ATO Interpretative Decision

ATO ID 2010/62

Income Tax

Employee share scheme: whether interests in a corporate limited partnership are ordinary shares
FOI status: may be released
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

Is an interest in a corporate limited partnership treated as an ordinary share for the purposes of the ordinary share condition in subsection 83A-35(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

Yes. An interest in a corporate limited partnership is treated as an ordinary share for the purposes of the ordinary share condition in subsection 83A-35(4) of the ITAA 1997 if the interest does not give the holder preferential rights with respect to distributions out of profits or capital, or on winding up of the limited partnership.

Facts

A business is operated through a limited partnership structure.

The limited partnership satisfies the definition of a corporate limited partnership in subsection 995-1(1) of the ITAA 1997 and is treated for income tax purposes as a company.

The limited partnership operates a remuneration scheme under which it provides interests in the limited partnership (limited partner units) to selected employees at a discount, as part of its remuneration and retention strategy.

The rights and obligations of a partner in the limited partnership are set out in the partnership agreement, including the partner's entitlement to distributions.

The partnership agreement provides that all distributions to partners are made to the partners on a pro rata basis in accordance with the number of units that the partner holds in the limited partnership divided by the total number of units held by all partners in the limited partnership (partner's sharing percentage).

On dissolution of the limited partnership, the partners are entitled to share in the distribution out of partnership assets after the satisfaction of the claims of all creditors, on a pro rata basis in accordance with the partner's sharing percentage.

Reasons for Decision

Division 83A of the ITAA 1997 provides for the taxation of ESS interests acquired under employee share schemes at a discount.

An ESS interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

The Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009 (EM), which inserted Division 83A into the ITAA 1997, at paragraph 1.385 notes that the employee share scheme rules also apply to interests in corporate limited partnerships in the same way as the rules apply to shares in companies.

Corporate limited partnership is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 94D of the Income Tax Assessment Act 1936 (ITAA 1936).

Under section 94D of the ITAA 1936, a limited partnership is a corporate limited partnership for the 1995-96 or later years of income if the exceptions in that section do not apply.

A limited partnership is relevantly defined in subsection 995-1(1) of the ITAA 1997 as an association of persons (other than a company) carrying on business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited.

Where limited partnerships are corporate limited partnerships, they are taxed as companies through modifications to a number of provisions in the income tax law. More relevantly, a reference to:

a company includes a reference to a corporate limited partnership (section 94J of the ITAA 1936); and
a share includes a reference to an interest in a corporate limited partnership (section 94P of the ITAA 1936).

Therefore, the limited partner units are ESS interests for the purposes of Division 83A of the ITAA 1997.

The limited partner units are acquired under an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 as they are acquired under a scheme in which ESS interests in a company (in this case the corporate limited partnership) are provided to employees in relation to the employees' employment.

Generally, an individual will include the discount given in relation to an ESS interest acquired under an employee share scheme in their assessable income in the income year in which the ESS interest is acquired (up-front taxation) or have an amount in relation to the ESS interest included in their assessable income in the income year in which the ESS deferred taxing point for the ESS interest occurs (deferral taxation).

Where the ESS interest is either eligible for the up-front tax concession in Subdivision 83A-B or the deferral concession in Subdivision 83A-C of the ITAA 1997, one of the conditions that applies to the upfront tax concession (subsection 83A-35(4) of the ITAA 1997) or the deferral concession (paragraph 83A-105(1)(b) of the ITAA 1997) is that, when the individual acquires the ESS interest, all of the ESS interests available for acquisition under the employee share scheme must relate to ordinary shares (ordinary share condition).

In this instance, the interests available for acquisition under the employee share scheme are limited partner units. The ordinary share condition will be satisfied if the limited partner units are treated as ordinary shares for the purposes of Division 83A of the ITAA 1997.

Ordinary share is not defined in the ITAA 1997. Therefore 'ordinary share' takes its ordinary meaning, having regard to its legislative context and the purpose or object of Division 83A of the ITAA 1997.

In Norman v. Norman (1990) 19 NSWLR 314, McLelland J, when considering whether certain shares were ordinary shares, noted at 315 and 316 that:

The expression 'ordinary shares' is [not] defined ... in the articles of association nor in the Companies Act 1961 which was in force at the time of incorporation of the company. Counsel were unable to refer me to any authority in which the expression has been defined.
In my opinion in ordinary usage the meaning of the expression 'ordinary shares' is, and was in 1971, shares other than preference shares.

The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne, defines ordinary shares as 'shares entitling holders to a dividend from net profits (cf. preference shares)' and preference shares are defined as 'shares or stock whose entitlement to dividends takes priority over that of ordinary shares'.

In the Glossary of sharemarket terms, ASX Limited, viewed 23 February 2010, http://www.asx.com.au, an ordinary share is defined as 'a class of shares which have no preferential rights as to either dividends out of profits or capital on a winding up' and preference shares are defined as 'shares that rank before ordinary shares in the event of liquidation'.

The EM at paragraph 1.164 in relation to the ordinary share condition in Subdivision 83A-C of the ITAA 1997 (also see paragraph 1.121 of the EM in relation to the ordinary share condition for the up-front tax concession) notes that:

Deferred taxation is restricted to interests over ordinary shares to encourage the alignment of employee and employer interests. ESS interests that are not ordinary shares, such as preference shares, may have less 'risk' associated with them because they pay a more stable income stream and have priority over ordinary shares if the company winds up. They are therefore less likely to align the shareholder's interest with that of the company.

Whether a share is an ordinary share in a company for the purposes of the condition in subsection 83A-35(4) of the ITAA 1997 is to be determined by considering the rights attached to the share in relation to distributions of profits and capital and on winding up of the company, as compared to other shares in the company. Shares that have a priority as to dividends or distributions in the event of winding up are preference shares. If shares are not preference shares, they are ordinary shares.

Therefore, the limited partner units acquired by employees under the employee share scheme are treated as ordinary shares for the purposes of Division 83A of the ITAA 1997, because they do not have preferential rights over any other interest in the partnership as to distributions of profits or capital of the limited partnership, or any priority rights on winding up of the limited partnership.

Date of decision:  10 March 2010

Year of income:  Year ended 30 June 2010

Legislative References:
Income Tax Assessment Act 1936
   section 94D
   section 94J
   section 94P

Income Tax Assessment Act 1997
   Division 83A
   Subdivision 83A-B
   Subdivision 83A-C
   subsection 83A-10(1)
   subsection 83A-10(2)
   subsection 83A-35(4)
   paragraph 83A-105(1)(b)
   subsection 995-1(1)

Case References:
Norman v Norman
   (1990) 19 NSWLR 314

Other References:
Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009
The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne
Glossary of sharemarket terms, ASX Limited, viewed 23 February 2010

Keywords
Employee share schemes & options
Limited partnerships

Siebel/TDMS Reference Number:  1-1WLXFSX; 1-5VR8G83

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  12 March 2010
Date reviewed:  9 April 2015

ISSN: 1445-2782