Innovative Business CGT: What it means for ESS start-ups
Innovative Business CGT: What it means for ESS start-ups
What does the draft legislation mean for start-ups with employee share schemes?
The Government has released exposure draft legislation for its proposed Innovative Business CGT Concession (IBCC), providing much needed detail on how innovative Australian start-ups may be treated under the broader capital gains tax (CGT) reforms announced as part of the 2026-27 Federal Budget.
For start-ups that already operate an employee share scheme, or are considering implementing one, the proposed concession is particularly significant. One of the key concerns with the broader CGT reforms was that founders, employees and early-stage investors often acquire shares, options or rights for little or no consideration and therefore may derive limited benefit from a regime based solely on cost base indexation. The proposed IBCC seeks to address this concern by preserving concessional CGT treatment for eligible investments in innovative Australian businesses.
While the legislation remains in draft form, it provides greater clarity of how employee equity arrangements could change from 1 July 2027 and highlights actions start-ups can begin considering now.
Why does this matter for employee share schemes?
Employee share schemes (ESS) play a critical role in helping start-ups attract and retain talent when cash resources are limited. In many cases, employees are prepared to accept lower cash remuneration in exchange for the opportunity to participate in the future growth of the business through shares, options or rights.
Importantly, eligible options and rights issued under the start-up ESS concession can currently provide highly favourable tax outcomes. Where the relevant conditions are satisfied, employees may effectively receive options or rights without an upfront tax liability and can ultimately receive shares with no tax arising at exercise. Instead, the employee is generally taxed under the CGT regime when they eventually dispose of the shares, allowing the employee to participate in future growth on capital account rather than as ordinary employment income.
This concessional treatment has long been one of the key reasons why start-ups have used ESS arrangements to compete for talent against larger and better-funded employers. The ability for employees to access potentially significant equity upside without an immediate tax impost can be a powerful recruitment and retention tool.
The proposed CGT reforms raised concerns that some of these benefits could be diluted. While the start-up ESS concession itself remains available, employees who acquired shares through the concession may have had reduced access to the traditional 50 per cent CGT discount under the broader reform package. For many start-up employees, this could mean that a larger proportion of their future equity growth was effectively exposed to the new indexation and minimum tax regime.
The proposed Innovative Business CGT Concession is therefore particularly important for businesses operating start-up ESS arrangements. Subject to satisfying the eligibility requirements, the concession may allow founders, employees and investors to continue accessing a 50 per cent CGT discount on qualifying gains. In practical terms, this helps preserve the attractiveness of the start-up ESS regime and supports the original policy intent of encouraging employees to share in the long-term growth of innovative Australian businesses.
What does the draft legislation propose?
The draft legislation introduces a new CGT concession for qualifying interests in innovative Australian businesses. Subject to satisfying the eligibility requirements, an individual may be entitled to a 50 per cent CGT discount on gains realised from qualifying interests in an eligible business. Treasury has also proposed that gains qualifying for the concession would not be subject to the proposed minimum tax on capital gains.
Although the draft legislation is intended to support innovative businesses, eligibility is expected to be closely linked to the existing Early-Stage Innovation Company (ESIC) framework. This means that simply being a start-up may not be enough to qualify. Companies will still need to meet a range of innovation and other eligibility requirements, potentially excluding businesses that face similar funding, growth and talent challenges to those that qualify.
What should existing ESS companies be doing now?
Businesses that already have a start-up ESS in place should not assume that existing arrangements will automatically qualify for the concession.
Depending on the final form of the legislation, companies may need to review:
The structure of existing share, option and rights plans
- The timing and mechanics of future equity issuances
- Disposal restrictions and holding period requirements
- Participant communications and education materials, and
- The documentation supporting eligibility as an innovative business.
For businesses planning to undertake future funding rounds, there may also be merit in considering how future share issuances can be structured to maximise access to the concession for founders, employees and incoming investors.
What about businesses considering a start-up ESS?
For businesses that are considering implementing an ESS, the proposed concession provides another reason to revisit whether equity remains an effective part of the remuneration strategy.
While the rules are not yet final, businesses considering a new ESS should start thinking about whether they are likely to satisfy the proposed innovation requirements, how future participants may benefit from the concession and whether plan documentation can be drafted with sufficient flexibility to accommodate the final legislation.
This is particularly important for high-growth businesses where employee participation and long-term alignment with founders and investors are key objectives of the remuneration strategy.
BDO insight
From an ESS perspective, the proposed IBCC may preserve much of the value proposition that has historically made the start-up ESS concession so attractive. While the start-up concession can deliver a nil taxing point on exercise for qualifying options and rights, the long-term benefit for employees has always depended on how future growth in value is taxed. By potentially retaining access to a 50 per cent CGT discount for qualifying innovative businesses, the proposed IBCC helps ensure that founders and employees can continue to participate in that growth on a concessional basis.
The release of the exposure draft is also a positive sign that Treasury has recognised the important role employee ownership plays in helping start-ups attract, retain and incentivise talent. However, the proposed concession is only available to businesses that satisfy a relatively narrow set of eligibility requirements. As currently drafted, simply being a start-up or growth business is unlikely to be sufficient. Companies will still need to satisfy a range of innovation and other qualifying criteria, which may exclude some businesses facing many of the same commercial and funding challenges that the concession is intended to address.
There may be merit in broadening the eligibility criteria before the legislation is finalised. Doing so could make the concession accessible to a wider range of genuine early-stage businesses, improve its practical effectiveness and better support the Government's objective of encouraging innovation, investment and employee ownership. It would also reduce the risk of unintended outcomes where businesses that would otherwise benefit from the policy are excluded because they fail to satisfy a narrow technical requirement.
As the legislation remains in exposure draft form, the rules are still subject to consultation and may change before being enacted. For businesses operating, or considering implementing, a start-up ESS, this is an area worth monitoring closely.
How BDO can help
BDO's tax specialists can help assess eligibility for the proposed Innovative Business CGT Concession, review existing equity arrangements and prepare for potential changes ahead of the proposed 1 July 2027 commencement. To discuss the proposed reforms and their potential impact on your business, speak with your local adviser or learn more about our tax services.
