Employee share scheme: what Australian small businesses need to know

Published Saturday 25 July 2026

Table of contents

• What is an employee share scheme?
• Types of employee share schemes
• Tax treatment of employee share schemes in Australia
• ESS startup concessions
• Recent changes to employee share scheme rules
• How to set up an employee share scheme for your small business
• Costs of setting up an employee share scheme
• Common mistakes to avoid
• Simplify your small business finances with Xero
• FAQs on employee share schemes

Key takeaways

• An employee share scheme (ESS) lets you offer shares or options to your team, helping you attract and retain talent without increasing your cash payroll costs
• Australian tax law provides startup concessions that can make employee share schemes more affordable for eligible businesses, including tax-deferred treatment and potential capital gains tax (CGT) discounts
• Recent regulatory changes have increased per-employee offer thresholds from $5,000 to $10,000 and reduced disclosure requirements, making it simpler for small businesses to run these schemes
• Setting up a compliant employee share scheme typically costs between $5,000 and $7,000 for a straightforward structure, so it's worth planning your budget and timeline early

What is an employee share scheme?

An employee share scheme (ESS) is an arrangement where you offer your employees shares in your company, or the right to acquire shares at a future date. It's a way to give your team a direct stake in the success of your business.

These schemes are popular with startups and growing businesses because they let you reward employees with equity rather than relying solely on cash compensation. For small businesses competing for talent against larger employers, an employee share scheme can be a powerful drawcard.

How employee share schemes work

At a high level, an employee share scheme works by granting employees either actual shares or options to purchase shares at a set price. The specifics depend on the type of scheme you choose, but the general process follows these steps:

1. Decide how much equity to allocate to the scheme (a typical equity pool for startups is 10–15% of total shares).
2. Set the terms, including who's eligible, how many shares or options each employee receives, and any vesting conditions.
3. Grant employees their shares or options according to those terms.
4. Over time, as the company grows in value, your employees benefit from the increase in share price.

Vesting schedules are common. A standard approach is 25% vesting per year over four years, meaning employees earn their full allocation gradually. This encourages retention and aligns your team's interests with the long-term growth of the business.

Types of employee share schemes

There are several structures you can use when setting up an employee share scheme. The right choice depends on your business goals, your company structure, and the level of complexity you're comfortable managing.

Direct share plans

A direct share plan involves issuing actual shares to your employees. They become shareholders in your company, with the same rights as other shareholders, including voting rights and dividend entitlements.

This is the most straightforward structure. It works well for small businesses with a simple share register and a small team. The main consideration is that you're giving up real ownership, so it's important to plan your equity allocation carefully.

Share option plans (ESOPs)

An employee share option plan (ESOP) gives employees the right to purchase shares at a predetermined price, known as the exercise price, at a future date. The employee doesn't own shares immediately; they hold options that they can choose to exercise later.

ESOPs are popular because they give you flexibility. You set the exercise price at or above market value at the time of the grant, and employees benefit if the company's value increases above that price. This structure is especially common for startups and growing businesses where the share price is expected to rise.

Phantom or virtual share schemes

A phantom share scheme, sometimes called a virtual share scheme, doesn't involve issuing real shares at all. Instead, you create a contractual arrangement where employees receive cash payments that mirror the value of actual shares.

This option is useful if you want to reward employees with equity-like incentives without diluting your ownership or complicating your share register. It's simpler from a regulatory perspective, but the tax treatment can differ from real share schemes, so it's worth getting professional advice.

Because phantom schemes generally don't involve actual equity interests, they may not qualify for the same ESS tax concessions as shares or options

Tax treatment of employee share schemes in Australia

Tax is one of the most important factors when setting up an employee share scheme. The Australian Taxation Office (ATO) has specific rules about how shares and options granted under an ESS are taxed, and the treatment depends on the type of scheme you choose.

Taxed-upfront schemes

Under a taxed-upfront scheme, your employees pay tax on the discount they receive at the time the shares or options are granted. The discount is the difference between the market value of the shares and the amount the employee pays for them (if anything).

If the discount per employee is $1,000 or less and the employee's adjusted taxable income is $180,000 or less, they may qualify for a tax reduction that effectively exempts the first $1,000 of discount from income tax. This can make smaller allocations more tax-efficient for your team.

Tax-deferred schemes

A tax-deferred scheme allows employees to defer paying tax on the discount until a later taxing point, rather than at the time of the grant. This is often more attractive because employees don't face a tax bill before they've had the chance to sell their shares.

The maximum deferral period is 15 years. A deferred taxing point is triggered when certain events occur, such as when the shares are no longer subject to a disposal restriction. Since 1 July 2022, ceasing employment is no longer a deferred taxing point, which gives employees more flexibility if they leave your business.

Capital gains tax treatment

Once an employee acquires shares under an ESS and later sells them, any profit above the cost base is treated as a capital gain. If the employee holds the shares for more than 12 months, they may be eligible for the 50% CGT discount, which halves the taxable capital gain.

This is a significant benefit, particularly for employees in startups where the share price may increase substantially over time. Planning the structure of your scheme with CGT in mind can help your team maximise their after-tax returns.

ESS startup concessions

The Australian Government offers specific concessions for employee share schemes run by eligible startups. These concessions are designed to make it easier and more affordable for early-stage businesses to use equity to attract and retain talent.

Eligibility criteria

To qualify for the startup concessions, your company must meet all of the following requirements:

• It's not listed on a stock exchange.
• It's been incorporated for fewer than 10 years.
• Its aggregated turnover is less than $50 million for the income year.
• The company is an Australian tax resident.

Each employee participating in the scheme must also hold less than 10% of the shares or voting rights in the company after the grant.

Rules for shares and options

The concessions come with specific conditions about how you structure shares and options:

• For shares: The discount must not exceed 15% of the market value at the time of issue.
• For options: The exercise price must be equal to or greater than the market value of the shares when the options are granted.
• For both: There must be a minimum disposal restriction of three years, meaning employees can't sell or transfer them for at least three years after the grant.

These rules are designed to ensure the scheme genuinely incentivises long-term commitment rather than short-term gains.

Tax benefits for employees

Under the startup concessions, employees don't pay any income tax at the time the shares or options are granted. The taxing point is deferred, and no amount is included in the employee's assessable income at that stage.

When the employee eventually sells the shares, the gain is treated as a capital gain rather than ordinary income. If they've held the shares for more than 12 months, the 50% CGT discount applies. This means the effective tax rate on the gain can be significantly lower than it would be under a standard ESS arrangement.

Recent changes to employee share scheme rules

Australian regulators have made several changes in recent years to simplify employee share schemes, particularly for startups and small businesses. These changes reduce the administrative burden and make it more practical to offer equity incentives.

Increased offer thresholds

Recent ESS reforms increased the regulatory offer cap from $5,000 to $10,000 per employee in certain circumstances, with higher limits available for some contribution plans and salary sacrifice arrangements.

This means you can offer more equity to individual employees before triggering additional disclosure and regulatory obligations. For small businesses, this creates more room to structure meaningful equity offers without extra compliance costs.

Dedicated ESS exemption

The Australian Securities and Investments Commission (ASIC) has consolidated and simplified its employee incentive scheme class orders into a single, streamlined legislative instrument. This dedicated ESS exemption simplifies compliance across disclosure, licensing, and on-sale obligations under the Corporations Act 2001, replacing the older and more fragmented regulatory requirements.

Reduced disclosure requirements

Under the updated rules, the disclosure documents you need to prepare for employees have been simplified. You still need to provide clear information about the terms of the scheme, but the level of detail required has been reduced. This lowers the cost and effort of setting up and running a compliant scheme.

Cessation of employment changes

From 1 July 2022, ceasing employment is no longer a deferred taxing point for ESS interests. Previously, when an employee left your business, it could trigger a tax liability on their deferred shares or options. This change means your former employees won't face an unexpected tax bill just because they've moved on, which makes your scheme more attractive to potential hires.

How to set up an employee share scheme for your small business

Setting up an employee share scheme involves several steps. Taking the time to plan properly helps you avoid common pitfalls and ensures the scheme works for both you and your team.

1. Define your objectives. Start by clarifying what you want the scheme to achieve. Common goals include attracting skilled employees, retaining key team members, and aligning your team's interests with business growth. Your objectives will shape every other decision in the process.
2. Choose the right structure. Decide which type of scheme suits your business. Consider factors like your company size, growth stage, and how much complexity you're prepared to manage. A direct share plan is simpler, while an ESOP offers more flexibility. Phantom schemes avoid dilution but have different tax implications.
3. Determine the valuation. You need a defensible valuation of your shares. For unlisted companies, this may mean getting an independent valuation. The valuation sets the baseline for calculating discounts, exercise prices, and tax obligations.
4. Set vesting terms and conditions. Define the vesting schedule and any performance conditions. A common approach is four-year vesting with 25% vesting each year. You might also include cliff periods (a minimum time before any shares vest) or performance milestones tied to business goals.
5. Prepare the documentation. You'll need a plan document that sets out the rules of the scheme, individual offer letters for each participant, and a disclosure document that explains the tax treatment, risks, and terms. Your legal adviser can help you draft these to meet regulatory requirements.
6. Address regulatory requirements. Make sure your scheme complies with the relevant ASIC regulations and tax laws. This includes meeting the conditions for any concessions you plan to rely on (such as the startup concessions) and preparing the required disclosure documents.
7. Communicate with your team. Once the scheme is ready, explain it clearly to your employees. Cover what the scheme involves, how it benefits them, the vesting schedule, the tax implications, and any restrictions. Good communication helps your team understand the value of what you're offering.

Because ESS arrangements have legal, tax, and valuation implications, it’s important to seek professional advice before implementing a scheme.

Costs of setting up an employee share scheme

The cost of setting up an employee share scheme varies depending on the complexity of your structure and the size of your business. Here's what you can typically expect:

• A simple scheme for a small business with a straightforward structure typically costs between $5,000 and $7,000 for initial legal and advisory fees.
• More complex arrangements, such as those with multiple share classes or performance conditions, can cost significantly more.
• Enterprise-level schemes with custom structures and ongoing administration can run to $100,000 or more.
• Ongoing costs include annual compliance, valuation updates, and scheme administration.

It's worth budgeting for both the initial setup and the ongoing running costs. Getting a clear quote from a specialist adviser early in the process helps you avoid surprises.

Common mistakes to avoid

Setting up an employee share scheme is a significant decision. These are some of the most common mistakes small businesses make, and how you can avoid them:

• Skipping professional advice: tax and legal advice is essential. The rules are complex, and getting them wrong can be costly for both you and your employees.
• Not getting a proper valuation: an inaccurate valuation can create tax problems and undermine employee trust in the scheme.
• Overcomplicating the structure: keep it as simple as your situation allows. Complex schemes are harder to administer and harder for employees to understand.
• Ignoring vesting schedules: without a clear vesting schedule, you risk giving away equity too quickly or creating disputes if employees leave early.
• Poor communication: if employees don't understand the scheme, they won't value it. Take the time to explain it clearly and answer questions.
• Failing to plan for leavers: decide upfront what happens to unvested and vested shares when an employee exits the business.

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FAQs on employee share schemes

Here are answers to some commonly asked questions about employee share schemes in Australia.

Do employee share schemes only apply to startups?

No. Any Australian company can set up an employee share scheme. However, specific tax concessions, such as the startup ESS concessions, are only available to eligible companies that are unlisted, less than 10 years old, and have aggregated turnover under $50 million.

What happens to shares when an employee leaves?

It depends on the terms of your scheme. Typically, unvested shares or options are forfeited when an employee leaves, while vested shares usually remain with the employee. Some schemes include buyback provisions. Since 1 July 2022, leaving employment no longer triggers a deferred taxing point, so departing employees won't face an immediate tax liability on deferred interests.

How much equity should you set aside for an employee share scheme?

There's no fixed rule, but a common benchmark for startups is to allocate 10-15% of total shares to an equity pool. The right amount depends on your business stage, hiring plans, and how much dilution you're comfortable with.

Can you offer an employee share scheme to contractors?

Generally, ESS tax concessions apply to employees, not independent contractors. Some schemes can be structured to include contractors depending on the arrangement, but the tax treatment may differ. Check with your adviser before extending offers to non-employees.

Are employee share scheme discounts tax-deductible for the employer?

The deductibility of ESS discounts for employers depends on the structure of the scheme and the specific circumstances. Employer tax deductions for ESS arrangements depend on the scheme structure and timing rules under Australian tax law. You should seek specialist tax advice before assuming deductions are available.