House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 8 - Relief for employee share scheme participants in the event of a corporate restructure

Outline of chapter

8.1 Schedule 5 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to allow employee share scheme (ESS) participants - who acquire shares in a scheme for the acquisition of shares by employees who are assessed under section 26AAC of the ITAA 1936 - to treat the new shares or rights they are issued because of a corporate restructure as a continuation of their old shares or rights.

8.2 These amendments also allow ESS participants - who have made an election under Division 13A of the ITAA 1936 to be taxed upfront - to treat the new shares or rights they are issued because of a corporate restructure as a continuation of their old shares or rights.

8.3 Amendments are also made to the Taxation Laws Amendment Act (No. 3) 2003, the Income Tax Assessment Act 1997 (ITAA 1997) and the Income Tax (Transitional Provisions) Act 1997 to ensure the capital gains tax (CGT) provisions in those Acts reflect the amendments to section 26AAC and Division 13A.

Context of amendments

8.4 An ESS participant acquires shares or rights under an ESS if the shares or rights were acquired in connection with employment, and if the consideration paid for them was less than their market value at that time. Any discount that an ESS participant receives from acquiring shares or rights for less than their market value is assessable as income.

8.5 If an ESS participant acquires shares or rights in respect of employment on or before 6.00 pm by legal time in the Australian Capital Territory on 28 March 1995 the section 26AAC provisions will apply. If an ESS participant acquires shares or rights after that time the Division 13A provisions will apply. Under both sets of provisions an ESS participant can, subject to certain conditions, access concessions in relation to the discount.

8.6 In the event of a corporate restructure, an ESS participant may be issued with new shares or rights to replace the old shares or rights they previously held. However, the new shares or rights may not qualify for the same concessions on the discount that applied to the old shares or rights.

8.7 These amendments ensure that the new shares or rights issued to ESS participants in the event of a corporate restructure are treated as a continuation of the old shares or rights they previously held, subject to certain conditions. The amendments also ensure that concessions in relation to the discount are not lost where shares or rights are disposed of in the event of a corporate restructure.

Summary of new law

8.8 Under section 26AAC an ESS participant can, subject to certain conditions, access one of two alternative tax concessions on the discount they receive: the tax-excluded concession and the tax-deferred concession.

8.9 These amendments ensure that ESS participants with tax-excluded shares or rights under section 26AAC can treat the new shares or rights they are issued in a corporate restructure as a continuation of their old shares or rights. This will ensure that the capital gain or loss a trustee makes when new shares or rights exit an employee share trust is disregarded.

8.10 The amendments also ensure that ESS participants with tax-deferred shares or rights under section 26AAC can treat the new shares or rights they are issued in a corporate restructure as a continuation of their old shares or rights. This will ensure the continuation of the deferral period that applies to tax-deferred shares or rights.

8.11 Under Division 13A an ESS participant can, subject to certain conditions, access one of two tax concessions in relation to the discount they receive: the tax-upfront concession and the tax-deferred concession.

8.12 These amendments ensure that ESS participants with tax upfront shares or rights under Division 13A can treat the new shares or rights they are issued in a corporate restructure as a continuation of their old shares or rights. In addition, certain conditions of the ESS do not need to be satisfied in relation to the new shares or rights. This ensures that:

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the capital gain or loss a trustee makes when new shares or rights exit a trust is disregarded;

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ESS participants with new shares or rights retain the same CGT cost base treatment as their old shares or rights;

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ESS participants who acquire new shares or rights no longer have to satisfy the condition relating to not disposing of the shares or rights within 3 years of acquiring them; and

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the new rights an ESS participant is issued are treated as a continuation of their old rights.

8.13 The amendments also clarify the point in time at which an ESS participant must be employed to have new rights to acquire shares under Division 13A treated as a continuation of old rights to acquire shares.

Detailed explanation of new law

Relief for section 26AAC shares or rights

Background

8.14 If an ESS participant acquires shares or rights under a scheme for the acquisition of shares by employees prior to 6.00 pm by legal time in the Australian Capital Territory on 28 March 1995, then the provisions in section 26AAC will apply. Under these provisions an ESS participant can, subject to certain conditions, access one of two tax concessions on the discount they receive: the tax-excluded concession, or the tax-deferred concession.

8.15 Under the tax-excluded concession, an ESS participant may be entitled to reduce the amount of the discount they are taxed on by up to $200 per year, with the remainder of the discount treated as assessable income in that same year. Any capital gain or loss an ESS participant makes from the shares or rights after they have paid tax on the discount is subject to CGT on disposal. The first element of the CGT cost base for the shares or rights is their market value at the time of absolute entitlement.

8.16 A corporate restructure may trigger a CGT taxing point for tax-excluded shares or rights as the shares or rights may no longer be owned by the ESS participant. The ESS participant may be issued with new shares or rights to replace the old shares or rights, however, these new shares or rights will not be recognised as a continuation of the old shares or rights. As a result, the taxation treatment attached to the old shares or rights will not apply.

8.17 The new tax-excluded shares or rights may be subject to double taxation if they have been held in a trust. Under existing law, any capital gain or loss a trustee makes is disregarded when shares or rights exit the trust. This ensures that the shares or rights are not taxed twice: once in the hands of the trustee and once in the hands of the ESS participant. However, this treatment only applies to old shares or rights, and any capital gain or loss made by a trustee on new shares or rights issued to replace old shares or rights will not be disregarded.

Example 8.1

In 1993 Luke acquired 500 tax-excluded ordinary shares in his employer Grape Company under a scheme for the acquisition of shares by employees. The shares are held in an employee share trust. In 2001 Grape Company is bought out by Orange Company and Luke is issued with 1,000 new ordinary shares in Orange Company with a total value equal to his 500 Grape Company shares at that time. These shares are also held in an employee share trust. In 2003 the shares are released from the employee share trust and Luke becomes absolutely entitled to his Orange Company shares. The trustee pays CGT on the shares when they exit the trust.

8.18 Under the tax-deferred concession, an ESS participant can elect to defer paying tax on the discount received until restrictions on disposal of the shares or rights cease, or the shares or rights are disposed of.

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The discount on shares is the difference between their market value at the time restrictions cease, and any amount paid or payable for the shares.

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The discount on rights (or shares which are disposed of prior to restrictions lifting) is the difference between the amount received for the rights and any amount paid or payable for the rights.

8.19 Any capital gain or loss an ESS participant makes from the shares or rights after they have paid tax on the discount is subject to CGT at a later time, for example, on disposal. The first element of the CGT cost base for the shares or rights is their market value at the time the tax on the discount is paid.

8.20 A corporate restructure may trigger a taxing point for tax-deferred shares or rights if the shares or rights are considered to be disposed of by the ESS participant. The ESS participant may be issued with new shares or rights to replace the old shares or rights, however, these new shares or rights will not be regarded as a continuation of the old shares or rights, and the treatment attached to the old shares or rights will not apply.

8.21 As a result, the deferral time which applied to the old tax-deferred shares or rights will end, and the ESS participant will be liable to pay tax on the discount received at the time of the corporate restructure. The deferral period cannot be carried over and applied to the new shares or rights.

Example 8.2

In 1989 Jodie acquired 2,000 tax-deferred ordinary shares in her employer Sunlight Company under a scheme for the acquisition of shares by employees. The shares are held in an employee share trust. In 2002 Sunlight Company restructures and splits into Moonlight Company and Starlight Company. Jodie is issued with 1,000 new shares in her new employer, Moonlight Company, however these shares are not considered to be a continuation of her old shares in Sunlight Company. Consequently, Jodie is required to pay tax on the discount received on her Sunlight Company shares.

8.22 These amendments resolve these issues by ensuring that in the event of a corporate restructure new shares or rights are treated as a continuation of old shares or rights, provided that:

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the new shares or rights in the new company can be reasonably regarded as matching the old shares or rights acquired under a scheme for the acquisition of shares by employees in the old company [Schedule 5, item 3, paragraph 26AAD(1)(a)] ;

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the new shares or rights in the new company are issued in connection with a corporate restructure or 100 per cent takeover of the old company [Schedule 5, item 3, paragraph 26AAD(1)(b)] ; and

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the shares or rights in the old company ceased to be held by the ESS participant as a result of the corporate restructure or 100 per cent takeover of the old company [Schedule 5, item 3, paragraph 26AAD(1)(c)] .

Conditions for matching shares or rights

8.23 Relief is limited to matching shares or rights that can be reasonably regarded as matching or mirroring the conditions of the old shares or rights that the ESS participant held in the old company. Matching shares or rights are the replacement shares or rights provided to ensure that the financial position of an ESS participant immediately before a corporate restructure is maintained afterwards. [Schedule 5, item 3, paragraph 26AAD(1)(a)]

8.24 Matching shares or rights should reasonably match the value of the old shares or rights that the ESS participant held immediately before the restructure so there is no additional benefit from the restructure. There is no need for a one-to-one ratio between the old shares and rights and the new shares or rights for them to be matching, provided the value of the new shares or rights relative to the old shares or rights remains unchanged. [Schedule 5, item 3, paragraph 26AAD(1)(a)]

Example 8.3

In 1992 Tim acquired 900 tax-deferred ordinary shares in his employer Progress Company under a scheme for the acquisition of shares by employees. In 2006 Advantage Company buys out all shares in Progress Company. At the time of the buy out each share in Progress Company was valued at $2. Tim is issued with 300 shares in Advantage Company valued at $6 each. The 300 new shares that Tim receives in Advantage Company are considered matching as they have the same value as his original shares in Progress Company. Tim can continue to defer payment of tax, provided certain other conditions are met.

8.25 The replacement of old shares or rights with a combination of equivalent shares or rights and cash is also considered to be matching. However, to the extent that the old shares or rights are replaced with cash or some other thing of value, shares or rights to the value of that cash or some other thing will not be considered a continuation of the old shares or rights and will cease to exist, as relief only applies to matching shares or rights. [Schedule 5, item 3, subsection 26AAD(2)]

Example 8.4

In 1991 Naomi is issued 5,000 tax-deferred shares in Nappy Company under a scheme for the acquisition of shares by employees. In 2007 Rattle Company acquires Nappy Company in a 100 per cent takeover. Immediately prior to the takeover, Naomi's shares in Nappy Company were valued at $1 each. Rattle Company issues Naomi with 2,000 shares valued at $2 each and pays her $1,000 cash. The value of her new shares in Rattle Company is less than the value of her old shares in Nappy Company. Relief only applies to the proportion of Nappy Company shares that match the value of the Rattle Company shares. The old shares in Nappy Company that Naomi holds that are not matched by new shares in Rattle Company will have a cessation time, and Naomi will have to pay tax on the discount on those shares.

8.26 To be regarded as reasonably matching, the attributes of the new shares or rights need to be the same, or substantially the same, as those old shares or rights that existed immediately before the restructure. Attributes include whether it was a share or right. For example, the replacement of shares with rights after a corporate restructure would not be considered matching, as the interests of the ESS participant after the restructure would have substantially changed. [Schedule 5, item 3, subsection 26AAD(2)]

8.27 Relief will only apply to matching new shares or rights acquired in connection with a 100 per cent takeover or restructure. Relief will not apply to shares or rights that an ESS participant ceases to hold for reasons other than a corporate restructure, such as a voluntary disposal of shares or rights. [Schedule 5, item 3, paragraph 26AAD(1)(b)]

8.28 Relief is achieved by ensuring that the replacement of old shares or rights in the old company, does not give rise to a disposal for taxation purposes of the old shares or rights in that company. That is, the new shares or rights are taken to be a continuation of the old shares or rights, subject to certain conditions. [Schedule 5, item 3, paragraph 26AAD(1)(c)]

8.29 Where an ESS participant has acquired shares or rights in the old company at different times, the matching shares or rights are also held to be acquired at those different times. Any restrictions on disposal will continue to apply from the date it first applied to the old shares or rights. This also means that the new shares or rights are treated as having the same acquisition date as the old shares or rights. [Schedule 5, item 3, paragraph 26AAD(1)(c)]

8.30 The treatment of non-matching shares or rights immediately after a corporate restructure will be determined on the basis of the application of the existing law. Relief will not apply.

Other conditions for relief

8.31 In order for a share or right to be treated as a continuation of an old share or right, the first condition is that the ESS participant must have held shares or rights in the old company in a scheme for the acquisition of shares by employees, immediately before the corporate restructure. It does not matter whether the ESS participant was employed by the old company at that time or not. [Schedule 5, item 3, subsection 26AAD(3)]

8.32 The second condition is that the new shares or rights must be ordinary shares, or rights to acquire ordinary shares. This ensures that relief is only provided to ESS participants that have the voting and other rights associated with ordinary shares. Relief is not available to those ESS participants who do not have ordinary shares, or rights to acquire ordinary shares. [Schedule 5, item 3, subsection 26AAD(4)]

Example 8.5

In 1992 Zoe acquired tax-excluded rights to buy 100 shares under a scheme for the acquisition of shares by employees in her employer, Bass Company. In 2007 the company restructured and a new holding entity called Treble Company was formed. Zoe was employed by Treble Company, and received new rights to buy ordinary shares in Treble Company equal in value to the rights she held in Bass Company immediately before the restructure. Relief will apply to Zoe's replacement rights as they were rights to acquire ordinary shares.

8.33 Another condition is that the matching shares or rights are subject to the same conditions and restrictions, or conditions and restrictions that have the same effect as, those that the old shares or rights were subject to (if any) prior to the corporate restructure. [Schedule 5, item 3, subsection 26AAD(5)]

8.34 For example, an employer may loan an ESS participant funds to buy shares under a scheme for the acquisition of shares by employees on the condition that the loan be fully repaid when the ESS participant ceases employment. In the event of a corporate restructure it would be appropriate for a condition with the same effect to apply to the new shares or rights. [Schedule 5, item 3, subsection 26AAD(5)]

Example 8.6

In 1988 Jeff acquired 10,000 tax-excluded shares under a scheme for the acquisition of shares by employees in his employer, Abacus Company. Abacus Company lent Jeff money to purchase the shares and imposed the condition that the loan must be fully repaid when Jeff leaves the employment of Abacus Company. In 2006 Abacus Company was bought out by Calculator Company. Jeff received new shares in Calculator Company equal in value to the shares he held in Abacus Company immediately before the restructure. Calculator Company continued the loan to Jeff and imposed the condition that the loan must be fully repaid when Jeff leaves the employment of Calculator Company. Relief will apply as the conditions that apply to Jeff's new shares have the same effect as the conditions that applied to his old shares.

Types of corporate restructures that can give rise to relief

8.35 Relief is provided where a corporate restructure has occurred. A corporate restructure may include a change in ownership, or a change in the structure of the ownership of the company, which results in some or all of the shares or rights in the company under a scheme for the acquisition of shares by employees being replaced, or reasonably regarded as being replaced. [Schedule 5, item 3, subsection 26AAD(8)]

8.36 Relief is also provided where a 100 per cent takeover occurs. A 100 per cent takeover of a company by another company is an arrangement that is intended to result in the company becoming a 100 per cent subsidiary of the other company, or of a holding company. [Schedule 5, item 3, subsection 26AAD(8)]

8.37 In a takeover scenario an ESS participant of the old company becomes an ESS participant of the new or restructured company when their shares or rights are replaced by matching shares or rights in the new or restructured company. Relief will only apply where 100 per cent of the old company's shares and rights are acquired by the new company. In the case of a partial takeover, an ESS participant may choose whether or not to dispose of their old shares or rights, but relief will not apply. [Schedule 5, item 3, subsection 26AAD(8)]

Example 8.7

In 1994 Hannah acquired 1,500 tax-deferred shares under a scheme for the acquisition of shares by employees in her employer Buggy Company. In 2008 Car Company makes a takeover offer for Buggy Company. Hannah decides to sell 500 of her shares but remains employed by Buggy Company. Car Company ultimately acquires a 65 per cent interest in Buggy Company. A cessation time arises for the 500 shares and relief does not apply because there is not a 100 per cent takeover. No relief is necessary for the remaining shares as Hannah still owns them and is still employed by Buggy Company.

8.38 Relief can also apply to demergers in limited circumstances. It will only apply, however, to the extent that an ESS participant's interest in the old company ceases. ESS participants must no longer hold shares or rights in the old company for the new shares or rights to be treated as a continuation of the old shares or rights. [Schedule 5, item 3, subsection 26AAD(8)]

Apportionment of consideration paid for the old shares and rights

8.39 Any consideration an ESS participant paid for the old shares or rights should be spread evenly among the matching new shares or rights in proportion to their market values immediately after the restructure. This ensures that an ESS participant is not advantaged or disadvantaged because of a corporate restructure. [Schedule 5, item 3, subsection 26AAD(6)]

8.40 When calculating the value of the apportionable assets for the original shares or rights consideration should be given to:

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the value of the new matching shares or rights held by an ESS participant because of the relief provisions [Schedule 5, item 3, paragraph 26AAD(7)(a)] ;

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the value of anything else that an ESS participant may have acquired in connection with the corporate restructure that can reasonably be regarded as matching shares or rights [Schedule 5, item 3, paragraph 26AAD(7)(b)] ; and

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the value of the old shares or rights an ESS participant may have held in the old company immediately before and after the corporate restructure, that can reasonably be regarded as matching shares or rights [Schedule 5, item 3, paragraph 26AAD(7)(c)] .

Example 8.8

In 1990, Julie acquires 1,000 shares worth $3 each in her employer, Chocolate Company, for $2 each. In 2005, Chocolate Company is bought out by Nut Company. Chocolate Company shares are worth $10 each at this time. Julie's 1,000 shares in Chocolate Company are replaced with 2,000 $5 shares in Nut Company. The $2,000 that Julie paid to acquire the 1,000 Chocolate Company shares is apportioned between the 2,000 Nut Company shares. That is, Julie is treated as having paid $1 for each Nut Company share.

Interaction between section 26AAD and the CGT provisions

8.41 Subdivision 130-DA of the Income Tax (Transitional Provisions) Act 1997 treats an ESS participant as having acquired a share or right at the time it was acquired by an employee share trust, if, at the time it was acquired by the trust, it was possible to determine that the share or right would later be provided to the ESS participant.

8.42 These amendments ensure that this treatment also applies to matching new shares or rights which are treated as a continuation of old shares or rights acquired by an employee share trust. [Schedule 5, item 15, subsection 130-80(3)]

8.43 Subdivision 130-D of the Income Tax (Transitional Provisions) Act 1997 establishes the interaction between section 26AAC and CGT. However, the Subdivision only applies to old shares or rights acquired under a scheme for the acquisition of shares by employees.

8.44 These amendments ensure that this Subdivision also applies to matching new shares or rights acquired as a result of a corporate restructure, and that new matching shares or rights are treated as a continuation of old shares or rights held under section 26AAC for CGT purposes. [Schedule 5, items 17 and 18, subsections 130-95(3) and 130-110(5)]

Example 8.9

In 1993, Michael acquired 5,000 tax-excluded ordinary shares in his employer Donut Company. The shares are held in an employee share trust. In 2007 Donut Company is bought out by Biscuit Company, and Michael receives matching shares in Biscuit Company equal in value to the shares he held in Donut Company immediately before the restructure. Relief will apply so that the new shares in Biscuit Company are not taxed when they exit the employee share trust, and so that Michael retains the same cost base treatment that applied to his shares in Donut Company, for his new Biscuit Company shares.

Relief for Division 13A shares or rights

Background

8.45 If an ESS participant acquires shares or rights in respect of employment after 6.00 pm by legal time in the Australian Capital Territory on 28 March 1995 then the provisions in Division 13A will apply. Under these provisions an ESS participant can, subject to certain conditions, access one of two alternative tax concessions in relation to the discount: the tax-deferred concession and the tax-upfront concession.

8.46 Under the tax-deferred concession, an ESS participant can defer paying tax in relation to the discount until a cessation time occurs, up to a maximum of 10 years. The discount in relation to the share is either the consideration received on disposal of the share less what was paid to acquire the share, or the market value of the share at the cessation time less what was paid to acquire the share. In relation to rights which are exercised, the amount paid for the share will include the value of any consideration given to exercise that right.

8.47 A corporate restructure will, in most instances, have no impact on an ESS participant with tax-deferred shares or rights as relief is provided for such shares or rights under section 139DQ of the ITAA 1936. ESS participants with tax-deferred shares or rights can treat the new shares or rights they are issued as a continuation of their old shares or rights.

8.48 Under the tax-upfront concession, ESS participants can elect that the first $1,000 of the discount on the shares or rights is not taxable, but they are taxed on the remaining discount in the year the shares or rights are received. Any capital gain or loss an ESS participant makes from the shares or rights after they have paid tax on the discount is subject to CGT.

Issues for tax-upfront shares and rights in a corporate restructure

Continuation

8.49 Without relief a corporate restructure may trigger a CGT taxing point for tax-upfront shares or rights as the shares or rights may no longer be owned by the ESS participant. The ESS participant may be issued with new shares or rights to replace the old shares or rights, however, these new shares or rights will not be considered a continuation of the old shares or rights. As a result, the taxation treatment attached to the old shares or rights will not apply.

Employee share trusts

8.50 Without relief the replacement tax-upfront shares or rights may also be subject to taxation if they cease to be held by an employee share trust. Under existing law, any capital gain or loss a trustee makes is disregarded when shares or rights exit the trust. This is to ensure the shares or rights are not taxed twice: once in the hands of the trustee and once in the hands of the ESS participant. This treatment only applies to old shares or rights; any capital gain or loss made by a trustee on new shares or rights issued to replace old shares or rights will not be disregarded.

Example 8.10

In 2002, Simon acquired a beneficial interest in a share worth $20 in his employer Reef Company. The share was held under an employee share trust and Simon elected to pay tax upfront. Reef Company is taken over by Sand Company, and the share within the trust (now worth $25) is replaced with a new share. When the new share is released from the trust (now worth $30), the trustee and the employee pay capital gains tax on any increase in value in the new share. If there had been no takeover, Simon would not have paid capital gains tax when the old share was released from the trust.

Cost base

8.51 Without relief the replacement shares or rights may also have a different CGT cost base to the old shares or rights.

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For a tax-upfront share or right acquired on or after 5.00 pm by legal time in the Australian Capital Territory on 27 February 2001, the first element of the cost base is the market value of the share or right at the time it was beneficially acquired.

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For a tax-upfront share or right acquired before this time, ESS participants have a choice whether the first element of the cost base is the market value of the share or right at the time it was absolutely acquired, or the market value of the share or right at the time it was beneficially acquired.

Example 8.11

In 2000, Nicola acquired a beneficial interest in 200 shares worth $10 each in her employer North Company, held under an employee share trust and elected to pay tax upfront. In 2001, North Company is taken over by South Company, and Nicola is issued with matching new shares which are held in the trust. In 2002 the shares (now worth $11 each) are released from the trust. In 2004 Nicola sells the shares for $9 each. Nicola has no choice as to the cost base, and must use $10 (the market value at the date of beneficial entitlement) as the cost base.

3-year holding requirement

8.52 Without relief the new tax-upfront shares or rights may also fail to satisfy the 3-year holding condition. To receive the $1,000 discount, an ESS must be operated so that no ESS participant is permitted to dispose of the shares or rights acquired under the ESS before the earlier of 3 years or cessation of employment from the time the shares or rights were acquired. A corporate restructure may result in the new company deciding not to operate the replacement ESS plan to satisfy this 3-year holding condition. Where this happens an ESS participant would be liable to repay the tax payable on the $1,000 discount.

Example 8.12

In 2004, Melanie acquired shares under an ESS in her employer Bottle Company. She paid tax upfront and accessed the $1,000 concession. In 2006, Bottle Company is acquired by Can Company, and Melanie's Bottle Company shares are replaced with matching Can Company shares. Melanie has disposed of her ESS shares in Bottle Company within 3 years of acquiring them, and without relief would be required to repay the tax on the $1,000 concession.

Refund of taxation on rights

8.53 An ESS participant with a tax-upfront right is treated as never having acquired the right to acquire shares if the right is lost without the ESS participant having exercised it. If a right is lost and an ESS participant has elected to pay tax upfront on that right, any tax paid on the right is refundable to the ESS participant. However, without relief, if an ESS participant receives new matching rights as a result of a corporate restructure and those rights are subsequently lost, the ESS participant will not be entitled to a refund of tax paid.

Example 8.13

Maddi received rights to acquire shares in her employer Solar Company under an ESS, and paid tax upfront, but could only exercise the rights if the company met a certain performance target. Solar Company was taken over by Energy Company, and Maddi's rights to acquire shares in Solar Company were replaced with rights to acquire shares in Energy Company with the same restrictions attached. As this is not considered to be a loss of the right to acquire shares in Solar Company, Maddi could not access a refund of tax paid at this time.

Maddi continues to be employed by Solar Company. A few months later Solar Company failed to meet a certain performance target, and Maddi lost her rights to acquire shares in Energy Company without exercising her rights. Without relief Maddi would not be entitled to a refund of tax paid because the new rights are not treated as a continuation of the old rights.

8.54 These amendments resolve these issues by ensuring that, in the event of corporate restructure, new shares or rights are treated as a continuation of old shares or rights.

Relief for tax-upfront shares and rights

Continuation

8.55 Relief is available to ESS participants with tax-upfront shares or rights acquired under an ESS who acquire new shares or rights as a result of a corporate restructure. Relief is provided in the same way that continuation is provided to tax-deferred ESS participants who access continuation treatment under section 139DQ of the ITAA 1936. [Schedule 5, item 10]

8.56 The mechanism for providing relief for tax-upfront shares or rights is the removal of subsection 139DR(4) of the ITAA 1936, which limits relief to ESS shares and rights that have a cessation time. While a cessation time may arise for tax-deferred shares or rights in the event of a corporate restructure, there is no cessation time for tax-upfront shares or rights. Hence they cannot access the relief provisions in section 139DQ which are conditional on subsection 139DR(4) being met. Removing this subsection enables ESS participants with tax-upfront shares or rights to access relief. [Schedule 5, item 10]

8.57 There is no requirement for employment to continue after a 100 per cent takeover or corporate restructure in order for tax-upfront ESS participants to receive relief. In effect, relief is not conditional on a continuing employment relationship for tax-upfront shares or rights. [Schedule 5, item 9, subsection 139DR(2)]

Example 8.14

In 1998 Ben acquired shares under an ESS in his employer Bell Company and elected to pay tax upfront. Ben changed employers in 2004, but continued to hold shares in Bell Company in an employee share trust. In 2006 Bell Company is acquired by Whistle Company, and Ben is issued new shares in Whistle Company. Relief will be provided when Ben's new shares exit the employee share trust.

Refund of taxation on rights

8.58 When a new right to acquire a share, which is a continuation of an old right, is lost without having been exercised, and the company was, at the time the right was acquired, the employer of the ESS participant, the ESS participant is treated as never having acquired the right.

8.59 Subsection 139DD(2A) clarifies that a right is not lost if a new right is treated as a continuation of an old right. However, a right is lost when a new right is lost without having been exercised. [Schedule 5, item 6, subsection 139DD(2A)]

8.60 To access the refund of tax paid, the ESS participant must be employed by the company at the time that the right is issued. This has the same effect as the current law but the wording is changed to make the timing clearer. [Schedule 5, item 7, subsection 139DD(3)]

Example 8.15

From Example 8.13, Maddi acquired rights to acquire shares in her employer Solar Company under an ESS, and paid tax upfront, but could only exercise the rights if Solar Company met a certain performance target.

Solar Company was subsequently taken over by Energy Company, and Maddi's rights to acquire shares in Solar Company were replaced with rights to acquire shares in Energy Company, with the same restrictions attached. Solar Company did not meet the performance target, and Maddi lost the rights to acquire shares in Energy Company without exercising them. Maddi is entitled to a refund of tax paid.

8.61 There is no requirement for employment to continue after a 100 per cent takeover or corporate restructure in order for an ESS participant with tax-deferred rights to receive relief. An ESS participant with tax-deferred rights who has ceased employment and subsequently loses the rights may be unfairly disadvantaged if relief is limited to only ESS participants with continuing employment. [Schedule 5, item 8, subsection 139DD(3B)]

Example 8.16

From Example 8.13, Maddi's co-worker Catherine acquired rights to acquire shares under the same ESS, but deferred the payment of tax. The same restrictions applied, namely that she could only exercise the rights if Solar Company met a certain performance target. Catherine later ceased employment with Solar Company and paid tax on her rights but was not required to exercise them at that time.

Solar Company was subsequently taken over by Energy Company, and Catherine's rights to acquire shares in Solar Company were replaced with rights to acquire shares in Energy Company, with the same restrictions attached. Solar Company did not meet its performance target, and Catherine lost her rights in Energy Company without exercising them. Catherine, like Maddi, is also entitled to a refund of tax paid, even though she is not employed by Energy Company.

3-year holding requirement

8.62 The 3-year holding condition does not need to be satisfied in the event of a 100 per cent takeover or corporate restructure provided that the new shares or rights are treated as a continuation of the old shares or rights. [Schedule 5, items 4 and 5, subsections 139CE(1) and (3A)]

Example 8.17

From Example 8.14, if the new shares are treated as a continuation of the old shares, Melanie does not have to comply with the 3-year requirement to receive relief.

Interaction between Division 13A and the CGT provisions

Employee share trusts

8.63 When a new share or right, which is a continuation of an old share or right, is released from an employee share trust, any capital gain or loss made by a trustee or beneficiary is disregarded, provided certain conditions are met.

Example 8.18

From Example 8.10, because the new share is treated as a continuation of the old share, Simon and the trustee do not have to pay CGT when the new share exits the trust.

Cost base

8.64 When an ESS participant is provided with new shares or rights that are treated as a continuation of old shares or rights, they are treated as a continuation for the purposes of the cost base choice described in paragraph 8.51. [Schedule 5, item 19]

8.65 For a tax-upfront share or right acquired before 5.00 pm by legal time in the Australian Capital Territory on 27 February 2001, ESS participants have a choice whether the first element of the cost base of the new share or right is the market value of the old share or right at the time it was absolutely acquired, or the market value of the old share or right at the time it was beneficially acquired. [Schedule 5, item 19]

Example 8.19

From Example 8.11, because her new shares are treated as a continuation, Nicola can elect whether to use the market value at the date of beneficial entitlement or the market value at the date of absolute entitlement as the first element of cost base for her shares.

Other CGT outcomes

8.66 For the purposes of the CGT 50 per cent discount (which requires that an asset be held for 12 months for the concession to be accessed), an ESS participant is treated as having acquired an ESS share at the time that they first acquired a beneficial interest in the share. A new share or right which is treated as a continuation of an old share or right is treated as having been acquired at the time the ESS participant first acquired a beneficial interest in the old share or right. [Schedule 5, item 13, subsection 115-30(1A)]

8.67 Section 130-80 of the ITAA 1997 establishes the cost base treatment for tax-upfront shares and rights. The insertion of a new note into section 130-80 will clarify that new tax-upfront shares or rights issued to replace old tax-upfront shares or rights can be treated as a continuation. [Schedule 5, item 14, subsection 130-80(1)]

8.68 As previously noted in paragraph 8.41, Subdivision 130-DA of the Income Tax (Transitional Provisions) Act 1997 treats an ESS participant as having acquired a share or right at the time it was acquired by an employee share trust, if, at the time it was acquired by the trust, it was possible to determine that the share or right would later be provided to the ESS participant. This treatment will also apply to shares or rights which are treated as continuations of original shares or rights acquired by an employee share trust. [Schedule 5, item 16, subsection 130-80(4)]

Application and transitional provisions

8.69 These amendments will apply to corporate restructures which occur on or after Royal Assent. [Schedule 5, item 20]