Edited version of private ruling

Authorisation Number: 1011405899999

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Ruling

Subject: Employee Share Scheme

Relevant facts

The taxpayer company (the taxpayer) established an employee share trust (EST) to facilitate the provision of its shares to its Australian employees.

As the scheme was established after 1 July 2009 it will be considered under Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997).

The trustee of the EST (the trustee) will be an entity unrelated to the company and one that does not form part of its tax consolidated group.

Shares in the trustee will be held by entities such that the trustee is controlled by the company's shareholders.

The trustee applied for a private ruling on how the taxation law applies to the employee share schemes.

The company operates an Australian-based business.

The company has implemented employee share schemes.

The employee share schemes broadly operate as follows:

§ To motivate achievement and promote longevity of employment

§ Invitation to apply for options is at the employer's discretion

§ Options are granted for no consideration

§ Options granted are able to be exercised, subject to a vesting period

§ Options exercised are convertible to one share

§ There is an exercise price for each option

§ Options are personal to the employees and cannot be sold, transferred, encumbered or disposed of by the employee

§ The last date of the vesting period is referred to as "the closing date" and options granted expire 2 years from this date

§ After the closing date, an employee may sell any exercisable options to the company or other shareholders, only

§ The company can also redeem options or shares at any time

§ Shares issued on exercise of options carry the same rights to the capital and dividends of the company as other ordinary shares

§ Through exercise of the option, employees agree to be bound by the terms of the company's constitution and shareholders agreement

§ At the time of the ruling application options were outstanding

§ Unexercised options, will be amended and incorporated in the EST

§ If an option holder ceases to be an employee, their options lapse

§ Administration of the scheme is vested in the board

§ On exercise of options, the trustee of the EST will acquire the shares on behalf of each employee, through acquisition from existing shareholders, via a new share issue or by an allocation of shares already acquired

§ While such shares are held on trust in the EST on behalf of the employees, the employees will be entitled to dividend and voting rights

§ Employees are absolutely entitled to the shares as against the trustee from when the shares are allocated to them

§ By written notice, employees can apply for legal title to the shares held in the EST to be transferred to them or their nominee or to be sold on their behalf with a remittance of the sale proceeds (less any brokerage costs).

The application states that the EST is intended to operate in accordance with the trust deed, as a sole purpose trust to acquire shares for participants in share schemes and accordingly hold the shares in trust for eligible employees.

The trust deed states, that the trust will be managed and administered so that it satisfies the sole activities test for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936) and that it will be an 'employee share trust' as defined in subsection 995-1(1) of the ITAA 1997.

The EST will be funded by contributions from the company for the purchase of the shares under the share schemes.

Shares acquired by the EST will be allocated to employees who will become absolutely entitled to them.

The structure of the EST and the rules of each employee share plan are such that shares allocated to each employee will generally be transferred into the name of the relevant employee (or their nominee) on receipt of a withdrawal request.

The trustee will be permitted to sell shares on behalf of an employee where the relevant rules permit.

The trustee may not exercise any voting rights, participate in rights issues or hold any bonus shares in relation to unallocated trust shares.

The company's establishment of the EST provides benefits including:

§ Capital management flexibility

§ An arm's length vehicle for acquiring and holding its shares

§ A streamlined approach to the administration of the share schemes

§ Allowing for shares to be acquired and warehoused by the EST

§ Better visibility of management's share transactions

§ A means to give effect to disposal restrictions after vesting

§ It allows for the recycling of shares

§ A single entity for the administration of the share schemes; and

§ A flexible arrangement for long-term incentive schemes.

Reasons for decision

Question 1

Will the Trustee of the EST be assessed under sections 6-5 or 6-10 of the ITAA 1997 on the irretrievable contributions of money it receives for the provision of shares to participating employees?

Detailed reasoning

As stated in the Relevant facts the EST, as an employee share trust, will be funded by contributions from the taxpayer, for the purchase of shares, either on-market or via subscription, which will be allocated to relevant employees who will become absolutely entitled to them.

The Trustee will use the funds for a specific purpose, namely the acquisition of shares for participants in the employee share plans. Consequently, in receiving these amounts, the Trustee will not have derived anything in the nature of income or profit and therefore the funds will not constitute assessable income in the hands of the Trustee under either section 6-5 or 6-10 of the ITAA 1997. However, unlike the irretrievable contributions made to the EST to acquire shares, other payments and income that do not form part of the corpus of the EST, are assessable income of the Trustee.

In coming to our decision on this matter we have considered ATO Interpretative Decision ATO ID 2002/965 Income Tax - Trustee not assessable on employer contributions made to it under the employer's employee share scheme.

Question 2

Will a Trustee capital gain or capital loss arising under section 104-75 of the ITAA 1997 be disregarded under section 130-90 of the ITAA 1997, at the time when employees become absolutely entitled to the taxpayer's shares, at the same price or less than the cost base of the shares in the hands of the Trustee?

Detailed reasoning

The taxpayer established the EST after 1 July 2009 to facilitate the provision of its shares to its Australian employees and appointed a Trustee. A clause of the Trust Deed, states that the taxpayer and the Trustee agree the Trust will be managed and administered to satisfy the meaning of 'employee share trust' as set out in section 130-85(4) of the ITAA 1997.

Application of Division 83A of the ITAA 1997

Division 83A of the ITAA 1997 will apply to ESS Interests issued on or after 1July 2009 and also, in certain circumstances, to ESS Interests that were provided under an employee share scheme established prior to 1 July 2009.

Options issued on or after 1 July 2009

Division 83-A of the ITAA 1997 will apply to options issued on or after 1 July 2009 as they will have been acquired on or after 1 July 2009 thereby satisfying subsection 83A-5(1) of the IT(TP)A 1997.

Options issued before 1 July 2009

Division 83A of the ITAA 1997 will apply to all options issued before 1 July 2009, that satisfy subsection 83A-5(2) of the IT(TP)A 1997.

Under section 104-75 of the ITAA 1997 a capital gain or capital loss may arise for a trustee of an employee share trust when the latter allocates shares to an employee, unless an exception for employee share trusts applies, namely the new Subdivision 130-D of the ITAA 1997.

Subdivision 130-D of the ITAA 1997

Section 130-90 of the ITAA 1997 (Shares held by employee share trusts) states:

130-90(1)

Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if:


(a) the CGT event is CGT event E5 or E7; and


(b) the CGT event happens in relation to a *share; and


(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and


(d) the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

130-90(2)

Subsection (1) does not apply if the beneficiary acquired the beneficial interest in the *share for more than its *cost base in the hands of the *employee share trust at the time the *CGT event happens.

Amounts paid under the employee share plans for the exercise of options are paid to the taxpayer, not the Trustee, and will not be taken into account for the purposes of section 130-90 of the ITAA 1936.

The conditions of section 130-90 of the ITAA 1997 are satisfied by the taxpayer's employee share plans: the trust has been established as an employee share trust within the meaning of subsection 130-85(4); the shares acquired meet the conditions of subsections 130-90(1) and 130-90(2) of the ITAA 1997. Accordingly, when a beneficiary becomes absolutely entitled to a share any Trustee capital gain or capital loss arising under section 104-75 of the ITAA 1997, will be disregarded pursuant to section 130-90 of the ITAA 1997.

Employee share trust

The term 'employee share trust' referred to in subsection 130-90(1) of the ITAA 1997 is defined in subsection 995-1 of the ITAA 997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

Subsection 130-85(4) of the ITAA 1997 provides that an employee share trust for an employee share scheme (having the meaning given by subsection 83A-10(2) of the ITAA 1997) is a trust whose sole activities are:

(a) obtaining shares or rights in a company; and

(b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of:
(i) the company; or
(ii) a subsidiary of the company; and

(c) other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b).

The right to acquire a share and the beneficial interest in the share that is acquired pursuant to the exercise of the right are both ESS interests within the meaning of subsection 83A-10(1) of the ITAA 1997.

An employee share scheme is defined in subsection 83A-10(2) of the ITAA 1997 as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

The taxpayer's employee share plans are employee share schemes within the meaning of subsection 83A-10(2) of the ITAA 1997 because they are schemes under which rights to acquire shares in the company are provided to employees in relation to the employee's employment (see further discussion of term 'employee share scheme' under the heading 'Paragraph 130-90(1)(d) of the ITAA 1997' below).

Under its employee share plans the taxpayer has established the EST to acquire shares in the company and to allocate those shares to employees to satisfy options acquired under the schemes. The beneficial interest in the shares is itself provided under an employee share scheme because it is provided under the same schemes in which the options to acquire the shares are provided to the employee in relation to the employee's employment, being employee share schemes as defined in subsection 83A-10(2) of the ITAA 1997.

Therefore, paragraphs 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

§ the EST acquires shares in the company,

§ the EST ensures that ESS interests as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in those shares, provided under an ESS, as defined in subsection 83A-10(2) of the ITAA 1997, by allocating those shares to the employees in accordance with the governing documents of the scheme.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will require a trustee to undertake incidental activities that are a function of managing the employee share schemes and administering the trust.

For the purposes of paragraph 130-85(4)(c) of the ITAA 1997, activities which are merely incidental include:

§ the opening and operation of a bank account to facilitate the receipt and payment of money

§ the receipt of dividends in respect of shares held by the trust on behalf of an employee, and their distribution to the employee;

§ the receipt of dividends in respect of unallocated shares and using those dividends to acquire additional shares for the purposes of the employee share scheme;

§ dealing with shares forfeited under an employee share scheme including the sale of forfeited shares and using the proceeds of sale for the purposes of the employee share scheme

§ the transfer of shares to employee beneficiaries or the sale of shares on behalf of an employee beneficiary and the transfer to the employee of the net proceeds of the sale of those shares

§ the payment or transfer of trust income and property to the default beneficiary on the winding up of the trust where there are no employee beneficiaries

§ receiving and immediately distributing shares under a demerger.

Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered merely incidental.

For the purposes of the EST the general powers of the Trustee are set out in the Trust Deed. Clauses effectively read down the general powers given to the Trustee so as to ensure that the general powers are exercised for the purposes of the taxpayer's employee share plans thereby making it clear that the Trustee can only use the contributions received exclusively for the acquisition of shares for eligible employees in accordance with the taxpayer's employee share plans. To this end, all other duties/general powers listed in the Trust Deed are considered to be merely incidental to the functions of the Trustee, in relation to its dealing with the shares to be acquired for eligible employees for the purposes of the taxpayer's employee share plans.

Therefore, the EST is an employee share trust, as defined in subsection 995-1(1) of the ITAA 1997, as the activities of the EST in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 and its other activities (general powers) are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997.

Paragraph 130-90(1)(a) of the ITAA 1997

CGT event E5 is the CGT event that will apply under the terms of the taxpayer's employee share plans at the time the participant becomes absolutely entitled to the shares in the taxpayer as against the trustee. Therefore paragraph 130-90(1)(a) will be satisfied.

Paragraph 130-90(1)(b) of the ITAA 1997

Section 995 of the ITAA 1997 defines a share to mean a share in the capital of a company. An ordinary share in the taxpayer held by the Trustee and to which a participant is entitled upon exercise of an option is a share in the capital of a company, that is, the taxpayer. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c) of the ITAA 1997

Paragraph130-90(1)(c) is satisfied as a participant will have acquired a beneficial interest in a share (in the taxpayer) by exercising a Right (option) granted under the employee share plans.

Paragraph 130-90(1)(d) of the ITAA 1997

Subsection 83A-20(1) of Subdivision 83A-B of the ITAA 1997 states:

This Subdivision applies to an *ESS interest if you acquire the interest under an *employee share scheme at a discount.

The term 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997. Subsection 83A-10(2) states:

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;….

in relation to the employees' employment.

For the purposes of subsection 83A-10(2) of the ITAA 1997, section 995 of the ITAA 1997 defines the term 'scheme' as follows:

scheme means:

(a) any ^*arrangement; or
(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The taxpayer's employee share plans are employee share schemes for the purposes of Division 83A of the ITAA 1997 as they are schemes under which an ESS interest i.e. a beneficial interest in a right to acquire a beneficial interest in a share of the taxpayer, is provided to eligible employees in relation to their employment by the taxpayer or its subsidiaries. The options are acquired under the taxpayer's employee share plans at no cost.

Accordingly, prima facie Subdivision 83A-B of the ITAA 1997 will apply to options acquired under the taxpayer's employee share plans as pursuant to subsection 83A-20(1) of the ITAA 1997 the ESS interest (that is, options issued under the taxpayer's employee share plans) will be acquired under an employee scheme (for the reasons stated immediately in the preceding paragraph) at a discount. It should be noted however that whether a participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B of the ITAA 1997) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C of the ITAA 1997), will depend on which of the additional requirements in subdivision 83A-B of the ITAA 1997 or subdivision 83A-C of the ITAA 1997 have been satisfied. Under either circumstance subparagraph 130-90(d) of the ITAA 1997 will be satisfied.

Accordingly, all the conditions in subsection 130-90(1) of the ITAA 1997 have been satisfied.

Provided (as stipulated in the Question) that the beneficiary does not acquire the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time that CGT event E5 happens, subsection 130-90(2) of the ITAA 1997 will also have been satisfied.

Under these circumstances, section 130-90 of the ITAA 1997 operates to disregard any capital gain or loss made by the Trustee on any share when a participant becomes absolutely entitled to that share.

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