The end of the CGT Discount: what the 2026–27 Budget means for equity based employee incentives

Equity based employee incentive arrangements have long been a cornerstone of Australia's corporate remuneration landscape.

From ASX-listed multinationals seeking to align executive interests with shareholder value, to cash-constrained start-ups offering equity in lieu of higher salaries, equity based employee incentives represent a powerful tool for attracting, retaining and incentivising employee talent. Management incentive plans are also a core feature of the private equity landscape, heavily utilised by private equity and venture capital funds seeking to incentivise portfolio company executives to drive value creation over the life of their investment.

The tax settings underpinning these schemes, particularly the 50% capital gains tax discount (CGT Discount) for assets held longer than 12 months, have been instrumental in making equity participation genuinely attractive for employees. The 2026–27 Federal Budget proposes to fundamentally alter that equation.

Key changes

• Withdrawal of the 50% CGT Discount for equity interests (including employee share schemes (ESS) interests acquired for market value or held beyond the deferred taxing point) from 1 July 2027, replaced by CPI-linked cost base indexation and a 30% minimum tax on real capital gains.

• Employees receiving incentives issued with a nil or low cost base, will receive minimal or no benefit from indexation, effectively resulting in gains being taxed at the employee's marginal income tax rate.

• Employees holding equity interests through discretionary (family) trusts face a compounding disadvantage: loss of the CGT Discount combined with a new 30% minimum trust tax from 1 July 2028.

Transitional arrangements will apportion gains on assets held across the commencement date, preserving the CGT Discount for the portion accrued before 1 July 2027 and applying the new indexation and minimum tax rules to gains accruing thereafter.

The Government has indicated that it will consult with stakeholders on the details of the CGT reforms to the early-stage and start-up sectors leaving scope for potential modifications before the reforms are legislated for this sector.

Key takeaways

At the time of writing the Federal Government had introduced a bill to Parliament to give effect to the wide-ranging CGT and negative gearing changes but certain key details have not yet been provided. Given the legislation is still before Parliament and certain implementation details remain subject to consultation, stakeholders should monitor developments closely.

Despite the changes, equity incentives remains a valid and compelling tool for retention, motivation and alignment: the fundamental commercial rationale endures regardless of how gains are ultimately taxed.

However, while the Budget reforms do not eliminate the utility of equity-based remuneration, they fundamentally alter the economic calculus that has driven equity based employee incentive arrangement design for over two decades for schemes falling outside the ESS Rules and under the CGT regime.

The tax changes may diminish the attractiveness of equity-based incentives or require employers to offer larger equity share to their employees to deliver the same after-tax return. Alternatively, phantom equity schemes (ie. cash incentives which track underlying equity value) may become more appealing due to their simplicity.

Companies with existing schemes, particularly those structured for capital account outcomes, should be modelling the impact of the new rules now and considering restructuring or go forward options ahead of the 1 July 2027 commencement date.

For the early stage and start-up sectors, active engagement in the Government's upcoming consultation process is essential to ensure that the policy intent of the start-up concession, enabling cash-poor businesses to attract world-class talent, is not inadvertently undermined by reforms directed at an entirely different mischief.

The current landscape

ESS schemes in Australia come in various shapes and sizes but broadly fall into one of two categories. The practical effect of the CGT changes depends substantially on the nature of the equity arrangement and the employee's cost base.

Under the tax law's ESS Rules, where ESS interests (ie. shares, options or rights) are issued to employees at a discount to market value the discount is included in the employee's assessable income (and therefore taxed at their marginal rate of tax). The “discount” is generally the market value of the interest at the taxing point less any consideration paid by the employee.

Plans relying on the deferral regime within the ESS Rules: The ESS Rules allow broad, ordinary share based equity incentive plans that meet prescribed requirements to access certain tax concessions. These plans are typically structured so that the taxing point is deferred until there is an ability to liquidate the relevant shares. However, it is generally the case that all, or a significant proportion of any gain up to the deferred taxing point is taxed at marginal income tax rates (without the benefit of the CGT Discount).

These schemes are common for listed companies, where employees have the opportunity to sell all or a portion of their award to fund their tax liability. These schemes will not be materially affected, given that their schemes were already structured to deliver benefits assessed on income account - although shares which continue to be held beyond the deferred taxing point will lose the CGT Discount on any subsequent gain but gain the benefit of CPI-linked cost base indexation.

Plans not relying on the deferral regime within the ESS Rules: This category includes schemes which do not meet the criteria to rely on the ESS Rules (eg. interests other than ordinary shares or whether less than 75% employees are eligible to participate) or where shares were not offered at a discount. This is the case for most private equity based schemes. It includes structures such as:

• loan funded share plans where the employer lends money (on a limited recourse and interest free basis, and prior to the employee becoming a shareholder) for an amount equal to all or a portion of the market value of the shares to be acquired; and

• premium priced options where employees receive the right to acquire shares in the future, at an exercise price sufficiently more than the current value of the underlying share.

Provided options or the resulting shares are held on capital account and for at least 12 months, any gain on these options or shares would have been eligible for the CGT Discount. That discount ceases to apply under the proposed changes and is replaced with cost base indexation. This means the gap between capital account treatment and ordinary income treatment narrows considerably.

Impact analysis

Reduced after tax returns for participants

Under the current regime, a top-marginal-rate taxpayer realising a capital gain after holding shares for more than 12 months pays an effective tax rate of approximately 23.5% owing to the CGT Discount. Under the proposed regime, that same gain to a top-marginal-rate taxpayer will be subject to tax at a rate of 47% (including the 2% Medicare levy), with only CPI indexation of the cost base reducing the taxable gain, a far less generous concession for participants whose initial cost base may be very low relative to their exit proceeds.

If equity is held on capital accounts, a greater proportion of equity may be required to deliver the same after tax return as a result of the increased tax liability. If employees are not willing to absorb this reduction, employers may be required to increase cash-based remuneration or offer more equity to compensate. Employers, such as private equity funds, reliant on incentivising management will need to grapple with how to manage this effective reduction in their employee's remuneration packages.

Alignment of interests

A critical policy objective of equity incentive arrangements is fostering genuine alignment between employees and shareholders. The CGT Discount historically made:

• equity based remuneration more attractive to employees than cash-based remuneration, particularly high income earners; and

• provided an incentive for employees acquiring shares within the scope of the ESS Rules to hold shares beyond the deferred taxing point,

creating long-term ownership that aligned employees' economic interests with those of the business. With that incentive diminished, there is a risk that employees will be more inclined to seek cash-based remuneration or to sell immediately upon vesting or exercise, reducing the alignment function that underpins equity-based remuneration.

Cost base dynamics and timing

For loan-backed share plans, the participant acquires shares at market value from the outset establishing a meaningful cost base that can be indexed over time.

However, for premium-priced options, where the participant pays only a small premium (or nothing) upfront and only acquires shares on exercise, the cost base will be minimal until the option is exercised, limiting the benefit of indexation. Moreover, exercising an option creates a new CGT asset, which could eliminate the availability of indexation from the grant date altogether (albeit this may be of limited value). We therefore expect to see a reduction in the usage of option based schemes as a result of the removal of the CGT Discount.

Employer willingness to offer actual equity

For private companies that have historically structured their management equity plans to deliver capital account treatment, including loan-funded share schemes and premium-priced option arrangements, the removal of the CGT Discount erodes much of the financial incentive that justified the complexity of these structures – although the indexation system will deliver some benefits depending on cost base.

Without employees benefiting from the CGT Discount, companies may reassess whether such schemes provide sufficient reward to justify their inherent complexity, including Division 7A issues, shareholder register management, potential disclosure requirements, and bad leaver mechanics including buy-backs and compulsory share transfers.

Phantom equity plans, which were previously less common due to the superior CGT outcomes available through actual equity ownership, may also gain traction given their structuring flexibility, availability of tax deductions to the employer and overall regulatory simplicity. That said, equity ownership may continue to be preferred if financial investors desire a structure that encourages management retention through ownership changes (eg. where management are required to rollover a portion of their equity through an exit process).