On ESOPs and Trusts: What Is Best Practice? 

What is an ESOP?

Employee share ownership plan (ESOPs), renowned for their capacity to empower employees and ensure seamless business continuity, represent a cornerstone of wealth management strategy. By offering employees ownership stake in the company, ESOPs foster a sense of loyalty and commitment while incentivizing performance. However, their effectiveness is amplified when integrated with a Family Trust. Family Trusts serve as an additional layer of protection, shielding assets from potential risks and ensuring a sustainable legacy for generations to come

Can I purchase ESOPs through a family trust?

Holding assets in a family trust is commonly practiced for its asset protection and tax advantages. In this instance however, there are certain considerations to take into account specifically for ESOPs.

What is the ‘Associate Rule’?

According to the ESS regime, when a family trust (or any associate of an employee) acquires ESS interests connected to the employee’s work, these interests are considered as if acquired directly by the employee under Division 83A of the Income Tax Assessment Act 1997, a principle referred to as the ‘Associate Rule’.

For instance, you might transfer some of your shares to your spouse or child. Yet, the regulations remain applicable to you, requiring you to add any discount to your taxable income.

Should you have reported a discount in your taxable income concerning ESS interests, and those interests are later forfeited or become worthless, you can revise your tax return to remove the discount from your taxable income (instead of that of your family member), assuming you meet the criteria for a refund.

Your associates can be your spouse, child, company or trustee of a trust (other than the trustee of an employee share trust)

Case Study: Upfront Taxation Scheme – Qualifies for Discount, ESS Interests Obtained by a Family Member

Marcus is employed at Orion Innovations Co. and receives shares as part of his employment contract. He decides to transfer half of these shares to his son, Alex.

Since the shares are compensation related to Marcus’s job and thus part of his income, Marcus must report the discount in his tax return. Alex, on the other hand, is not required to report this discount in his tax return.

Ownership of the shares lies with Alex because they are registered in his name, not Marcus’s. Consequently, after their inclusion in Marcus’s income under the employee share scheme (ESS) regulations, the shares are no longer connected to Marcus.

For the purposes of Capital Gains Tax (CGT), it is assumed that Alex acquired the shares at their market value on the date they were transferred to him.

Should Alex incur any additional expenses concerning the shares, these expenses can be added to the shares’ cost base. Upon selling the shares, this cost base will be used to determine any capital gains or losses that Alex might realize from the sale.

Exception to Acquisition Rules and the correlation to the Associate Rule

Under the Capital Gains Tax (CGT) framework, the rules specify, among other aspects, that shares obtained through the exercise of Employee Share Scheme (ESS) interests (including options or rights within an ESS) where the ESOP regulations have been applied to reduce the taxable income inclusion for the person acquiring them, are considered to have been acquired at the time those interests (options or rights) were originally acquired. The challenge lies in defining an ‘acquirer’ and understanding how this interacts with the Associate Rule. 

Specifically, the Associate Rule implies that only the individual employee participant can benefit from a reduced tax liability under the Start-Up ESOP rules. Thus, while the Start-Up ESOP rules may reduce the tax liability for an individual under the ESS taxation framework, if the options are not directly issued to the individual employee, the special rules for acquiring shares through Start-Up ESOP options do not apply. Instead, the standard rules take effect, requiring the shares to be held for a minimum of 12 months after being exercised to meet the 12-Month Holding Period Rule.

Taking Action with Aero Accounting Group

Strategic implementation of ESOPs and Family Trusts is essential for high-income earners aiming to optimize their potential. This involves aligning these mechanisms while considering the unique dynamics of the business and its stakeholders.

Aero Accounting Group emerges as a trusted partner and advisor, with a wealth of expertise in ESOPs and Family Trusts. We offer strategic counsel and personalized solutions tailored to the unique needs of each client. Beyond mere services, we are committed to fostering long-term partnerships built on trust, integrity, and shared success. 

Partner with Aero Accounting Group today and let us assist you with navigating the complexities around ESOPs and family trust.