Senate

Taxation Laws Amendment Bill (No. 3) 2003

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Previous citation Taxation Laws Amendment Bill (No. 8) 2002

Chapter 2 - Employee share schemes

Outline of chapter

2.1 Part 1 of Schedule 2 to this bill amends the income tax law to ensure that the CGT provisions that deal with ESSs operate as intended. The amendments are required where an ESS is operated through a trust and the employee elects under Division 13A of the ITAA 1936 to be assessed on the discount on the shares at the time the shares or rights are acquired by the trustee. The amendments ensure that:

capital gains and losses while the shares or rights are held in an employee share trust are recognised ; and
the time of acquisition of shares or rights for the purpose of the CGT 50% discount is the time the shares or rights are acquired by the trustee.

2.2 Part 2 of Schedule 2 inserts an integrity measure into Subdivision 130-DA of the IT(TP) Act 1997 to ensure that trustees currently holding ESS shares or rights in a trust cannot take advantage of the non-recognition of capital gains on shares or rights while held in trust.

2.3 Parts 1 and 2 of Schedule 2 also make technical amendments to the CGT provisions in the ITAA 1997 and IT(TP) Act 1997 that deal with ESSs.

2.4 Part 3 of Schedule 2 makes a technical amendment to the FBTAA 1986 to ensure consistency between the FBTAA 1986 and Division 13A of the ITAA 1936.

Context of amendments

Existing law - employee share schemes

2.5 Division 13A of the ITAA 1936 deals with the taxation of benefits provided to employees under an ESS. Generally, where an employer provides a share or a right to a share to an employee at less than market value under an ESS, the discount is included in the employee's assessable income in the year of income in which the shares or rights to shares are acquired.

2.6 Division 13A of the ITAA 1936 provides concessional treatment that applies to qualifying shares or rights. An employee who acquires a qualifying share or right may defer income tax on the discount for up to 10 years or elect to have the discount assessed in the year of income the share or right is acquired.

2.7 A taxpayer who makes an election is eligible for a reduction of up to $1,000 on the discount, subject to the ESS satisfying further conditions, including the requirement that the shares or rights be held at least 3 years before disposal. If the employee does not make an election, the employee will be assessed on the discount in the year of income the cessation time occurs.

Employee share trusts

2.8 Employers often establish a trust to hold the shares or rights to shares for their employees and thus restrict an employee's ability to dispose of them for the period they are held in trust.

2.9 A share or right to a share is acquired for the purpose of Division 13A when the employee receives a legal or beneficial interest in the share or right. If the share or right is acquired by a trust, the employee acquires the shares or rights held in trust at the time the trustee provides the employee with a legal or beneficial entitlement to those shares or rights.

2.10 The effect is that for Division 13A purposes, where an ESS is operated through a trust, the value of ESS benefits is taxed to the employee, not the trustee. This recognises the fact that the trustee holds the shares or rights for the sole purpose of providing them to the employee.

2.11 If the employee does not make an election to have the discount assessed in the year the shares or rights are acquired, the employee is assessed in the year of income in which the cessation time occurs. For an employee share trust, this is often the time the shares or rights are physically transferred from the trustee to the employee.

Existing law - CGT provisions as they relate to ESS shares and rights

Time of acquisition

2.12 In general terms, the date of acquisition of a CGT asset is the date on which a taxpayer becomes the asset's owner.

2.13 The time of acquisition for shares or rights to shares acquired under an ESS operated through a trust is the date when the employee becomes absolutely entitled to the shares or rights (table item relating to CGT event E5 (the beneficiary becoming absolutely entitled to a trust asset) in subsection 109-5(2) of the ITAA 1997)).

CGT discount

2.14 A CGT discount is available for capital gains made by certain entities listed in section 115-10 of the ITAA 1997. The CGT discount (50% for individuals and trusts other than complying superannuation entities) is generally available where the asset has been owned by the taxpayer for at least 12 months.

2.15 The 12-month ownership period for shares or rights acquired under an ESS operated through a trust begins on the happening of CGT event E5 (i.e. the date when the employee becomes absolutely entitled as against the trustee to the shares or rights).

Cost base/reduced cost base

2.16 Division 110 of the ITAA 1997 sets out general rules as to how to work out the cost base (for a capital gain) and reduced cost base (for a capital loss) of a CGT asset. Division 112 of the ITAA 1997 sets out situations that may modify the general rules about the cost base and reduced cost base of a CGT asset. Generally, if an element of the cost base is modified, the taxpayer uses the modified amount in CGT calculations and in relation to ESSs the modifications are listed in section 112-75.

2.17 Sections 130-80 and 130-85 of the ITAA 1997 establish the first element (the acquisition cost) of the cost base and reduced cost base for shares and rights acquired under an ESS where the discount on the shares or rights is assessed in the year of acquisition (i.e. it will be market value). Different rules are in section 130-83 for the circumstance where the taxpayer elects, in effect, to be assessed in the year of acquisition so there is a deferral of assessment on the discount.

Section 130-90

2.18 Section 130-90 provides a special rule in relation to a share or right to a share acquired under an employee share trust. It provides that a capital gain or loss a trustee makes when the beneficiary becomes absolutely entitled to the share or right is disregarded. This rule is intended to ensure that there is no double taxation, that is, that a discount on the shares or rights that is taxed to the employee is not then taxed as a capital gain.

Problems with the existing law

2.19 The existing law does not operate as intended in relation to:

the recognition of capital gains and losses while the shares or rights are held in an employee trust; and
the application of the CGT 50% discount .

2.20 As the law currently operates, any capital gain or loss which accrues during the period the shares or rights to shares are held in the trust is not recognised for CGT purposes. Any increase in the market value of the shares or rights during this period will not be subject to CGT. Conversely, if the market value of the shares or rights has fallen during this period, the employee will be denied a capital loss.

2.21 Also, an employee is denied access to the CGT discount if the employee disposes of the shares or rights within 12 months of becoming absolutely entitled to them.

2.22 In former Assistant Treasurer's Press Release No. 7 of 27 February 2001 the Government announced that it would introduce amendments to ensure the law operates as intended and also include an integrity measure rule to ensure that taxpayers's cannot take advantage of the non-recognition of capital gains on shares or rights held in an employee share trust.

Summary of new law

Section 1 - amendments to CGT provisions in the ITAA 1997

Amendment to Subdivision 115-A (discount capital gains)

2.23 This bill amends subsection 115-30(1) (special rules about acquisition times for the CGT discount) of the ITAA 1997 to ensure that, for shares or rights acquired under an ESS operating through a trust, the 12-month ownership period requirement for the 50% CGT discount commences from the date when the employee or associate acquires a beneficial interest in the shares or rights to shares held by the trust. The amendment will apply where:

a CGT asset is a share or right to a share acquired under an ESS via an employee share trust; and
if the shares or rights are qualifying shares or rights the taxpayer has made an election under section 139E of the ITAA 1936.

[Schedule 2, item 5]

2.24 The amendment ensures that for the purposes only of the 12-month minimum qualifying period for the CGT discount, taxpayers who acquire shares or rights under an ESS through a trust and elect to be assessed on the discount at the time the shares or rights are acquired will be treated under the CGT rules as having acquired the shares or rights at that time. This reflects the fact that, once the amendments take effect, these taxpayers will be subject to CGT from when the trustee acquires the shares or rights on their behalf.

2.25 A consequential amendment is made to the table in section 109-55 (which lists CGT acquisition rules) so that the above modification to the acquisition date for CGT discount purposes is listed. [Schedule 2, item 3]

Amendments to Subdivision 130-D (CGT ESS provisions)

2.26 This bill provides that where:

an employee acquires shares or rights to shares through an employee share trust; and
if the shares or rights are qualifying shares or rights the taxpayer has made an election under section 139E of the ITAA 1936,

then the cost base or reduced cost base of the shares or rights for the taxpayer is the cost base or reduced cost base when the taxpayer acquires a beneficial interest in the shares or the rights. [Schedule 2. item 6, subsection 130-80(3)]

2.27 The time the taxpayer acquires a beneficial interest in the shares or rights will be the time the trustee first holds the shares or rights for the taxpayer. The effect is that:

an increase in the value of the shares or rights during the trust holding period is subject to CGT on the ultimate disposal of the shares or rights by the taxpayer; and
a decrease in the value of the shares or rights during this period is available to the taxpayer as a capital loss or as a smaller capital gain.

2.28 This bill also deals with the equivalent situation where an associate of the employee acquires the shares or rights. [Schedule 2, item 9, subsection 130-85(3)]

2.29 A definition for the term employee share trust is inserted as a dictionary term in subsection 995-1(1) of the ITAA 1997. [Schedule 2, item 11]

Application date

2.30 The amendments apply to shares or rights acquired by a taxpayer under an ESS through a trust after the date of announcement, that is, 5.00 pm eastern summer time on 27 February 2001. [Schedule 2, subitems 12(2) and (3)]

2.31 However, in the case of amendments made to sections 130-80 and 130-85 a taxpayer can choose that the amendments can apply to share or rights to shares acquired (within the meaning of Division 13A) by a taxpayer via an employee share trust before 5.00 pm eastern summer time on 27 February 2001 [Schedule 2, subitem 12(3)]. For example, the taxpayer's shares may decline in value over the trust holding period. In the absence of this provision, the taxpayer could not make a capital loss on disposal of the shares or rights or a smaller capital gain.

2.32 A taxpayer can make this choice by how he or she prepares their income tax return including supporting documentation that he or she keeps. If the return has already been lodged, the taxpayer will need to seek an amendment to their assessment.

Section 2 - integrity measure - IT(TP) Act 1997

2.33 A trustee of a employee share trust that is already in existence at the date of the Government announcement could change the terms and conditions of the trust to take advantage of the non-recognition of capital gains on shares or rights held in an employee share trust. The trustee could achieve this by extending the trust holding period so that capital gains accruing during this period are not subject to CGT on disposal of the shares or rights.

2.34 This bill amends the IT(TP) Act 1997 to provide that where:

the shares or rights to shares are held by an employee share trust at 5.00 pm eastern summer time on 27 February 2001;
at the time the employee share trust acquired the shares or rights it was possible to determine how long the shares or rights would be held in trust (this period could be determined by a specified date or at the occurrence of a particular event); and
the shares or rights held in trust are acquired at a later time from that time,

then the first element (acquisition cost) of the cost base and the reduced cost base is its market value as determined under sections 139FA to 139FF of the ITAA 1936 at the earlier time. [Schedule 2, item 13]

Example 2.1 On 1 January 2001 Barbara acquires shares in an ESS via an employee share trust. Barbara makes an election under section 139E of the ITAA 1936 to be assessed on the discount on the shares at the time the trustee acquires the shares. The market value of the shares at the time Barbara acquires the shares is $1.00.The trustee changes the trust deed to extend the trust holding period from 3 years to 5 years. At the end of the 3 year trust holding period the market value of the shares is $3.00 and at the end of the 5 year period is $5.00.Under new section 130-80 of Subdivision 130-DA of the IT(TP) Act 1997 Barbara will be taken to have a cost base for the shares at the end of the extended trust holding period of $3.00.

Section 3 - minor technical corrections

2.35 Certain amendments contained in Schedule 2 to Part 1 of this bill will make corrections to the CGT provisions in the ITAA 1997 and the IT(TP) Act 1997 that relate to ESSs.

Table 2.1: Amendments to the Income Tax Assessment Act 1997
No. What the provision does What the amendment will do
1. 109-55 - lists rules for acquisition of a CGT asset. Item 12 in the table refers to an acquisition rule contained in 130-83(3). Repeal item 12 in 109-55. Taxation Laws Amendment Act (No 7) 2000 repealed section 130-83 and replaced it with a provision, which does not contain a rule for the time of acquisition. Item 12 should have been repealed at the same time [Schedule 2, item 2]. (The reference in column 4 in table item 12 to section 130-80 rather than 130-83 was always incorrect).
2. 112-75 - lists where an element of the cost base/reduced cost base of a share or right acquired under an ESS is affected. The sections listed are 130-80 and 130-85. List 130-83 in section 112-75. This provision also contains a rule, which affects the cost base/reduced cost base. [Schedule 2, item 4]
3. 130-90 - provides that where an employee becomes absolutely entitled to a share as against a trustee of an employee share trust a capital gain or capital loss of the trustee is disregarded.

Ensure that any capital gain or loss that arises to an employee on becoming absolutely entitled to the shares or rights to shares is also disregarded. This correctly reflects the intention of the provision, which is to ensure that no capital gain or loss arises to a trustee or employee when an employee becomes absolutely entitled to the shares or rights to shares [Schedule 2, item 10]. It also conforms to the ATO administrative practice.

Make consequential amendment to 104-75(6) similar to the note to 104-75(4). [Schedule 2, item 1]

4. 130-83(2) - provides that where a taxpayer disposes of a share or right to a share at the cessation time or within 30 days after that time any capital gain or capital loss is disregarded. List CGT event C2 (which includes forfeiture of rights) as one of the CGT events that result in the disposal of rights by a taxpayer. [Schedule 2, item 7]
5. 130-83(2) - sets out the CGT consequences if a CGT event happens in relation to shares or rights at the cessation time or within 30 days of the cessation time. Change the word "disposal" to "event" to ensure consistency with the CGT event terminology as used throughout the CGT provisions. [Schedule 2, item 8]
Table 2.2: Amendment to the Income Tax (Transitional Provisions) Act 1997
No. What the provision does What the amendment will do
1. 130-95 - describes the application of Subdivision 130-D.

In subsection 130-95(1), substitutes "This Subdivision" for "Subdivision 130-D of the Income Tax Assessment Act 1997 ". [Schedule 2, item 14]

In subsection 130-95(2), substitutes "this Subdivision" for "Subdivision 130-D of the Income Tax Assessment Act 1997 ". [Schedule 2, item 15]

This reverses an inappropriate amendment made by Act No. 114 of 2000. This amendment should not have been made to subsections 130-95(1) and (2) as these provisions relate to section 26AAC Employee Share Acquisition Scheme CGT provisions.

Table 2.3: Amendment to the Fringe Benefits Tax Assessment Act 1986
No. What the provision does What the amendment will do
1. Paragraph (hb) of the definition of fringe benefit in subsection 136(1) - ensures that an employer does not provide a fringe benefit to employees where ESS shares are provided to an employee through an employee share trust.

Includes the words "to employees of the employer" after employees of the employer.

Provides that a fringe benefit (and therefore double taxation) will not arise where the shares or rights are provided to associates of employees. This ensures consistency between Division 13A and the FBTAA 1986. [Schedule 2, item 17]

Application date

2.36 The amendments to the ITAA 1997 and the IT(TP) Act 1997 are to apply to assessments for the 1998-1999 income year and later income years. [Schedule 2, subitem 12(1), item 16]

2.37 The amendment to the FBTAA 1986 is to apply from 1 April 1995 and later FBT years. [Schedule 2, item 18]


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