Passing the Torch with Employee Incentive Schemes

When it comes to preparing the next generation of leaders in your business, an employee incentive scheme (EIS) can be one of the most powerful tools at your disposal. The right structure helps you ‘pass the torch’ by aligning your team’s interests with the long-term success of your enterprise, attracting and retaining talent, and creating a clear succession pathway.

An EIS should be more than a reward — it’s a strategic succession and growth tool. The right approach will depend on your stage of business, your long-term exit strategy, and how you want to balance reward, control, and tax efficiency.

Choosing Your Scheme Structure

The first decision is whether your scheme will be formalised (equity or options) or flexible (shadow or phantom). The options for structuring an EIS include:

• Equity-based – issue shares or units to promote an ownership mindset
• Options/rights – give the right to acquire equity in the future (treated as ESS interests under Div 83A ITAA 1997)
• Shadow/phantom – cash bonuses linked to business performance, mirroring ownership value but without actual equity or voting rights, and
• Blended – combines equity and performance vesting for succession.

Common Types of Schemes – Advantages and Disadvantages

Defining Clear Objectives

Every model starts with a clear “why”:

• Retention – encourage long-term commitment from key talent
• Succession – transition leadership/ownership to trusted individuals
• Performance – reward outcomes that drive your business forward

Tailoring examples:

• Gradual vesting for succession planning
• Time or performance-based vesting for retention and alignment

Business Succession Planning Tip

If your incentive scheme is part of a long-term exit or family business transfer, build in performance triggers and buy-back rights early. This gives you the option to adjust or unwind if circumstances change — without damaging team morale.

Governance and Control Considerations

When equity is issued, governance must protect the founder’s strategic vision:

• Constitution and shareholder agreements – must authorise equity issues, transfer restrictions, buy-backs, and vesting/forfeiture terms
• Founder clause – optional veto or unanimous approval requirement to prevent loss of control
• Clear vesting conditions – ensure participants earn equity over time and remain aligned

These should be documented through:

• Shareholders’ or unitholders’ agreements
• Employee plan rules
• Offer letters compliant with the Corporations Act ESS regime

Tax Implications

Equity and options under an EIS will generally be ESS interests governed by Division 83A ITAA 1997.

Two main tax categories:

1. Concessional schemes – eligible for:
   • Taxed upfront with $1,000 reduction (if offered broadly to employees and other conditions met)
   • Start-up concession – minimal/no upfront tax for eligible start-ups and ESICs meeting strict criteria
   • Tax-deferred schemes – tax deferred until sale, cessation of employment, or 15 years from acquisition
2. Non-concessional schemes – discount taxed immediately at market value minus any consideration paid

Impact on Small Business CGT concessions:

Issuing equity can reduce the original owner’s shareholding. The significant individual test requires ≥ 20% interest — dropping below can block CGT concessions in a later sale.

Shadow/phantom schemes are taxed as ordinary income (PAYG, payroll tax, possible FBT), not under Div 83A.

Corporations Act Compliance

Since 1 October 2022, the statutory ESS regime in the Corporations Act 2001 (Cth) has replaced previous ASIC class order relief.

Relief from disclosure, licensing, and anti-hawking rules is available only if plan conditions are met — for example:

• Monetary caps for retail offers
• Specific disclosure content
• Offer eligibility criteria

Failure to meet these requirements can result in the scheme being unlawful or unenforceable.

Other Legal and Tax Considerations

This risks for not preparing EIS documents correctly include:

• Harsh good/bad leaver provisions breaching employment law
• Employees failing to qualify for Div 83A concessions
• Loans to employees (or the interest itself) attracting Division 7A or FBT
• Loans breaching financial assistance provisions (s 260A Corporations Act)
• No valid relief from Corporations Act disclosure rules
• Loan documents drafted incorrectly and unenforceable
• Material dilution from discounted share issues causing value shifts for existing shareholders
• EIS counted as part of wages for payroll tax purposes, and
• EIS unenforceable due to lack of authority in the company’s constitution or shareholder agreement.

Collaboration with Your Accountant

Your accountant plays a critical role in preparing the next generation of leaders in your business, including:

• Advising on correct tax treatment and valuation
• Preparing and lodging the ESS annual report with the ATO (due 14 July each year) and providing employee statements
• Integrating the scheme into your broader tax, succession, and exit planning

 Final Thoughts

An employee incentive scheme can be a powerful part of your succession strategy — but structure, governance, and tax planning are critical. Work with both your lawyer and accountant to ensure your scheme rewards the right people, keeps control where it belongs, and preserves valuable tax concessions.

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