• ESS – Indeterminate rights

    Division 83A of the Income Tax Assessment Act 1997:

    • contains employee share scheme rules (ESS rules) that apply to shares, rights and stapled securities acquired on or after 1 July 2009
    • introduces the concept of an indeterminate right being a beneficial interest in a right that may later become a right to acquire a beneficial interest in a share
    • is taken to have applied as if the right had always been an ESS interest (a right to acquire a share where such a right is acquired after 30 June 2009)

    See also:

    For example, a company may grant rights to acquire:

    • shares with a specified total value, rather than a specified number of shares
    • an indeterminate number of shares, the number being dependent on the share price at a time in the future
    • either shares or cash (at the discretion of your employer).

    These rights are known as indeterminate rights.

    The indeterminate rights may become rights to acquire shares upon the occurrence of certain events, including:

    • when shares are provided in satisfaction of the rights
    • when the company makes a decision to satisfy the rights with shares
    • when the number of shares that will be provided in satisfaction of the rights can be determined.

    See also:

    Examples of what are and are not indeterminate rights

    Example 1: At employer's discretion, employee receives shares

    Example 2: At employer's discretion, employee receives cash

    Example 3: Employee has a deferred taxing point in earlier income year

    Example 4: Indeterminate rights are forfeited or lapse

    Example 5: Number of shares cannot be determined at grant

    Example 6: Rights to shares vest subject to performance conditions

    Example 7: Rights to shares granted subject to shareholder approval

    Example 8: Shareholder approval to grant rights to shares in future

    Example 9: A right that only later becomes an indeterminate right

    Example 10: An indeterminate right with limited board discretion

    Example 11: Creation of indeterminate right at beginning of performance period, employee receives cash or shares

    Example 12: Creation of indeterminate right at beginning of performance period, employee receives shares

    Example 1: At employer's discretion, employee receives shares

    On 30 March 2012, Tim was granted rights by his employer, Tea Leaf Ltd, to 1,000 shares in Tea Leaf Ltd. However, company management reserves the right to grant Tim the cash value of the shares, rather than actual Tea Leaf Ltd shares.

    The rights are provided in relation to Tim's employment with Tea Leaf Ltd, and Tim does not pay anything for them. Tim will forfeit the rights if he ceases employment within three years of the date of grant.

    On 31 March 2015, shares are transferred to Tim in satisfaction of his rights.

    The rights are not rights to acquire shares at the time they are granted to Tim. However, when the shares are transferred to Tim on 31 March 2015, the ESS rules treat the rights as if they had been rights to acquire shares since 30 March 2012.

    Example 2: At employer's discretion, employee receives cash

    The facts are the same as for example 1, except that on 31 March 2015 Tim receives cash to satisfy his rights. Tim will not be assessed under the ESS rules. Instead, Tim will be assessed on the cash received as salary and wages under the relevant provisions of the income tax law in the year in which he receives the cash.

    Example 3: Employee has a deferred taxing point in earlier income year

    On 15 February 2011, Sofia was granted rights by her employer, Metals Ltd, to acquire either 1,000 shares in Metals Ltd or a cash equivalent. The rights are provided in relation to Sofia's employment with Metals Ltd, and she does not pay anything to acquire the rights.

    The rights will vest in three years' time if performance hurdles are satisfied. Metals Ltd will decide whether to give Sofia shares or cash once the performance hurdles have been met. Metals Ltd will advise their employees of this decision before the actual transfer of shares or payment of cash.

    Sofia ceases employment on 31 March 2013 and is entitled to keep her rights, which remain subject to satisfaction of the same performance hurdles.

    On 20 March 2014, Metals Ltd determines that the performance hurdles have been met and advises Sofia that it will transfer shares in Metals Ltd to her in satisfaction of her rights.

    The rights are not rights to acquire shares at the time they are granted to Sofia. However, when Metals Ltd makes their decision to issue shares on 20 March 2014, the ESS rules treat Sofia's rights that were granted on 15 February 2011 as if they had always been rights to acquire shares.

    In this case, the rights were acquired under a tax-deferred scheme. Sofia's taxing point for the rights occurred when she ceased employment on 31 March 2013. Sofia amends her 2012–13 income tax return and includes the discount for the rights.

    Example 4: Indeterminate rights are forfeited or lapse

    The facts are the same as for example 3, except that the performance hurdles are not met and Sofia's rights are forfeited. Because Sofia's rights never become rights to acquire shares, she will not be taxed under the ESS rules.

    Example 5: Number of shares cannot be determined at grant

    On 15 October 2015, Krystal is granted rights under a tax-deferred scheme to acquire shares in her employer, Design Ltd, in three years' time. At the time that Krystal acquired the rights, she held more than 10% of the shares in Design Ltd. The rights are provided in relation to Krystal's employment with the company – she does not pay anything for the rights.

    The rights are indeterminate rights because the number of shares that Krystal is entitled to acquire will be determined on 30 October 2018 in accordance with a formula that depends on the share price of the company at that future time. At the time the rights are granted (October 2015), the number of shares that may be acquired cannot be determined.

    On 30 October 2018, the number of shares that Krystal is entitled to acquire under the formula is worked out to be 5,000.

    The rights are not rights to acquire shares at the time they are granted to Krystal. However, when the number of shares that Krystal is entitled to acquire is determined, the rights become rights to acquire 5,000 shares. The ESS rules apply to the rights as if the rights acquired on 15 October 2015 had always been rights to acquire shares.

    Although the rights were granted under a tax-deferred scheme, the conditions for deferral were not satisfied at the time the rights were acquired because Krystal held greater than 10% of the shares in Design Ltd. As a result, the discount for the rights is assessable in the year of acquisition, which is in the 2015–16 income year.

    Krystal requests an amendment to her income tax return for 2015–16 income year to include the discount.

    Example 6: Rights to shares vest subject to performance conditions

    James is granted 5,000 rights to shares in his employer company, Artco, on 31 May 2015. The rights will vest in three years. The exercise of rights is subject to the company meeting certain performance conditions and James remaining an employee of Artco during the vesting period. James will be entitled to the 5,000 shares if all performance conditions are met; if the performance conditions are only partially met, only a proportionate percentage of the rights will vest. The rights will lapse if performance conditions are not met or James ceases employment within three years of the date of grant.

    The rights granted to James are rights to shares, not to indeterminate rights. Because the rights are subject to real risk of forfeiture, the rights are granted under a tax-deferred scheme and any discount in respect of the rights is assessed at the deferred taxing point.

    Example 7: Rights to shares granted subject to shareholder approval

    Kale enters into an employment contract with his employer, Travel Ltd, on 5 May 2014. Under that contract, he is granted rights to acquire 1,000 shares subject to shareholder approval. If shareholder approval is not obtained, the company will pay Kale a cash equivalent. Kale does not pay the company anything for these rights.

    The rights in the employment contract are indeterminate rights, not rights to acquire shares at the time they are granted to Kale.

    On 10 November 2014, the company holds its AGM and shareholders approve the grant of rights to Kale. The ESS rules apply to Kale's rights as if they had always been rights to acquire shares from the time that Kale entered into the employment contract on 5 May 2014. In this case, the rights were acquired under a taxed-upfront scheme. Kale includes the discount for the rights in his assessable income in the 2013–14 income year, being the year in which he acquired the rights under his employment contract.

    See also

    • TD 2016/17 Income tax: in what circumstances does a contractual right, which is subject to the satisfaction of a condition, become a right to acquire a beneficial interest in a share for the purposes of subsection 83A-340(1) of the Income Tax Assessment Act 1997?

    Example 8: Shareholder approval to grant rights to shares in future

    The shareholders of Health Research Ltd resolve at the company's AGM on 22 November 2014 to authorise the company to grant rights to acquire shares to key employees, including Brin.

    On 15 August 2015, Health Research Ltd enters into a contract with Brin granting her rights to acquire shares in the company.

    Brin does not acquire indeterminate rights when the AGM is held. At the AGM, the shareholders resolve to approve the company granting rights to shares in the future. No rights are created in Brin at that time – she acquires rights to shares on 15 August 2015 when she enters into a contract with Health Research Ltd. The ESS rules will apply to determine when Brin will be assessed on the rights acquired.

    Example 9: A right that only later becomes an indeterminate right

    On 1 July 2016, Richard is advised by his employer, Ferries Ltd (Ferries), that he may be entitled to a maximum of $50,000 worth of shares and/or cash. To receive this incentive:

    • his individual performance must meet management expectations
    • he must remain employed by Ferries until 1 July 2018
    • Ferries must meet its financial targets
    • the Remuneration Board must make a decision to pay incentives to eligible employees for the financial year, by December 2018. This decision is made entirely at the Board’s discretion and it is Ferries’ intention that no right is granted to Richard before then.

    Richard remains employed by Ferries and on 1 August 2018, after Ferries’ AGM, he is advised that he has performed to management expectations and Ferries has met its financial targets, and that the Board has decided it will pay Richard the full $50,000 worth of incentives. The Board has yet to decide whether the incentives will be paid in cash, shares or a combination of both.

    On 1 December 2018, the Board determines Richard will receive his incentive in the form of $10,000 cash and rights to acquire shares worth $40,000.

    On 10 December 2018, Richard receives the cash and rights. Richard must remain with Ferries for a further six months before he can exercise the rights to acquire shares.

    As the Board has the complete discretion over whether Richard receives any incentive and, if so, what that incentive will be, he has no right or entitlement on 1 July 2016. When the Board makes the decision to pay incentives on 1 August 2018 and Richard has met the other conditions to receive his incentive, he has a contractual right to enforce the payment of an incentive at the value of $50,000 at that time. When the Board later determines Richard will receive $40,000 of rights to acquire shares, the ESS rules treat these rights as if they had been rights to acquire shares since 1 August 2018, when the decision to pay incentives was made.

    Example 10: An indeterminate right with limited board discretion

    On 1 July 2016, Marta is granted rights to a maximum of 100,000 shares by her employer, Tents Ltd (Tents). The rights are provided in relation to Marta’s employment with Tents and she does not pay anything for the rights. The rights are subject to a number of conditions, including:

    • Marta and Tents must meet certain performance targets
    • Marta must remain employed by Tents until 1 July 2018
    • the Remuneration Board has a discretion to reduce, in part or in full, the number of rights that would otherwise vest (having satisfied the other conditions) in certain circumstances.

    Marta remains employed by Tents and on 1 August 2018 is advised that all of the performance targets have been met and the Board has determined that only 80,000 rights will vest on that date (that is, the Board has exercised its discretion to reduce the number of rights that will vest). Marta now has 80,000 rights to acquire shares in Tents.

    The rights granted on 1 July 2016 are conditional and also subject to the exercise of the Board’s discretion. Marta does not have any rights to acquire shares at that time.

    When Marta is advised on 1 August 2018 that her 80,000 rights have vested, the ESS rules treat those rights as if they had always been rights to acquire shares, from 1 July 2016.

    Example 11: Creation of indeterminate right at beginning of performance period, employee receives cash or shares

    On 1 July 2016 Raj, an employee of Ultra Research Ltd (Ultra Research), is provided with an award letter advising of his eligibility to participate in the company’s incentive scheme. The award letter states that Raj will potentially receive cash and shares subject to the terms of the scheme. The rights are provided in relation to Raj’s employment with Ultra Research and he does not pay anything to acquire the rights.

    Raj’s maximum incentive under the scheme is $50,000, which he will receive as 50% cash and 50% shares, to the extent that he meets specific performance goals for the financial year. The Remuneration Board has a discretion under the scheme to determine the level of performance and resulting incentive. However, Ultra Research’s intention is that participants in the incentive scheme receive a conditional right to receive cash and shares when they are given the award letter at the start of the year.

    In August 2017, Raj is advised that he has met all of his performance goals and his conditional entitlement has vested in full. In September 2017, Raj receives $25,000 cash and 5,000 Ultra Research shares valued at a total of $25,000 (based on Ultra Research’s share price in September 2017). Under the terms of the scheme, Raj cannot sell his shares for a further 12 months.

    On 1 July 2016, Raj acquired a right which comprised of a conditional right to receive up to $25,000 in cash and up to $25,000 of Ultra Research shares. When the number of shares is determined in September 2017, the ESS rules treat the original right acquired on 1 July 2016 as if it had always been rights to acquire 5,000 Ultra Research shares.

    Example 12: Creation of indeterminate right at beginning of performance period, employee receives shares 

    Assume in Example 11 that Raj’s award letter of 1 July 2016 had advised the potential award of $50,000 would be wholly satisfied in shares.

    On 1 July 2016, Raj acquired an indeterminate right which was a conditional right to receive up to $50,000 of Ultra Research shares at a later date. When the number of shares was determined at that later date, the ESS rules would treat Raj’s right, granted on 1 July 2016, as if it had always been a right to acquire that number of shares.

    End of example

    Transitional treatment of indeterminate rights

    What are transitioned interests?

    Transitional interests are shares or rights to shares that you acquired under an employee share scheme before 1 July 2009 if:

    • they are qualifying shares or rights under the rules in former Division 13A of the Income Tax Assessment Act 1936, and
    • the shares or rights are not covered by an election under the former Division 13A rules, and
    • a cessation time has not happened to the shares or rights before 1 July 2009 under the former Division 13A rules.

    Under the transitional rules, some of the rules in former Division 13A are preserved. Also, some of the rules in Division 83A do not apply, or are modified in the way that they apply to a transitioned interest.

    How do the transitional provisions apply to indeterminate rights?

    If you received indeterminate rights before 1 July 2009 that are later treated as rights to acquire shares under an employee share scheme after 1 July 2009, you must include the discount you received on those rights as part of your assessable income. The year in which you include the discount depends upon whether the indeterminate rights are treated as qualifying rights and whether you elected to be taxed upfront for the year you acquired the indeterminate rights. If the former Division 13A rules result in tax being deferred to a time after 1 July 2009, the rights will be transitioned into the Division 83A rules and treated like other ESS interests as detailed above.

    As a result, at the time the indeterminate rights become rights to acquire shares, you may be required to amend your income tax assessment for an earlier year to include the discount amount, either for the year in which the rights were acquired or in the year in which the cessation time or deferred taxing point occurred.

    Section 139E elections

    If you acquired qualifying shares or rights before 1 July 2009, the default taxation position was that you were assessable on any discount given at the cessation time. The former Division 13A rules gave you the opportunity to make an election under section 139E to have the discount given in relation to qualifying shares or rights assessed in the income year of acquisition. When an election is made, it operates to assess the discount given in relation to all qualifying shares and rights you acquired in that year.

    Where a taxpayer fails to make the section 139E election either at the right time or in the approved form, they can seek the Commissioner of Taxation's discretion to accept a later election. If the discretion is exercised, the taxpayer may then make the section 139E election to have the discount assessed in the income year of acquisition.

    There is no provision in the tax law or any other law administered by the Commissioner for the taxpayer to revoke an election made, nor does the Commissioner have the power to revoke the election.

    Qualifying and non-qualifying shares and rights

    A share in a company will be a qualifying share under the former Division 13A rules if it satisfies all of the following requirements:

    • the share is acquired by you under an employee share scheme
    • the company is your employer or your employer's holding company
    • the shares or rights to shares available from the employee share scheme are ordinary shares or rights to ordinary shares
    • after acquisition of the share, you do not hold a legal or beneficial interest of more than 5% of the shares in the company
    • after acquiring the share you are not in a position to cast, or control the casting of, more than 5% of the votes in the company's general meeting, and
    • when you acquired the share, at least 75% of the permanent employees of your employer were, or at some earlier time had been, entitled to acquire shares or rights to shares from an employee share scheme of your employer or its holding company.

    A qualifying right must satisfy the same requirements, except the last requirement above.

    See also:

    Election made in the year the indeterminate rights were acquired

    If you acquired shares or rights in addition to your indeterminate rights in an income year before 2009–10 and you made a section 139E election in respect of the shares or rights, you must amend your earlier year's income tax return to include the discount given in relation to your indeterminate rights when they become rights to acquire shares.

    Example 9: Taxpayer makes an election in the year in which they acquired the indeterminate rights

    Sharon acquired 1,000 qualifying shares and a number of indeterminate rights in the 2008–09 income year. She made a section 139E election for that income year and the discount given in relation to the 1,000 qualifying shares was included in her assessable income.

    In the 2009–10 income year, Sharon's indeterminate rights became rights to shares, and she received another 1,000 shares. Under the transitional provisions, her indeterminate rights are considered to have been acquired in the 2008–09 income year. Because Sharon has made a section 139E election for the 2008–09 income year, she will be required to amend her assessment for the 2008–09 income year to include the discount in relation to those indeterminate rights in the acquisition year.

    End of example

    Indeterminate rights acquired before 1 July 2009 are non-qualifying when they become rights to shares

    If any shares or rights you receive are non-qualifying, any discount amounts will be assessable in the year of acquisition. As a result, if you acquired indeterminate rights that become rights to shares in a later income year, you must amend your earlier year's income tax assessment to include the discount given in relation to your indeterminate rights, if those rights to shares are considered non-qualifying.

    Cessation time before 1 July 2009 – indeterminate rights became rights to shares after 1 July 2009

    Where you receive indeterminate rights, and a cessation time has occurred before the indeterminate rights become rights to shares, the taxing point will be the date of cessation, provided the rights are qualifying rights and you did not make a section 139E election.

    Where a section 139E election was made for the year the indeterminate rights were acquired, the taxing point will be in the year of acquisition.

    Example 10: Taxpayer allowed to keep indeterminate rights after resignation

    Ben acquired 1,000 qualifying shares and a number of indeterminate rights in the 2007–08 income year. Ben resigned from his employment in the 2008–09 income year and was allowed to keep the indeterminate rights.

    In the 2011–12 income year, Ben's indeterminate rights became qualifying rights to shares, and he receives another 1,000 shares.

    Under the transitional provisions, Ben's indeterminate rights are considered to have been acquired in the 2007–08 income year. Because the rights are qualifying rights, and Ben did not make a section 139E election for that income year, his indeterminate rights will be taxed at the cessation time, which in this case is termination of employment. As a result, Ben will be required to amend his assessment for the 2008–09 income year to include the discount given.

    End of example

    Taxpayer received only indeterminate rights and would like to make a later election

    Where you only received indeterminate rights in an income year prior to 1 July 2009, and those rights later become qualifying rights to acquire shares after 30 June 2009, you may request the Commissioner's discretion to allow a later election to be made for the acquisition year.

    The Commissioner will exercise the discretion on a case-by-case basis.

    Example 11: Taxpayer received only indeterminate rights and would like to make a later election

    Michael is granted indeterminate rights in the 2008–09 income year. He does not acquire any other employee share scheme interests in that income year and, as a result, could not make a section 139E election. In 2010–11, the indeterminate rights became qualifying rights to acquire shares and are taken to have been acquired in the 2008–09 year. Michael may request the Commissioner's discretion to allow a later section 139E election for the year of acquisition.

    The Commissioner will exercise the discretion on a case-by-case basis.

    End of example

    Taxpayer was deemed to have made an election in the year they acquired indeterminate rights

    For the 2008–09 income year only, you are deemed to have made an election if you acquired qualifying shares or rights under an employee share scheme that meet the exemption conditions and the total discount related to the shares or rights is not more than $1,000. This means that you are not required to make an election in your tax return for these qualifying shares or rights, nor are you required to include the discount in your assessable income.

    In order to be deemed to have made an election in the 2008–09 income year, the employee share scheme under which the shares or rights are acquired must meet all of the following conditions:

    • the scheme did not have any conditions that could result in any employee forfeiting ownership of the shares or rights
    • the scheme was operated so that no recipient would be permitted to dispose of the shares or rights (or shares acquired on exercise of the rights) before the earlier of
      • three years after their acquisition (or for shares acquired on exercise of the rights, three years after acquisition of the rights)
      • the time the employee's employment ceased with the employer
       
    • the employee share scheme operated on a non-discriminatory basis (including the provision of financial assistance in respect of the acquisition of shares or rights), which means that
      • participation in the scheme is open to at least 75% of permanent employees
      • the time for acceptance of each offer is reasonable
      • the essential features of each offer are the same for at least 75% of permanent employees.
       

    Where you acquire shares or rights with a total discount of less than $1,000 under a scheme that meets the exemption conditions, in the 2008–09 income year, you are deemed to have made an election under section 139E. If, when the indeterminate rights later become rights to acquire shares and the total discount in the acquisition year increases to more than $1,000, you will no longer be deemed to have made an election. As a result, where the rights are qualifying, you will either have to request the Commissioner's discretion to allow a later election or amend the relevant income tax assessments to include the discount income in the year in which the cessation time occurred. If a later election is not requested, the discount in respect of the shares or rights acquired under a scheme that met the exemption conditions will be assessable in the year in which the cessation time occurred.

    Shortfall interest charge – for indeterminate rights acquired before 1 July 2009

    Where your amendment results in a tax shortfall amount, you may be liable to interest charges on the shortfall. However, remission of interest charges will be considered with your amendment request.

    Where you request an amendment to your income tax assessment to include income from indeterminate rights, shortfall interest will generally be remitted in full where you did so because of one of the following circumstances:

    • you made a section 139E election in the income year in which you acquired the indeterminate rights
    • your indeterminate rights are not qualifying and the discount must be included in the acquisition year, or
    • you had a cessation time or deferred taxing point in an income year before the year in which your indeterminate rights became rights to acquire shares and the discount income is assessable in that earlier income year.

    Where we amend your income tax assessment to include income from indeterminate rights as a result of allowing a later election, we will generally remit the shortfall interest in full to the extent that it relates to the discount included for the indeterminate rights.

    In these circumstances, the Commissioner will remit the shortfall interest to the earlier of:

    • the time when the amended assessment is made, or
    • the due date for lodgment (or within such further time as the Commissioner allows) following the income year that the indeterminate rights became rights to shares.

    If we allow a later section 139E election in circumstances where you would have had a cessation time or deferred taxing point in an income year prior to your rights becoming rights to shares, we will generally remit the shortfall interest as follows. The shortfall interest will be remitted in full from the time that income tax was due to be paid on the assessment for the year in which the cessation time or deferred taxing point occurred until the earlier of:

    • the time when the amended assessment is made, or
    • the due date for lodgment (or within such further time as the Commissioner allows) following the income year that the indeterminate rights became rights to shares.

    Employer reporting obligations

    From 1 July 2009, as an employer, you are subject to reporting obligations if, under an employee share scheme, you provide ESS interests to your employees or to their associates. These reporting obligations also apply to indeterminate rights.

    See also:

    Timing for reporting of indeterminate rights

    Transitioned interests

    If your employee acquires rights before 1 July 2009, which after 30 June 2009 become rights to acquire shares that are qualifying, and a possible cessation time happens to those rights after 30 June 2009 (whether or not the employee made an election), you are required to provide an ESS statement to your employees. You also need to provide an ESS annual report to the Commissioner for the income year in which the possible cessation time occurs.

    There is no reporting requirement if the rights are not qualifying, or if the cessation time for the rights occurred before 1 July 2009.

    For more information on the application of the previous ESS rules, see ESS interests with a taxing point before 1 July 2009.

    Taxed-upfront scheme

    If, after 30 June 2009, your employee acquires indeterminate rights which later become rights to acquire shares under a taxed-upfront scheme, you must:

    • if the indeterminate rights become rights to shares in the same income year in which the employee acquired the indeterminate rights, give the information to the employee in an ESS statement by 14 July and to the Commissioner in the ESS annual report by 14 August after the end of the income year, and
    • if the indeterminate rights become rights to shares after the end of the income year in which the employee acquired the indeterminate rights, give the employee an amended ESS statement and give the Commissioner an amended ESS annual report for the acquisition year within 30 days of the indeterminate rights becoming rights to shares.

    Tax-deferred scheme

    If, after 30 June 2009, your employee acquires indeterminate rights which later become rights to shares under a tax-deferred scheme, you must:

    • if the deferred taxing point occurs in a financial year before the indeterminate rights become rights to shares
      • give the employee an amended ESS statement for the year in which the deferred taxing point occurred, within 30 days of the indeterminate rights becoming rights to shares, and
      • give us an amended ESS annual report for the year in which the deferred taxing point occurred, within 30 days of the indeterminate rights becoming rights to shares.
       
    • if the deferred taxing point occurs during the income year in which the indeterminate rights become rights to shares
      • give the employee information on the rights in their ESS statement by 14 July
      • give us information on the rights in the ESS annual report before 14 August
       
    • if the deferred taxing point occurs after the income year in which the indeterminate rights become rights to shares
      • give the employee information on the rights in their ESS statement for the year in which the deferred taxing point occurs, and
      • give us information on the rights in the ESS annual report for the year in which the deferred taxing point occurs.
       
      Last modified: 27 Apr 2017QC 25098