ESOP tax accounting: What do you need to do?

ESOP Tax Accounting

Often when startups organise the setup of an employee share options plan (ESOP), the legal matters are set in place, but the tax accounting is left by the wayside. Don’t be left out of the compliance loop – read to find out what’s your ESOP tax accounting requirements. 

Don’t be left out in the cold with tax, in this article we show you how to meet your ESOP Tax accounting obligations. But if you don’t understand how an ESOP works checkout our overview.

ESOP NTA Valuation

This is usually a startup’s first piece of work regarding tax and accounting for their ESOP. When determining the exercise price for the ESOP Offer & Plan documents, the lawyer will often ask you about its value. 

The exercise price is the amount payable by the employee to convert the options into shares. This is often a figure that many advisors will advise to put a negligible value – after all most employees wouldn’t be in the market to purchase until there is a liquidity event (company sale or listing) to help reimburse the employee with cash to first exercise the options. 

It is important to note that choosing a negligible value for the exercise price isn’t a given. The startup concession criteria in s83A ITAA 1997 and via ESS 2015/1 must often be passed to allow a negligible valuation for tax regarding the shares of the company – based on effectively the net asset value of the balance sheet. 

Choosing an exercise price lower than the valuation determined from this procedure could potentially lead to a “taxable discount” for the employee so it is key to get this figure right. If conducted correctly the startup concessions for ESOPs effectively allow for a cashless transaction for the employee (with no tax applicable on the grant or vesting of the associated shares or options in the startup).

With the help of a seasoned ESOP tax advisor, you can evaluate whether your venture meets the numerous criteria for the startup concession and calculate a value of the ESOP for tax purposes (via ESS 2015/1). 

Balance Sheet Valuation

So you now have an ESOP plan running and incentivising “buy-in” from your staff. Now comes around end of tax year time and you have to account for the value of the option plans on your balance sheet. Amongst bootstrapped founders this is often a forgotten exercise, but when there are other sophisticated stakeholders onboard (such as when a VC requests a statutory declaration from founders on the state of the accounts) that’s when its necessary to get proper figures included for the options. 

Whilst there are many different ways to calculate the value of options for accounting purposes, the Black-Scholes method is by far the most popular and takes numerous variables into account including exercise price, risk-free interest rate, volatility amongst many others. 

At the end of the financial year, your ESOP accountant can take the basic details for your option plan and convert them with some quite detailed formulas and spreadsheets to arrive at a figure for the equity section of your balance sheet. Being a complex operation, allow your accountant some time to calculate this section properly. 

Your auditors will thank you for it! 

ATO Annual ESS Report

Asides from external stakeholders, the ATO is also interested in the details for your ESOP tax accounting plan. Whilst no immediate tax is payable under the startup tax concessionsthe ATO still needs you to prepare & report annually on your ESOPs via ESS statements. ESS stands for employee share schemes and the ATO often refers to ESOPs by this term instead. 

The ESS statements serve the purpose of helping your employees calculate a capital gains event on their shares in the future and are to be provided to both the employee and the ATO.  

Your ESOP tax accountant should be able to complete this for you for each employee in receipt of an ESOP with the details on hand. 

Tax Planning & Advisory for your Employees

When participating in an ESOP you can be sure that your employees will also have questions around the best practices for taxThey often have queries around tax projections, when to sell or exercise, what concessions are available and what structure they should hold the shares in or even a simple tax review of the arrangement.  

Ensuring they have access to a tax advisor who can best advise on their ESOP is the key part of help staff feel comfortable with this mode of remuneration. 

ESOP accounting is not part of the regular assignments that tax accountants manage so it is key to work with an advisor seasoned in the space. Fullstack have been advising on ESOP tax accounting and setups for years.

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Stuart Reynolds is the founder of Fullstack Advisory, an award-winning accounting firm for businesses leading the future. He is a 3rd generation accountant who specialises in tech & online companies.

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