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ESOP tax accounting: What do you need to do?

ESOP Tax Accounting

Often whenstartupsorganise 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 leftout ofthe 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 astartup’sfirst 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 youabout its value.

The exercise priceisthe amount payableby the employee to convert theoptions into shares. This isoften a figure that manyadvisors will advise to put a negligible value– afterallmostemployees wouldn’t be in the market to purchase untilthere is a liquidity event(company sale or listing)tohelpreimbursethe employeewith cash tofirst exercise the options.

It is important to note thatchoosing a negligible value for the exercise price isn’t a given.Thestartupconcessioncriteria ins83A ITAA 1997 and via ESS 2015/1 must often bepassed 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 pricelowerthan the valuation determined from this procedure couldpotentially lead to a “taxable discount”for the employeeso 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).

Withthe help of aseasonedESOP tax advisor,youcanevaluate whether yourventure meets the numerous criteria for thestartupconcessionand calculatea value of the ESOPfor tax purposes(via ESS 2015/1).

Balance Sheet Valuation

So you now have anESOPplan running and incentivising “buy-in” from your staff.Now comes around end of tax year time andyouhave to account for the value of the option plans on your balance sheet. Amongstbootstrapped founders this is often a forgotten exercise, but when there are othersophisticated stakeholders onboard (such as whena VCrequestsastatutory declaration from founders on the state of the accounts) that’s when its necessary to getproper figures included for the options.

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

At the end of the financial year, yourESOP accountantcan take the basic details for your option planandconvert them with some quite detailed formulas and spreadsheetstoarrive at a figure for the equity section of your balance sheet. Being acomplex 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.Whilstnoimmediate taxispayableunder thestartuptax concessions,the ATO still needs you to prepare & reportannuallyon your ESOPsviaESS 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 helpingyour employees calculate a capital gains event on their shares in the futureandareto be provided to both the employee and theATO.

Your ESOP tax accountantshould be able to complete this for youfor each employee in receipt of anESOPwith the details on hand.

Tax Planning & Advisory for your Employees

Whenparticipating in an ESOP you can be sure that your employees will also have questions aroundthe best practices for tax.They often have queries aroundtax projections,when to sell or exercise, whatconcessions are available and what structure they should hold the sharesinor 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 keypart ofhelp stafffeel comfortable with this mode of remuneration.

ESOP accounting is not part of the regularassignments that tax accountants manage so it is key to work with an advisor seasoned in the space. Fullstackhave 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 companies, crypto and entrepreneurs.

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