Rebecca Archer
Welcome to Navigating the New Normal, Grant Thornton's podcast exploring trends in business and the marketplace. I'm Rebecca Archer and today I'm joined by Peter Hills, remuneration taxes partner at Grant Thornton and Laurie Wood, Managing Director at HRAscent. Today we're talking about employee share schemes to attract and retain good quality people.
Welcome Peter and Laurie.
Rebecca Archer
Now the media has been reporting for a number of months that unemployment is at record lows, and there is a scarcity of people with the right skills in certain industries. Companies can reward employees in a number of ways. Cash is not the only way. Laurie, from a remuneration consultant’s perspective, what are you seeing in the market?
Laurie Wood
Thanks Rebecca. The current challenge in the labor market is only now just starting to come through in the data. Prior to the recent lifting the inflation rate of 5.1% back in March, the information was really showing wage price growth in the low 2%, and we haven't seen the wage indicators kick up yet, given the lag, but that is still to come and will be coming. Over the past month we have seen much talk about inflation numbers, interest rate rises and in June the Fair Work Commission's decision for a significant increase in award wages. So we've seen the discussion recently or since late 2021 about a tightening labor market, and this is now starting to come through and being reflected in the competition for skills.
The culmination of low unemployment, high participation rate high demand from business means that this is going to be an ongoing challenge during 2022. Of course, cash is critical in an offer, but employers need to look at the broader employment arrangements to be competitive. Equity is not for all employers/employees, but it's certainly an option to consider either as enhanced or to offset against some of the remuneration costs.
Rebecca Archer
That's great Laurie, thank you. And Peter, what type of inquiries are you getting from Grant Thornton clients?
Peter Hills
We’re getting a number of enquiries Rebecca, let me go through a few of them that we're getting and maybe I'll go back in time first. When COVID first hit, we had a number of companies come to us to implement employee share plans to save cash. Things have changed now though; we're seeing a number of companies come to us to essentially refresh or replace existing employee share plan. So I'll give you a couple examples. Certain startup companies might have been able to utilise so called ‘concessional startup employee share plans’, and now they don't meet those plans tests, and so therefore they have to go through the process of looking at the ordinary employee share plan rules. Other companies might be looking at utilising different types of employee share interests. And a classic example is that we've seen a few companies come back to us who have implemented premium price option plans, and now deciding to look at so called performance right plans. We’re also getting a lot of companies wanting to implement employee share plans for the first time. And I sat back and I was reflecting what's causing this? There's actually no clear trend that's causing the new people coming through, or new companies coming through to implement employee share plans.
I went back and thought about it and I thought well maybe it's to do with wanting to allow employees to have skin in the game, looking for additional tools to remunerate employees. Potentially becoming very common with peer companies. So therefore needing to implement employee share plan to be competitive and comparable. And then lastly probably to attract and retain employees, so it’s a number of reasons. The last trend, which is a really interesting one. And I think it is the sign of the market. We're seeing a number of companies come to us and seeking advice in relation to the tax implications of exit events, such as trade sales, alternatively listing. The trade sales one is an interesting one. We have some companies come to us wanting advice on the tax implications of replacement employee share interests in purchase co, and then at the same time we're seeing a number of companies wanting just an outline of the tax implications of essentially the employees selling their excess interest. Now having to think about that as well. And I thought, well, what should companies be doing or considering? Well, clearly it's the commercial consideration, but there does have some benefits in target code issuing replacement employees share interests to the employees because it assists with that retention factor when they take over that new company. From a listing point of view, it’s going back to the basics. For companies that have been listing in the last 6 to 12 months. We've been going through with them the commercial and tax issues of utilising employee share plans, and what makes sense for them and which type of plan best fits those commercial and tax objectives.
Rebecca Archer
It sounds like it's keeping you very busy Laurie, what do you advise companies to consider when attracting new talent?
Laurie Wood
The first thing is really to understand the market they are operating in, and look at what is going on in trying to attract talent but also understanding what is going on to ensure that they aren’t going to be losing key people themselves. So the first is getting the value right in terms of remuneration and if appropriate, given the conversations about ESOPs, is what about equity. Now, of course we are remuneration consultants, so we tend to think the dollars are the most important thing. But in the current environment, and given the demographics of a lot of the workforces, employers need to think of the broader non-pay attractiveness working for them as well. So it is important to think about what's the benefits of the work environment, flexibility in the workplace, and some employers are coming up with some new innovative ways of making their employment offer even more attractive. One thing that we do see a bit more these days is around sign on bonuses, they did drop away for a while and this is not a strategy applied across the board, but very targeted for skills. And using them collectively where you can structure them through equity. And as part of an attractive to get something over the line, get an allocation of equity that vests progressively over the first 1 to 2 years of employment. That's a way of getting someone through the door and getting skin in the game from early in the employment. And it can be either as an enhanced offer, or it can be also to manage employment costs over the longer term.
Rebecca Archer
Certainly a lot there for both companies and employees themselves to consider and think about when taking on a new role. Peter, I'm wondering from a tax perspective, what should companies be considering when looking at attracting new talent?
Peter Hills
Probably the thing is to seek advice. Unfortunately, the employee share rules are not straightforward and the tax outcome depends on so many factors. It depends on the company profile, the employee profile, the type of employee share instrument that's being issued and in terms of the employee share plan. So, in seeking that advice, there's a couple of factors that need to be understood and one of the first factors is to make sure that the employee’s paying the right amount of tax and not paying too much tax. But then secondly, the fact that I like to make sure that people are made aware of, is that they need to pay tax at the right time and the right time is typically when you've got cash from the sale of the underlying share, and so therefore we need to make sure that tax matches that cash flow. We also recommend companies review how the employee share interests are going to be tapped under employees share rules, capital gains tax rules. The advantage of the capital gains tax rules is that individuals and trusts can access the 50% CGT discount. Also note that gains taxed under the ESS rules are taxed as ordinary income. So for employees on the top marginal tax rate, the difference in tax between the capital gains tax rules and the employees share rules can be 23.5% of the game. However, there's always a however, to fall within the capital gains tax rules, the employee needs to pay more for the employee share interests, so that the interest is not issued at a discount to market. So this takes away some of the benefits of the tax savings. And so therefore, we recommend an analysis be done of the various excess instruments are proposed to be used, and the tax implications of those interests, they're going to be used.
The best example, explaining what I've said is for a listed company comparing a performance right with an option that's issued at a premium to market, and so therefore there's a comparison of essentially the cost of issuing that instrument and the tax implications of them. The startup companies, we recommend that they look seriously at the employees share startup rules. There's a couple of reasons why I say that. The first reason is that there's so many other startup companies that are doing employee share plans or implementing employee share plans for their employees under the startup rules, that they need to be comparable and competitive. The advantage of the startup rules is that all the capital gain or the gain is taxed under the capital gains tax rules. So there's some real benefits and that's why there's such a popularity in that market.
Rebecca Archer
You have both talked about attracting talent. Companies of course, also need to look at ways to retain staff to minimise the effects of the war for talent. Laurie, are you seeing companies review their remuneration frameworks for existing staff, and how exactly are they using ESOPs to retain people?
Laurie Wood
We've seen a lot of activity over the past 18 months, even during the periods of lockdown and that where there's been a step up in organizations wanting to refresh their remuneration arrangements. So that's been doing benchmarking to market to ensure they are paying in the right position, and also checking their framework to make sure the structure is right. Part of that we typically also have been reviewing equity arrangements. I haven't seen there's been any radical change in it. I think it's been driven more by saying, are we paying appropriately in the market, and understanding what the market's doing.
So that has definitely increased, just increasing the awareness and understanding so that they can make decisions, and then if they do have to react, retaining of people, they know where they are. So that's probably been the main thing that we've been seeing over the past 18 months.
Rebecca Archer
And Peter are you also seeing companies using ESOPs for retaining staff and combating the so called great resignation?
Peter Hills
I actually haven't got much more to add and I really echo the comments that have been made by Laurie on that point.
Rebecca Archer
So Peter given the current resourcing constraints and increases in remuneration costs, how can using employee share schemes assist in managing costs overall for businesses?
Peter Hills
The first point I would like to make is just managing the cash cost of increasing employee salaries. Providing an option or share is generally a non-cash remuneration, and so therefore by providing an option or share you’re managing that cash cost to the business. It does have that cash flow saving, but I do note a couple of things around that. The first one is that by providing an employee share plan, it does create a shared dilution. So there is a cost to the shareholders by providing more shares, but also does require essentially the accounting of that share based expense in the financial statements as well. So there does have to be some representation of the cost in the account. The other thing to note though is the level of remuneration that you can provide can be greater than just simply by paying cash.
If you look at high growth companies for example, and you provide an employee share interest to them, and the employee share interest increases in values substantially, you would suggest or hope in that example that the remuneration that the employee receives being essentially the gain from the employee share interests would be far greater than what would have been comparable than if simply cash was paid to them.
Rebecca Archer
And so Peter, what types of companies specifically are you seeing implement an ESOP? Is it sort of across the board or quite specific to certain sectors?
Peter Hills
It really is across the board. It's been discussed a few times and the words come up, startup companies, and so therefore clearly we're providing services to a number of startups companies, but then if you go through then the life cycle of a company, so we see a number of other private companies coming to us. So the ones that are in a situation where they don't satisfy the employee share startup rules, and they might be dividend paying or they might be just in a growth phase, so that those private companies are providing employee shares. We're also seeing a number of companies that are going through the listing process come to us and we're also seeing listed companies come to us. Probably the hardest employees share plan to implement from a tax perspective is for private companies that don't have that future exit strategy. And what we do when we're providing our services in this area is that we have like a workshop and we go through the commercial objectives and where they're trying to situate themselves in the future from a commercial point of view, as well as a remuneration employee point of view, and we strategise with them to make sure that employee share scheme makes sense for them. And then through that if we find in our view that it doesn't make sense, we do recommend pulling away from employee share plans and just simply remunerated an employee by way of cash.
Rebecca Archer
And within the organizations themselves, who are you seeing participate in an ESOP?
Peter Hills
In our market, I refer to the mid-tier counting market, we're typically seeing employee share plans used for key management and directors. To give you an idea around that, we haven't implemented a whole of company employee share plan and an example of a whole company employee share plan is typically the $1,000 tax exempt share plans for a number of years. And it could be because of our marketplace, you know, I do recognise that companies like the BHPs of the world do have whole of company plans and so they are out there, but in our marketplace we're not seeing it as often. We are seeing some that are issuing whole of company optional performance rights plan, typically around the startup companies again, probably to essentially save cash flow. My recommendation though, is that if you're going to implement a whole company share plan, you need to speak to your lawyers to just make sure that you're satisfying the various corporation law requirements.
And also as a general comment, do I feel that employee share plans underutilised in providing remuneration to a greater proportion of employees in the company? Yes, I do. And you know, I would highly recommend that companies explore whether or not it makes sense to them to issue a whole company employee share plan.
Rebecca Archer
It's going to be a very interesting space to watch from here I think. It's been reported that to improve Australia's availability of talent, we need to attract people from overseas. Laurie with the borders now open, are you seeing more people relocating to Australia and employee share schemes being part of the remuneration package?
Laurie Wood
There's a lot of reporting around the difficulty in attracting key skills and also hearing the reports of the increase of people started to come back in. But you know, it's a long way from what it was a couple of years ago. We do see it and not a change, but we have over time at executive levels where equity forms part of their remuneration package in moving to Australia. However, there is a bit more complexity around that, coming back to what Peter was talking about before is a heightened level of managing the tax arrangements because you have dual tax systems, and also you have to acknowledge that these people may not be around for the normal longer term period investing. So you have to think about what the exit events are going to be as well so that it is a reward, and doesn't become a tax problem. Due to some of those complexities, I wouldn't see them being used as much going down through organisations. But with that I just hand over to Peter for any comments.
Peter Hills
Yes, I just want to reinforce a couple of those comments that Laurie was making in relation to the tax. What we do see is that a number of foreign residents come to Australia and if it is for a short period of time, they might be keeping their foreign tax residency. And so therefore if they are, there potentially could be issues in their foreign jurisdiction under their tax rules on taxing that employee share plan. And with that in mind it's a process that the company needs to review. Not only the Australian rules, but also the foreign tax jurisdiction rules.
Rebecca Archer
Peter and Laurie. Thank you very much to both of you for your time. Can people track you down on LinkedIn, phone, email if they'd like to talk more about employee share schemes?
Laurie Wood
Certainly.
Peter Hills
Please, definitely on LinkedIn. And obviously we got the Grant Thornton website that has my details on there.
Rebecca Archer
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