ATO Interpretative Decision
ATO ID 2010/61
Income TaxEmployee share scheme: real risk of forfeiture - minimum term of employment and good leaver provisions
FOI status: may be released
This ATOID provides you with the following level of protection:
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you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed.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.
Will rights to acquire shares acquired by employees under an employee share scheme satisfy the condition in subsection 83A-105(3) of the Income Tax Assessment Act 1997 (ITAA 1997), where the conditions of the scheme provide that the rights will be forfeited if a minimum term of employment is not completed and the scheme contains good leaver provisions?
Yes. Rights to acquire shares acquired by employees under an employee share scheme will satisfy the condition in subsection 83A-105(3) of the ITAA 1997, where:
- the minimum term of employment is 12 months or more; or
- the minimum term of employment is at least 6 months and the maximum period of deferral is 3 years or less.
The company operates a scheme under which rights to acquire shares in the company are provided at a discount to employees of the company, under an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997.
The employee share scheme is designed to motivate, reward and retain employees and align their interests with the interests of the company. The company operates the scheme in accordance with the conditions of the scheme.
Under the conditions of the scheme, the rights will vest according to the following vesting schedule provided that the employee is still employed by the company at the vesting date:
- 1/3 of the rights will vest 1 year from the date of grant of the rights;
- 1/3 of the rights will vest 2 years from the date of grant of the rights; and
- 1/3 of the rights will vest 3 years from the date of grant of the rights.
The employee cannot dispose of the rights.
When the rights vest the employee is automatically issued with shares in the company. The employee does not pay anything for the shares. The conditions of the scheme do not restrict the employee from disposing of the shares acquired on vesting of the rights.
If the employee ceases employment prior to the vesting of the rights the rights will be forfeited.
However, if the employee ceases employment because of death, invalidity, bona fide redundancy or retirement (unless the retirement happens within 6 months of the date of grant of the rights) the rights will vest according to the vesting schedule. If the employee retires within 6 months of the date of grant of the rights the rights will be forfeited.
Retirement is defined, for this scheme, as ceasing employment with the company when the employee is at least 55 years of age and has completed at least 10 years of service with the company.
Reasons for Decision
Division 83A of the ITAA 1997 provides for the taxation of ESS interests (shares, stapled securities and rights to acquire shares and stapled securities) acquired under an employee share schemes at a discount.
The discount given in relation to an ESS interest acquired under an employee share scheme is included in an employee's assessable income in the income year in which the interest is acquired under Subdivision 83A-B of the ITAA 1997 unless Subdivision 83A-C of the ITAA 1997 applies. If Subdivision 83A-C of the ITAA 1997 applies to the ESS interest, the employee will include an amount in the income year in which the ESS deferred taxing point for the ESS interest occurs.
Subdivision 83A-C of the ITAA 1997 applies, instead of Subdivision 83A-B, to an ESS interest when the conditions in subsection 83A-105(1) of the ITAA 1997 are met. If the ESS interest is a right, the condition under paragraph 83A-105(1)(d) and subsection 83A-105(3) of the ITAA 1997 requires that when the employee acquires the interest:
- there is a real risk that, under the conditions of the employee share scheme, the employee will forfeit or lose the ESS interest (other than by disposing of it, exercising the right or letting the right lapse); or
- there is a real risk that, under the conditions of the employee share scheme, if the employee exercises the right, they will forfeit or lose the beneficial interest in the share (other than by disposing of it).
Real risk of forfeiture
Subsection 83A-105(3) of the ITAA 1997 is to be interpreted by considering the ordinary meaning of the words having regard to the legislative context and the object or purpose of Division 83A of the ITAA 1997.
'Real' is defined in The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne as 'actually existing as a thing or occurring in fact' and 'genuine; rightly so called; not artificial or merely apparent'.
The Explanatory Memorandum (EM) to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009, which inserted Division 83A into the ITAA 1997, explains the purpose of having a real risk of forfeiture test to qualify for treatment under Subdivision 83A-C of the ITAA 1997 as follows:
Providing for the deferral of tax in these situations recognises that the employee may never have a chance to recognise the economic value of the ESS interest, and that having employee remuneration 'at risk' in this manner is consistent with the purpose of concessionally taxing employee share schemes, namely to align the interests of employees and employers.
The EM explains the real risk of forfeiture test at paragraph 1 156 and 1 158:
The 'real risk of forfeiture test' does not require employers to provide schemes in which their [ESS interests] are at significant or substantial risk of being lost. However, real is regarded as something more than a mere possibility. Something is not a real risk if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility.
The 'real risk of forfeiture' test is intended to provide for deferral of tax when there is a real alignment of interests between the employee and employer, through the employee's benefits being at risk. The test is a principle based test, intended to deny deferral of tax where schemes contrive to present a nominal risk of forfeiture without complying with the intent of the proposed law.
Therefore, for the 'real risk of forfeiture' condition to be met for an ESS interest acquired by an employee under an employee share scheme, a reasonable person must consider that:
- there is an actual possibility of forfeiture - if under no circumstance will the employee forfeit or lose the ESS interest it will not be an interest to which Subdivision 83A-C of the ITAA 1997 applies; and
- the risk of forfeiture is 'real' - that is, it must be genuine; not nominal; not artificial, apparent or contrived and the risk must not be a 'mere' possibility or 'rare' eventuality.
In considering whether a condition in a scheme imposes a real risk of forfeiture, regard should be had to whether a reasonable person would consider that there is a genuine connection between the forfeiture condition and aligning the interests of the employee and employer. If the risk of forfeiture is over a very short period of time to gain access to a relatively long period of deferral the risk will not be considered real.
Good leaver conditions that allow rights to be retained in the event of death, invalidity or bona fide redundancy do not prevent the rights being at a real risk of forfeiture provided that the scheme is operated in accordance with the conditions and employees do not routinely receive the benefit of the rights regardless of their reason for ceasing employment.
Employees who do not satisfy the definition of retirement
The scheme has been designed to motivate, reward and retain employees. The scheme operates so that employees who are granted rights have an interest in remaining employed with the company, and in the company performing well, as they will be provided with shares in the company when their rights vest in 1, 2 and 3 years from the date of grant if they are still employed at that time.
A condition imposing a minimum employment period of 12 months is considered to give rise to more than a 'mere' or 'rare' possibility of forfeiture and to be a condition genuinely directed to retaining employees and aligning their interests with the interest of the company.
The conditions that allow the rights to be retained in the event of death, invalidity or bona fide redundancy do not prevent the rights being at a real risk of forfeiture because they only operate when special circumstances occur that are outside the control of the employee. They do not prevent the risk of forfeiture for the employee if they cease employment in normal circumstances from being real. The good leaver provisions are consistent with the genuine purpose of the scheme to align the interests of the employee and employer and only provide relief for employees in unfortunate circumstances.
Therefore, employees who do not satisfy the definition of retirement will have a real risk, under the conditions of the employee share scheme, of forfeiting or losing the rights acquired under the scheme and the rights will satisfy the condition in subsection 83A-105(3) of the ITAA 1997. If an employee is not at least 55 years of age with 10 years of service at the time they acquire the rights, they are considered to be in the same position as any other employee even if they may satisfy the retirement definition at some time during the forfeiture period.
Employees who satisfy the definition of retirement
Under the conditions of this scheme, an employee who is at least 55 years of age and has completed 10 years of service as at the date the rights are granted must be employed with the company for a further 6 months from the date of grant of the rights before they will be entitled under the conditions of the scheme to vesting of the rights without risk of forfeiture.
In considering whether a minimum employment period of 6 months gives rise to a real risk of forfeiture, the Commissioner will consider whether the risk is genuine having regard to the deferral period provided under the scheme.
In this case, the rights will vest according to the vesting schedule. Therefore, there is a maximum 3 year deferral period from the time that the rights are granted, with a 6 month forfeiture period for employees of at least 55 years of age with 10 years of service at the time they acquire the rights. In these circumstances, the Commissioner is of the view that these employees will be subject to a real risk of forfeiture.
Year of income: Year ended 30 June 2010
The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne
Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009
Employee share schemes & options
Date reviewed: 14 January 2015