August 3, excludes several CGT events that do not involve a substantive realisation, it does not exclude the exercise of an employee option.
Shaun argues that omission should be fixed now because waiting for a third tranche of legislation unnecessarily prolongs uncertainty for companies designing plans today.
To read the full article, click here.
