Employee share schemes are one of the most powerful tools an Australian startup has for attracting and retaining great people. The ability to offer a slice of the upside – particularly when you can’t yet compete on salary – can make the difference between getting the person you want and losing them to a larger company.

But the tax rules around employee share schemes in Australia are genuinely complex, and the mistakes founders make when setting them up – or failing to set them up properly – have a habit of surfacing at the worst possible moments. Tax time. A fundraise. An exit.

Here’s what to watch out for.

Treating options and shares as interchangeable

One of the first mistakes founders make is not being clear on whether they’re issuing shares or options – and what the tax implications of each are for employees.

Options give employees the right to acquire shares in the future, usually after a vesting period and for a set exercise price. Shares are actual equity issued upfront. The tax treatment is different, the timing of any taxing point is different and the compliance obligations are different.

Under the Australian employee share scheme rules, tax generally applies at the earliest of: the time the interest vests, when there’s no longer a real risk of forfeiture or when the employee leaves. Getting the structure wrong can mean employees are taxed earlier than expected or on amounts that don’t reflect the actual value they’ve received.

Not using the startup concessions

Australia has specific tax concessions for employee share schemes in eligible startups, and a lot of founders either don’t know they exist or assume they don’t qualify. Under the startup concessions, options can be issued at a small discount to market value without triggering upfront tax, and the taxing point is deferred until the employee actually sells their shares.

This is a significant benefit. It means employees aren’t hit with a tax bill on paper gains before they’ve seen any actual cash – which is one of the biggest practical problems with equity compensation in startups.

To access the concessions, your company needs to meet certain criteria: broadly, incorporated in Australia, unlisted, less than 10 years old, aggregated turnover under $50 million and not controlled by another company. The options also need to be structured correctly and priced according to the rules. Issuing options without checking whether your company qualifies – and then structuring the scheme accordingly – is an expensive oversight.

Skipping or undervaluing the market value assessment

Options issued under the startup concessions need to be priced at a discount of no more than 15% to the market value of the underlying shares at the time of issue. And that means you need to know what the market value actually is.

A lot of early-stage founders either skip the valuation altogether and use a number that feels reasonable, or rely on a cap table tool to spit out a number without proper methodology behind it. The ATO expects a defensible valuation – and if your valuation is challenged, employees can end up with an unexpected tax liability on what they thought was a concessionally taxed option grant.

Getting a proper valuation done at the time of issue – even a straightforward one for an early-stage company – is worth the cost.

Not lodging the annual ESS return

This one catches founders by surprise. If you have an employee share scheme in place, you’re required to lodge an ESS annual return with the ATO and provide ESS statements to employees by 14 July each year. This applies even if no options vested or were exercised during the year.

Failing to lodge is a compliance breach that attracts penalties and – more practically – creates problems if you’re heading into due diligence for a raise or sale. Investors and acquirers check for this, and discovering years of unfiled ESS returns mid-deal is not a conversation you want to have.

Issuing equity to contractors without understanding the implications

Not everyone entitled to equity under your scheme may be an employee – and that matters. The startup concessions and ESS rules apply specifically to employees. Issuing options to contractors or advisers under the same scheme, without understanding that different rules apply, can mean those participants don’t get the tax treatment you intended.

For contractors and advisers, equity compensation is often structured differently and taxed under different provisions. This needs to be thought through at the scheme design stage, not retrofitted later when someone asks a tax question.

Getting your ESOP right from the start

At Standard Ledger, we help Australian startups set up employee share schemes that are structured correctly, tax-effective and built to survive a due diligence process. If you’ve already got a scheme in place and you’re not sure whether it’s been set up correctly, now is a good time to find out. Get in touch and let’s take a look.