MUNNERY v FC of TMembers:
E Fice SM
Administrative Appeals Tribunal, Melbourne
MEDIA NEUTRAL CITATION:
 AATA 175
E Fice (Senior Member)::
1. Mr Paul Munnery is employed in Australia by Hyder Consulting Pty Ltd (Hyder) as its payroll manager. Hyder is a wholly owned subsidiary of Hyder Consulting Holdings Pty Ltd. Hyder's ultimate holding company is Hyder Consulting Plc which is a public company listed on the London Stock Exchange.
2. By a declaration of trust made on 29 March 2010 by Hyder Consulting Employee Share Plans Pty Ltd (the Plan Trustee) as the trustee of an employee salary sacrifice share plan (ESS), a deed was settled (the trust deed) which allowed employees of Hyder to acquire beneficial ownership of shares in the public company. The trust deed placed certain restrictions on dealing with shares in the listed public company acquired by employees under the ESS. Clause 8.1 of the trust deed prevents participants from withdrawing from the plan or disposing of the shares for a period of 5 years after the shares were acquired. Once the shares become unrestricted shares, the participant can elect either to withdraw the unrestricted shares or to preserve them in the ESS. A participant wishing to preserve his or her shares is required to pay to the Plan Trustee an amount to preserve the unrestricted shares in the plan.
3. On 4 November 2010 Remuneration Strategies Group (RSG), on behalf of Mr Munnery, applied for a private ruling pursuant to s 359-10 of Schedule 1 to the Taxation Administration Act 1953 (Cth) (TAA). One of the questions upon which the Commissioner was asked to rule was:
"Will the payments of consideration by Mr Munnery at the occurrence of the ESS deferred taxing point to preserve his shares in the plan constitute the cost base of the shares as determined under Subdivision 110-A of the ITAA 1997?"
4. The Commissioner answered no to the above question. As a consequence of that answer, RSG lodged an objection on behalf of Mr Munnery against the private ruling issued on 22 December 2010. In a letter dated 8 February 2011 the Commissioner informed RSG that it had considered its objection and disallowed it. On 4 March 2011, pursuant to s 14ZZ of the TAA, Mr Munnery lodged with the Tribunal an application for review of the Commissioner's decision.
5. The only issue which I am required to determine is whether, on the occurrence of the ESS deferred taxing point for an ESS interest held by Mr Munnery in the employee share plan, the amount paid by Mr Munnery to preserve his unrestricted shares in the ESS forms part of the cost base of his interest in the shares as determined under Subdivision 110-A of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997).
Hyder salary sacrifice share plan
6. The purpose of the trust deed is said to be to provide an opportunity to employees to acquire beneficial ownership of shares in the public company and to access the $5000 per annum salary sacrifice deferred taxation concessions available under s 83A-105(4), Subdivision 83A-C of ITAA 1997.
7. Division 83A of the ITAA 1997 deals with employee share schemes. Section 83A-10 defines the meaning of ESS interest and employee share scheme as follows:
"83A-10 Meaning of ESS interest and employee share scheme
- (1) An ESS interest, in a company, is a beneficial interest in:
- (a) a *share in the company; or
- (b) a right to acquire a beneficial interest in a share in the company.
- (2) An employee share scheme is a *scheme under which *ESS interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:
- (a) the company; or
- (b) *subsidiaries of the company;
in relation to the employees' employment."
Note: See section 83A-325 for relationships similar to employment.
8. An eligible employee in the Hyder ESS may acquire an interest in shares in the public company by way of salary sacrifice agreement with the employer. The maximum amount which an employee can sacrifice in any one year is limited to $5000. Contributions to the trust plan are made by Hyder on quarterly basis to fund the acquisition of the fully paid ordinary shares in the public company. The shares acquired are issued to the Plan Trustee for the benefit of a general class of employees and those shares rank equally with and have the same rights as other fully paid ordinary shares in the public company (see clause 4.4 of the trust deed). The acquired shares are registered in the name of the Plan Trustee and they are allocated to the benefit of participants in the plan from time to time as directed by the board of Hyder (clause 4.9 of the trust deed). The participants in the plan must be notified by the board, comprising of some or all of the directors of the Plan Trustee acting as a board, of their allocation. Those shares are then placed in the allocated share account.
9. The purpose of capping the amount of salary sacrifice income to $5000 is so that the plan complies with Subdivision 83A-C of the ITAA 1997. Shares acquired under salary sacrifice arrangements can be subject to a deferred taxing point provided that the employee receives no more than $5000 worth of shares under the arrangement. As s 83A-100 provides:
" 83A-100 What this Subdivision is about
'If there is a real risk you might forfeit the share, right or stapled security you acquired under an employee share scheme, you don't include the discount in your assessable income when you acquired it. Instead, in the first income year you are able to dispose of the share, right or security, your assessable income will include any gain you have made to that time. If you cease employment earlier, or if 7 years pass, the gain is included in that income year instead.'
A share or stapled security you acquire under salary sacrifice arrangements can also be subject to this deferred taxing point if you get no more than $5,000 worth of shares under those arrangements."
10. Clause 7.2 of the trust deed provides that all shares acquired by the Plan Trustee will be held for the minimum period referred to in clause 8.1 and in accordance with the other terms set out in the 1st schedule to the trust deed. Clause 8.1 provides that shares allocated to the benefit of a participant in the plan must not be withdrawn from the plan or disposed of by the participant before 5 years after the date of acquisition, at which time the shares will become unrestricted shares. That time may be further extended by the board. Although the trust deed refers to the period of 5 years, the application for a private ruling stated that the restriction was in fact 3 years only. In the course of hearing this matter, Mr G Fitton, who appeared on the behalf of Mr Munnery, said that the correct restriction period was 3 years. Although the shares allocated to a participant are fully vested, they nevertheless remain subject to the restrictions on disposal which, under the plan, are 3 years or the cessation of employment. If a participant in the plan ceases to be employed by any company associated with the public company, the shares become unrestricted shares and the participant must withdraw from the plan or sell the shares held by him or her to the Plan Trustee for the market value (clause 8.4).
11. Upon receiving an unrestricted share notice, a participant may make what is described as a share preservation election. If a participant elects to withdraw the unrestricted shares, no further consideration is paid by the participant. Presumably, although not stated in the trust deed, when an employee withdraws unrestricted shares, that employee ceases to be a participant in the ESS. However, where a participant elects to preserve his or her shares in the plan, then that person may elect to make a loan application as set out in schedule 2 of the trust deed. The loan can only be used to provide what is described as consideration for unrestricted shares and no repayment of the loan is required until the earlier of the termination of employment of a participant or the sale of the unrestricted shares (clause 9.4). The loan does not bear interest. It cannot be assigned. An employee may repay the loan in full or in part at any time prior to the sale of the unrestricted shares.
12. The amount of the loan repayable by a participant on the sale of the unrestricted shares is the lesser of the consideration paid by the participant for the unrestricted shares and the balance of the loan outstanding at the time of sale of the particular unrestricted share (in the case where, at the time of sale, part of the loan has already been repaid). If unrestricted shares are sold, and the proceeds of sale are not sufficient to cover the outstanding loan amount, the Plan Trustee will accept the surrender of the unrestricted shares in full and final satisfaction of the debt outstanding as a result of the loan.
13. There was no dispute between the parties that the Hyder ESS is an employee share scheme as defined in the ITAA 1997 at s 83A-10(2) and that a resident employee of Hyder would acquire ESS interests as defined in s 83A-10(1). The trust deed makes it clear that shares allocated to the Hyder salary sacrifice share plan are held for the benefit of employees to whom shares are allocated. This is so even though, for the first 3 years, restrictions apply to the disposal of those shares by an employee. The shares allocated to an employee of the scheme are fully vested. The employee is entitled to receive dividends or other distributions or entitlements made by Hyder Consulting Plc. This may include bonus issues, rights issues or other pro-rata offers which might attach to the employee held shares.
14. The advantage to be achieved by an employee who participates in an employee share scheme is the deferral of the payment of income tax. Section 83A-110 of the ITAA 1997 provides:
" 83A-110 Amount to be included in assessable income
- (1) Your assessable income for the income year in which the *ESS deferred taxing point for the *ESS interest occurs includes the *market value of the interest at the ESS deferred taxing point, reduced by the *cost base of the interest.
Note: Regulations made for the purposes of section 83A-315 may substitute a different amount for the market value of the ESS interest.
- (2) Treat an amount included in your assessable income under subsection (1) as being from a source other than an *Australian source to the extent that it relates to your employment outside Australia."
Note: For the CGT treatment of employee share schemes, see Subdivision 130-D.
15. The expression, ESS deferred taxing point, is defined in s 83A-115(3) in the following way:
- " 83A-115 ESS deferred taxing point-shares
- (1) ...
Meaning of ESS deferred taxing point
- (2) ...
- (3) However, the ESS deferred taxing point for the *ESS interest is instead the time you dispose of the interest, if that time occurs within 30 days after the time worked out under subsection (2).
No restrictions on disposing of share
- (4) The first possible taxing point is the earliest time when:
- (a) there is no real risk that, under the conditions of the *employee share scheme, you will forfeit or lose the *ESS interest (other than by disposing of it); and
- (b) if, at the time you acquired the interest, the scheme genuinely restricted you immediately disposing of the interest-the scheme no longer so restricts you.
Cessation of employment
- (5) The 2nd possible taxing point is the time when the employment in respect of which you acquired the interest ends.
Maximum time period for deferral
- (6) The 3rd possible taxing point is the end of the 7 year period starting when you acquired the interest."
16. Applying s 83A-115 to the Hyder ESS, it is reasonably clear that the first possible taxing point which results from the acquisition of shares in the listed public company is after the 3 year restriction imposed on employees in disposing of their shares. There is a second possible taxing point in respect of the Hyder ESS and that may occur if an employee's employment ends prior to that employee holding a share for 3 years. The third point in time of course is at the end of a 7 year period starting when the employee acquired the interest in the shares.
17. The central issue in this matter concerns the payment which may be made by an employee in the Hyder ESS at the ESS deferred taxing point in circumstances where an employee appears to be required to make a payment in order to preserve unrestricted shares in the share plan. The question is whether any such payment forms part of the cost base for the purposes of calculating an employee's assessable income in accordance with s 83A-110(1) of the ITAA 1997.
18. The expression cost base as used in s 83A - 110(1) imports the definition of that term as it is used in the calculation of Capital Gains Tax (CGT). It is defined in the ITAA 1997 as: ...of a CGT asset has the meaning given by Subdivision 110-A.
19. Section 110-25(1) provides that the cost base of a CGT asset consists of 5 elements. Sections 110-25(2) to (6) of ITAA 1997 set out those 5 elements as follows:
" 110-25 General rules about cost base
- (1) ...
5 elements of the cost base
- (2) The first element is the total of:
- (a) the money you paid, or are required to pay, in respect of *acquiring it; and
- (b) the *market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition).
Note 1: There are special rules for working out when you are required to pay money or give other property: see section 103-15.
Note 2: This element is replaced with another amount in many situations: see Division 112.
- (3) The second element is the *incidental costs you incurred. These costs can include giving property: see section 103-5.
Note: There is one situation to do with options in which the incidental costs relating to the CGT event are modified: see section 112-85.
- (4) The third element is the costs of owning the *CGT asset you incurred (but only if you *acquired the asset after 20 August 1991).
These costs include:
- (a) interest on money you borrowed to acquire the asset; and
- (b) costs of maintaining, repairing or insuring it; and
- (c) rates or land tax, if the asset is land; and
- (d) interest on money you borrowed to refinance the money you borrowed to acquire the asset; and
- (e) interest on money you borrowed to finance the capital expenditure you incurred to increase the asset's value.
These costs can include giving property: see section 103-5.
Note: This element does not apply to personal use assets or collectables: see sections 108-17 and 108-30.
- (5) The fourth element is capital expenditure you incurred:
- (a) the purpose or the expected effect of which is to increase or preserve the asset's value; or
- (b) that relates to installing or moving the asset.
The expenditure can include giving property: see section 103-5.
Note: There are 3 situations involving leases in which this element is modified: see section 112-80.
- (5A) Subsection (5) does not apply to capital expenditure incurred in relation to goodwill.
- (6) The fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset. (The expenditure can include giving property: see section 103-5.)"
20. As Ms M Baker of counsel, who appeared behalf of the Commissioner, submitted, it is clear that the first element of the cost base is concerned with consideration, usually in the form of money. The second element deals with incidental costs. The third, fourth and fifth elements are concerned with expenditure incurred after acquisition of the CGT asset.
Costs to preserve shares in the Hyder share plan
21. At the time the shares acquired by an employee in the Hyder ESS cease to be subject to the disposal restrictions contained in the trust deed, the employee may withdraw from the plan, which in effect means that the employee may have the shares transferred into his or her name and may dispose of those shares, providing the Plan Trustee with a pre-emptive right of purchase. Alternatively, the employee may elect to remain in the share plan. As is set out in the Employee Salary Sacrifice Plan Handbook, the advantage to the employee of continuing to leave his or her shares in the share plan beyond 3 years while continuing employment with Hyder is that payment of tax is deferred until that person disposes of their shares (although nothing is said of the 7 year maximum time limit to deferral of the payment of tax).
22. However, it is not clear from the trust deed or the handbook that there is a cost associated with remaining in the share plan once the share becomes unrestricted. The trust deed simply provides that upon an employee receiving an unrestricted share notice, he or she may make a share preservation election and make a loan application. The loan application is said to be for the purpose of lending to the employee an amount equal to the market value of the unrestricted shares at the time of cessation of the restricted period for the purpose of providing consideration for the unrestricted shares.
23. The problem I find with this, although contrary to what Ms Baker submitted, is that an employee has already given consideration for the shares acquired by way of salary sacrifice or, perhaps more precisely, the equitable interest in those shares. The employee has foregone the legal right to be paid salary in the amount of the market value of the shares allocated to him or her and in return has acquired the interest in allocated shares. The question as to what constitutes consideration was settled long ago as was explained by Lord Lindley in
Fleming v Bank of New Zealand  A.C. 577, a decision of the Privy Council. His Lordship referred to the judgment of Lush J in
Currie v Misa (1875) L.R. 10 Ex. 153 and said, at 586:
"Lush J., in giving the judgment of the Exchequer Chamber, said (2): 'a valuable consideration in the sense of the law may consist either in some right, interest, profit, or benefit accruing to the one party, or some forbearance, detriment, loss, or responsibility given, suffered, or undertaken by the other: Com. Dig. Action on the case assumpsit B 1-15.' This definition has been constantly accepted as correct."
24. Furthermore, an employee who elects to withdraw shares from the plan when the shares become unrestricted is not required to provide any further consideration for those shares. In fact, the employee can simply sell those shares or have them transferred into his or her name. The same applies if the employee ceases to be employed by Hyder. For reasons which remain unexplained, where an employee elects to remain in the Hyder ESS and that employee elects to take out a loan as is provided for in the trust deed, then the loan monies must only be used to provide consideration for the unrestricted shares.
25. With respect to Mr Fitton, this simply makes no sense. In fact, when Mr Fitton was asked what was meant by the word preserve, he suggested that the correct word should be retain. Clearly, the shares held on trust for the employee do not require preservation. I am also not certain what is meant by the word consideration as it is used in the trust deed.
26. Then you have what is described as a loan granted to the employee which can only be used to provide consideration for unrestricted shares. It does not bear interest, it cannot be assigned and the loan itself is not repayable except on the sale of unrestricted shares. The employee is required to repay what is described as the lesser of the consideration paid for the unrestricted shares and the balance of the loan outstanding at the time of the sale. The word loan is not defined in ITAA 1997 and should therefore be given its ordinary meaning. The Shorter Oxford English Dictionary defines loan as:
"1. A gift or grant from a superior 2. A thing lent; a sum of money lent for a time, to be returned in money or money's worth, and usually at interest."
It defines preserve as:
"1. To keep safe from harm or injury; to take care of, guard. 2. To keep alive; to keep from decay, make lasting (a material thing, unnamed, a memory). b. To maintain (a state of things). c. To keep in one's possession; to retain."
27. Given the way in which the words preserve, loan and consideration are used in the trust deed, one could be forgiven for referring to Lewis Carroll's Humpty Dumpty where he said:
"When I use a word, Humpty Dumpty said, in a rather scornful tone, it means just what I choose it to mean - neither more nor less.
The question is, said Alice, whether you can make words mean so many different things."
(See: Chapter 6 of Lewis Carroll's, Through the Looking Glass)
28. I have no doubt that the right to receive salary which is foregone under the Hyder ESS is a legal chose in action and is properly described as property (see
Beswick v Beswick  A.C. 269). That fits the description set out in s 110-25(2)(b) of the ITAA 1997. It is property given by the employee in respect of acquiring the shares. The market value of the shares at the time of acquisition clearly forms part of the cost base for the purposes of s 83A-110(1).
29. The next question which arises is whether, if an employee elects to remain in the ESS after the shares become unconditional, and the employee elects to take out the so called loan, payment of the loan monies to the Plan Trustee for what is described as consideration for unrestricted shares falls into the cost base of those shares.
30. There are a number of problems which arise when the clause in the trust deed regarding the loan is analysed. The first, and most obvious, is that the monies do not move from the Plan Trustee to the employee and back to the Plan Trustee. At best, the loan can be described as notional. Therefore, there is a real question about whether or not a loan is in fact made to an employee under the trust deed. The second point is that although the trust deed describes the loan as being able to be only used for the purposes of providing consideration for the unrestricted shares, because consideration has already moved from the employee by way of having forgone salary to which the employee was legally entitled, the notional loan, even if used to pay money to the Plan Trustee, is not used for the purpose of providing consideration for the unrestricted shares. In fact the expression unrestricted shares is defined in the trust deed as shares which have been acquired by a Participant under the Plan and are no longer subject to restrictions on disposal pursuant to Clause 8 of the Trust Deed. The third point is, if it be needed, those employees who choose not to apply for a loan may nevertheless have their shares preserved in the plan.
31. Therefore, I find that the notional loan cannot properly be described as monies paid or monies required to be paid in respect of acquiring the shares. Nor is anything which the employee is required to do to preserve (retain) the shares in the plan properly described as the market value of any other property given in respect of acquiring the shares. It cannot fall within the first element of section 110-25(2) of ITAA 1997.
32. The second element of the cost base is the incidental costs incurred. Ms Baker submitted that the payment made by an employee to preserve unrestricted shares in the plan is not an incidental cost within the meaning of s 110-25(3) of the ITAA 1997. That section describes incidental costs as costs a taxpayer may have incurred to acquire a CGT asset or that relate to a CGT event. Quite clearly, the so-called preservation costs are not costs for the purpose of acquiring the shares. Furthermore, they cannot be described as a CGT event. The expression CGT event is defined in s 995-1(1) of the ITAA 1997 and it means any of the CGT events described in Division 104. Section 104-5 contains a summary of CGT events and although the list of CGT events is extensive, there is nothing in that list which so much as resembles a payment for simply holding shares. Accordingly, I find that the contingent payment which may be made by an employee to preserve his or her unrestricted shares in the Hyder ESS is not an incidental cost within the meaning of s 110-25(3) of the ITAA 1997.
33. The third element of the cost base can generally be described as the costs of owning the CGT asset. Section 110-25 (4) provides a non-exhaustive list of costs including interest on borrowings; costs of maintaining, repairing or ensuring the assets; interest on money borrowed to refinance money borrowed to acquire the asset; and interest on money borrowed to finance capital expenditure incurred to increase the asset value. As Ms Baker submitted, payments made to preserve unrestricted shares in the plan cannot be properly described as the cost of ownership. She submitted that the payment of that fee represents a fee paid to maintain the trust relationship rather than a cost of owning the shares themselves.
34. In my opinion, the so-called preservation fee does not go as far as Ms Baker suggests. It does not bear any relationship at all to the so-called preservation of the unrestricted shares in the plan. It appears to have been designed solely to increase the cost base of the shares thus ensuring that at the first possible taxing point, that is when the restrictions on disposal of the shares no longer applies, the cost base of the shares will be equal to their market value. That would of course ensure that no income tax was payable for the income year in which the ESS deferred taxing point arises even if the market value at that time was well in excess of the market value at the time the shares were acquired.
35. The fourth element of the cost base is capital expenditure incurred, the effect of which is to increase or preserve the asset value or that relates to installing or moving the asset. I agree with Ms Baker's submission that an election to preserve unrestricted shares in the plan is not capital expenditure incurred to increase or preserve the assets value. It plainly does not relate to installing or moving the asset. It does not fall under the fourth element of the cost base of the shares.
36. The fifth element of the cost base is capital expenditure incurred to establish, preserve or defend title to the asset, or a right of the asset. Ms Baker directed my attention to a decision by the Chancery Division of the High Court of the United Kingdom in which the court dealt with the UK capital gains tax legislation. The expression used in that legislation is not dissimilar to that found in s 110-25(6) of the ITAA 1997. In
Allison (Inspector of Taxes) v Murray (1975) 1 W.L.R. 1578, Goff J said at 1584-1585:
"So far as (b) is concerned, I accept the submission that that is dealing not with costs or expenses involved in the acquisition of, but with something done to, the acquired property. The word 'establishing' must be read in the context of subparagraph (b) as a whole, and in particular the juxtaposition of the words 'establishing, preserving or defending his title to, or to a right over, the asset.' In paying the premium Mrs. Murray was not 'establishing, preserving or defending' her title. She had her title to a contingent share, which was not challenged and was in no need of establishment, preservation or defence. What she was doing was not 'establishing, preserving or defending' her title to something greater but acquiring that greater thing; and in my judgement the paragraph simply does not apply to this premium."
37. Although Ms Baker submitted that the effect of the payment to the Plan Trustee from monies lent by the Plan Trustee when an employee elects to preserve the unrestricted shares in the plan is to ensure that the unrestricted shares continue to be held on trust in the plan, I cannot find anything in the trust deed which provides that should an employee not take out a loan, that employee is required nevertheless to make a payment to the Plan Trustee in order to preserve his or her shares in the plan. There is also nothing that I can find in the trust deed which requires an employee, who does not take out a loan, to make a payment to the Plan Trustee in order that his shares continue to be held in the trust. Clause 3.6 of the trust deed provides that Hyder will pay all the expenses, costs and charges incurred by the Plan Trustee in operating the plan. There is also nothing in the trust deed to prevent an employee, whose shares have become unrestricted, from leaving those shares and any further accumulated shares in the trust. Clause 8.3 of the trust deed simply provides that a participant may withdraw or sell some or all of his or her shares. The only obligation on an employee to withdraw shares from the trust is when that employee ceases to be employed by the company.
38. Clause 9.1 provides that an employee may, upon receiving an unrestricted share notice, make a share preservation election. Use of the word may strongly suggests that an employee is not required to make a share preservation election and a loan application concurrently. In any event, the statement in clause 9.4 (h) of the trust deed that the loan funds which are paid to the Plan Trustee to preserve an employee's shares are paid as consideration for the purchase of the unrestricted shares by the Plan Trustee is simply nonsense. Therefore, I accept Ms Baker's submission that it is clear an employee's title to his or her unrestricted shares, whether legally or beneficially held, is not threatened or at risk and is not in need of establishment, preservation or defence. I find that the payment does not form part of the fifth element of a cost base.
39. Mr Munnery contended that a payment made by him at the ESS deferred taxing point, which in this case, arises at the time the restriction to dispose of his interest in shares acquired under the Hyder ESS is lifted, forms part of the cost base of an employee's ESS interests. I do not agree with Mr Munnery's contention.
40. I find that the payment, which is made by a so-called loan provided by the Plan Trustee for the so-called preservation of unrestricted shares in the plan, which is also said to be consideration for shares which the employee already owns beneficially and for which he has already given consideration, being the foregoing of salary to which the employee was legally entitled, does not satisfy any of the five elements of the cost base set out in s 110-25 of the ITAA 1997. I find that the sole purpose of the so-called payment was to increase the cost base of the acquired shares to their market value at the ESS deferred taxing point. That of course would have the consequence of ensuring that no tax was payable by the employee as a result of acquiring shares by salary sacrifice.
41. I find that the Commissioner's objection decision made on 8 February 2011 regarding the so-called payment of consideration was correct. I affirm that decision.