From 1 July 2027, the CGT landscape for employee share schemes will change dramatically. The 50% general CGT discount will be removed for assets acquired on or after that date and replaced with cost base indexation and a 30% minimum tax. These amendments apply to all asset classes, including most shares and options issued under employee share schemes – materially eroding the key attractiveness of such arrangements for employees (particularly those of private companies).
Why the 2027 CGT changes matter for employee share schemes
With the war for talent across a range of industries increasing both competition and remuneration, many companies have historically looked to implement employee incentive arrangements in order to attract, retain and motivate key employees – and until recently, have been an attractive option for employees to invest and participate in the company they work for.
However, the recent Federal Budget changes to replace the CGT 50% discount with cost base indexation and a 30% minimum tax, fundamentally changes how employee incentive arrangements are taxed.
Whilst indexation can still produce a reasonable outcome for assets held over time, it offers little benefit where value is created quickly from a low-cost base, as is often the case for ESS interests.
Although we expect public companies to continue to use employee incentive schemes (due to the fact that shares can be sold on market to fund any resulting tax liability), the changes place significant pressure on the usual approach to equity in a private company context.
The use of employee share schemes by private companies has historically relied on CGT outcomes to deliver value on exit – those outcomes are now far less favourable (and significantly more complex).
The removal of the 50% general discount, introduction of a 30% minimum tax and cost base indexation is likely to have the most impact on wage earners acquiring shares under an employee share scheme, where equity is often acquired at a low-cost base. Gains that would previously have benefited from the 50% discount are now more likely to be taxed closer to marginal rates.
In practical terms, the difference between equity and cash remuneration narrows and reduces the incentive for employees to take on equity risk as a component of their remuneration.
Government response – The Innovative Business CGT Concession (IBCC): a new start‑up‑focused discount
Smaller companies in start-up phase are often looking to implement a scheme which will attract talent and enable employees to trade some cash salary for expected future gains made when the company grows. A key attraction of the use of such a scheme is in circumstances where a company simply may not have the funds available to attract and retain key employees solely based on traditional forms of remuneration.
However as noted above, the removal of the 50% CGT discount for shares in private companies post 1 July 2027 (particularly start up companies) will have a significant impact on the attractiveness of such arrangements for employees.
In response to concerns from investors, founders and industry bodies in the tech sector, the Government proposes to introduce a new Innovative Business CGT Concession (IBCC) which would operate to:
- reintroduce a targeted 50% discount for qualifying shares and options in ‘innovative start‑ups’;
- give taxpayers a choice between:
- the 50% discount (with no minimum tax); or
- indexation and the 30% minimum tax; and
- broadly seek to align the current CGT outcomes for investment in shares as between early stage investors, founders and employees.
Subject to the outcome of consultation (which closed on 10 July 2026), the IBCC is expected to apply to companies:
- that are unlisted, independent and genuinely innovative;
- are small and early stage (under $50 million turnover and less than ten years old);
- which carry on an ‘active’ business which is focused on developing new or significantly improved products or services with real growth and scale potential; and
- in which the shares must be held for at least five years.
There is also a proposed lifetime cap of $10 million in total gains eligible for the concession.
Who qualifies? Active business and innovation tests
Active business
A company will be treated as ‘active’ if at least 80% of its assets are used in carrying on its business (including cash and financial instruments), rather than being passive or investment in nature.
Innovation requirement
In addition to meeting the active test, the business must also be genuinely innovative. This is proposed to be assessed by reference to the Early Stage Investment Company (ESIC) requirements.
In effect, the introduction of the new IBCC increases complexity and seeks to align the requirements in order to qualify for the start up concession with those in place for companies raising capital (and allowing investors to access the ESIC concession).
As a result, a company must now also self-asses that, when issuing shares to its employees (or equity to investors), it meets the following criteria in order to allow the employee to qualify for the IBCC:
- the company must be genuinely focused on developing one or more new or significantly improved innovations for commercialisation;
- the business relating to that innovation must have high growth potential;
- the company must demonstrate that it has the potential to be able to successfully scale up that business;
- the company must demonstrate that it has the potential to be able to address a broader than local market, including global markets, through that business; and
- the company must demonstrate that it has the potential to be able to have competitive advantages for that business.
Transitional rules: existing ESS interests and the ATO’s proposed conditions
Transitional rules are expected to allow employees of some existing start-ups to access the concession for post 1 July 2027 gains on assets held prior to this date.
The below table is taken from the ATO’s consultation paper.
Practical implications for founders, employees and advisers
The proposed IBCC fundamentally misunderstands the purpose for which employee incentive arrangements are used by start-up companies.
Rather than simplify the process, in order to allow employees to access the 50% discount post 1 July 2027, the mechanisms place additional pressure on small, start up businesses to ensure that they satisfy the requisite ‘innovative’ qualitative criteria and seeks to align the tax outcomes for investors in such entities, with arrangements designed to attract and motivate employees.
It is unclear why the existing 50% CGT discount could not have simply been retained for shares and options issued under the start up concession – instead of imposing additional layers of complexity to an already complex system.
The changes also provide no solution for employees of the vast number of private companies which fall outside of the category of entities eligible for the IBCC. If a company elects not to undertake this additional work (or does not otherwise qualify), the recipients are penalised – and what was designed as an incentive becomes simply a mechanism to defer income tax (at marginal rates) on the value of shares received.
While it remains to be seen what changes will be made following the consultation process, if the proposals remain in their current form, traditional equity incentives such as shares and options issued at a discount will continue to have a role, we expect their use to be limited to listed companies and start up companies who can accurately self-assess against the new ‘innovative’ criteria.
Arrangements which see employees funding the acquisition of their shares (e.g. via a loan funded share scheme) are likely to again become flavour of the month as they offer the benefit of indexation on a market value cost base.