Edited version of private ruling

Authorisation Number: 1011550809609

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Ruling

Subject: Employee equity program

Issue 1

Question 1

Will company X obtain an income tax deduction pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the irretrievable cash contributions made by company X to the trustee of the trust to fund the subscription for or acquisition on-market of company X shares by the trust?

Answer

Yes

Question 2

Will company X obtain an income tax deduction pursuant to section 8-1 of the ITAA 1997 in respect of costs incurred in relation to the implementation and on-going administration of the trust?

Answer

Yes

Question 3

Are irretrievable cash contributions made by company X to the trustee of the trust, to fund the subscription for or acquisition on-market of company X shares by the trust, deductible to company X at a time determined by section 139DB of the Income Tax Assessment Act 1936 (ITAA 1936) and section 83A-210 of the ITAA 1997?

Answer

Yes

Question 4

If the EST satisfies the relevant equity plan obligations by subscribing for new shares in company X, will the subscription proceeds be included in the assessable income of company X under sections 6-5 or 20-20 of the ITAA 1997 or trigger a capital gains tax (CGT) event under Division 104 of the ITAA 1997?

Answer

No

Question 5

Will the Commissioner seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by company X in respect of the irretrievable cash contributions made by company X to the trustee of the trust to fund the subscription for or acquisition on-market of the company's shares by the trust?

Answer

No

Question 6

Is the provision of performance rights or shares by company X to company X employees under a company X equity plan a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No

Question 7

Will the irretrievable cash contributions made by company X to the trustee of the trust, to fund for the subscription for or acquisition on-market of company X shares, be treated as a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No

Question 8

Will the Commissioner seek to make a determination that section 67 of the FBTAA applies to increase the fringe benefits taxable amount to company X , by the amount of tax benefit gained from irretrievable cash contributions made by company X to the trustee of the trust, to fund the subscription for or acquisition on-market of company X shares?

Answer

No

This ruling applies for the following periods:

Year ending 31 December 2008

Year ending 31 December 2009

Year ending 31 December 2010

Year ending 31 December 2011

Year ending 31 December 2012

Year ending 31 December 2013

Year ending 31 December 2014

The scheme commences on:

1 January 2008

Relevant facts and circumstances

Company X is an Australian listed company which recently implemented the employee performance rights plan (PRP). Currently, the PRP forms the basis of company X's long-term equity based incentive scheme. Pursuant to the specific rules of the PRP, eligible senior employees identified by the board of directors of company X (board) may be granted performance rights. Each performance right results in an entitlement to one share in company X, subject to the satisfaction of certain pre-determined exercise conditions set by the board.

Company X is now proposing to establish the employee share trust (EST) to facilitate the provision of shares in company X to participants of the PRP. The EST will be managed by the trustee and governed by the trust deed.

The applicant envisages that the establishment of the EST will:

· provide company X with greater flexibility to accommodate the long term incentive arrangements of company X both now and into the future as the group continues to expand operations and therefore its employee numbers

· provide capital management flexibility for company X, in that the EST can use the contributions made by company X either to acquire shares in company X on market, or alternatively, to subscribe for new shares in company X, and

· provide an arm's-length vehicle through which shares in company X can be acquired and held in the company on behalf of the relevant employee thereby allowing company X to satisfy corporate law requirements relating to the company's dealing in its own shares.

Operation of the PRP

The key features of the PRP are as follows:

· it is at the absolute discretion of the board to extend an invitation to grant performance rights to eligible employees

· any offer and corresponding acceptance must be made in writing to the employee or company X respectively prior to the offer closing date stipulating the key terms and conditions of the offer

· eligible employees will receive the performance right to acquire shares (provided certain performance hurdles are satisfied) for nominal consideration of $Y

· performance rights are exercisable by lodging a notice of exercise of performance right and application for shares, together with the exercise price and the relevant certificate (which outlines the number of performance rights to which the particular employee is entitled), with the secretary of company X or such other person as the board designates, and

· performance rights will lapse upon the earliest if any of the conditions set out in the PRP rules.

Operation of the EST

The trust is a sole purpose trust to subscribe, purchase, deliver, allocate and hold shares under the company X equity plans for the benefit of company X Australian and foreign based employees.

In respect of any shares to be provided under a company X equity plan, company X may direct the trustee to purchase shares to be held on behalf of the participant, or subscribe for shares and company X must issue shares to be held on behalf of the participant.

The trustee will allocate shares under a share based equity plan to a participant who accepts an offer to participate, or a participant who exercises performance rights under an option based plan.

Shares acquired by the trustee will be transferred to the relevant employees as soon as reasonably practicable.

The trustee can sell shares on behalf of an employee where permitted under a relevant equity plan.

Summary

Detailed reasoning

Question 1

Subsection 8-1(1) of the ITAA 1997 is a general deduction provision. It provides:

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Subsection 8-1(2) of the ITAA 1997 then provides:

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income ; or

(d) a provision of this Act prevents you from deducting it.

Losses or outgoings

Pursuant to the trust deed, company X must provide the trustee with all the funds (contributions) the trustee requires so as to enable it to subscribe for or acquire shares in company X in accordance with the trust deed. The trustee will, in accordance with instructions received pursuant to the relevant plan rules, acquire, deliver and allocate shares for the benefit of participants provided that the trustee receives sufficient payment to subscribe for or purchase shares and/or has sufficient unallocated trust shares available. These contributions made to the trustee by company X will be non-refundable to company X (the trust deed provides that funds provided to the trustee will not be repaid to company X and no participant shall be entitled to receive the funds). On this basis, it is concluded that the irretrievable contributions made by company X are considered to be a loss or outgoing for the purpose of subsection 8-1(1) of the ITAA 1997.

Relevant nexus

The purpose of company X in establishing and making irretrievable contributions to the trustee of the trust is to provide benefits to certain eligible employees in the form of shares.

All the documentation provided indicates that the contributions are made to the trustee of the trust solely to enable the trustee to acquire shares for eligible employees of the business.

Accordingly, there is a sufficient nexus between the outgoings (company X's contributions to the trustee of the trust) and the derivation of its assessable income (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169), Amalgamated Zinc (De Bavay's) Ltd v. Federal Commissioner of Taxation (1935) 54 CLR 295; (1935) 3 ATD 288, Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; 4 AITR 236; (1949) 8 ATD 431.

Capital or Revenue?

Company X's contributions will be recurring and be made from time to time as and when company X shares are to be subscribed for or acquired pursuant to the trust deed. Therefore, it is concluded that the contributions are not capital in nature, but rather outgoings incurred by the company in carrying on its business. In support of this conclusion, the Court held in Pridecraft Pty Ltd v FC of T [2004] FCAFC 339; 2005 ATC 4001; 58 ATR 210; FC of T v Spotlight Stores Pty Ltd FCA 650;2004 ATC 4674; 55 ATR 745 that payments by an employer company to a trust established for the purpose of providing incentive payments to employees were on revenue account and not capital or of a capital nature. This confirms the view expressed in ATO Interpretative Decision ATO ID 2002/1074 that a company will be entitled to a deduction under section 8-1 of the ITAA 1997 for irretrievable contributions made to the trustee of its employee share scheme.

Nothing in the facts suggests that the contributions are private or domestic in nature, or are incurred in gaining or producing exempt income, or are otherwise prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936.

Question 2

The same reasons apply to these costs as in Question 1 above. These costs are part of the ordinary recurring costs of company X remunerating its employees and are, therefore, deductible under section 8-1 of the ITAA. This is consistent with the ATO view expressed in ATO Interpretative Decision ATO ID 2002/961.

Question 3

Pre 1 July 2009

Section 139DB of the ITAA 1936 determines when a deduction is allowable under such circumstances and states:

If, at a particular time, a person (the provider) provides another person with money or other property:

(a) under an arrangement; and

(b) for the purpose of enabling another person (the ultimate beneficiary) to acquire, directly or indirectly, a share or right, under an employee share scheme;

then, for the purpose of determining when any deduction is allowable to the provider in respect of provision of the money or other property, the provider is taken to have provided it not before the time when the ultimate beneficiary acquires the share or right.

Subsection 139C(4) of the ITAA 1936 provides that a taxpayer does not acquire a share under an employee share scheme where the share is acquired as a result of the exercise of a right acquired under an employee share scheme.

In relation to the equity plans an eligible employee will acquire a right under an employee share scheme because the conditions of section 139C of the ITAA 1936 are satisfied. Accordingly, shares acquired by eligible employees as a result of exercising their rights are not acquired under an employee share scheme and section 139DB of the ITAA 1936 will only apply if there is the relevant connection between the contributions made by the company and the acquisition of rights by the eligible employees.

The deductibility of money provided to employee share trusts is considered in ATO Interpretative Decision ATO ID 2005/181. The facts described in that ATO ID are similar to the present equity plans and the reasoning in it is relevant to them:

The granting of the rights, the providing of the money to the trustee, the acquisition and holding of the shares by the trustee and the allocating of shares to the participating employees are all interrelated components of the plan. All the components of the plan must be carried out so that the plan can operate as intended. As one of those components, the providing of money to the trustee necessarily allows the plan to proceed. Consequently, the providing of money to the trustee is considered to be for the purpose of enabling the participating employees, indirectly as part of the plan, to acquire the rights available under the plan.

Accordingly, section 139DB of the ITAA 1936 determines the time when a deduction is allowable to the taxpayer under section 8-1 of the ITAA 1997 in respect of the provision of money to the trustee of the employee share trust.

Therefore, company X will be allowed a deduction for contributions made to the trustee in the year of income in which they are made, provided and to the extent that they are in respect of the funding of the acquisition of shares to satisfy the obligations in relation to performance rights to acquire shares granted to participants under the equity plans in that income year or earlier income years.

Application of Division 83A of the ITAA 1997 (post 30 June 2009)

The provision of money to the trustee of the equity plans (EP) by the company for the purpose of remunerating its employees under the company EP is an outgoing in carrying on the company's business and is deductible under section 8-1 of the ITAA 1997.

The deduction under section 8-1 of the ITAA 1997 would generally be allowable in the income year in which the company incurred the outgoing but under certain circumstances, the timing of the deduction is specifically determined under section 83A-210 of the ITAA 1997.

Section 83A-210 of the ITAA 1997 provides that if:

(a) at a particular time, you provide another entity with money or other property:

(i) under an arrangement; and

(ii) for the purpose of enabling an individual (the ultimate beneficiary) to acquire, directly or indirectly, an ESS interest under an employee share scheme in relation to the ultimate beneficiary's employment (including past or prospective employment); and

(b) that particular time occurs before the time (the acquisition time) the ultimate beneficiary acquires the ESS interest; then, for the purpose of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time.

Section 83A-210 of the ITAA 1997 will only apply if there is a relevant connection between the money provided to the trustee, and the acquisition of ESS interests (directly or indirectly) by the company under the relevant company EP in relation to the employee's employment.

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 granting of the beneficial interests in the rights, the provision of the money to the trustee under the arrangement, the acquisition and holding of the shares by the trustee and the allocation of shares to the participating employees are all interrelated components of the equity plans. All the components of the scheme must be carried out so that the scheme can operate as intended.

As one of those components, the provision of money to the trustee necessarily allows the scheme to proceed.

Consequently, the provision of money to the trustee to acquire shares in the company is considered to be for the purpose of enabling the participating employees, indirectly as part of the equity plans, to acquire the rights.

However, if any amount of money is used by the trustee to purchase excess shares intended to meet a future obligation arising from a future grant of rights, the excess payment occurs before the employees acquire the relevant rights (ESS interests) under the scheme. Section 83A-210 of the ITAA 1997 will apply in that case and the excess payment will only be deductible to the company in the year of income when the relevant rights are subsequently granted to the employees.

Under the equity plans, the shares ultimately acquired by employees are interests acquired under an employee share scheme in relation to the employees' employment.

To the extent that the shares may be so acquired before the employees acquire a beneficial interest in the shares, section 83A-210 of the ITAA 1997 will operate to deny a deduction until that beneficial interest is acquired (in practice this should usually be in the same income year that the contribution has been made).

Question 4

Section 6-5 Income according to ordinary concepts

If you are an Australian resident, your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).

Income according to ordinary concepts is not defined in the ITAA 1997. However, there is a substantial body of case law which discusses factors that indicate whether an amount has the character of income according to ordinary concepts.

Dixon J in Sun Newspapers Limited and Associated Newspapers Limited v. Federal Commissioner of Taxation (1938) 61 CLR 337; 5 ATD 23; 1 AITR 403 (Sun Newspapers) outlined three matters to be considered in determining whether a payment is on capital or revenue account, including:

· the character of the advantage sought by the payment

· the way it is to be used or enjoyed; and

· the means adopted to obtain it.

The character of the advantage sought by the payment

In this ruling, the purpose of the taxpayer in establishing and funding its employee share plans is to retain and attract high quality staff by rewarding them for achieving performance criteria set by the board. A general aim of the taxpayer's employee share schemes is to enhance the profitability of the group's business. Therefore the character of the advantage sought is one of reward and retention of the human resources of the business as a contribution to its long term success, which distinguishes it as capital in nature.

The way it is to be used or enjoyed

As stated in the application the receipt of the subscription price will be accounted for as an addition in its share capital in its books and records. While this treatment of the subscription price is not decisive in itself, it is indicative of the taxpayer's treatment of the receipt and consistent with accounting principles.

The means adopted to obtain it

The payment is a premium or outlay to secure a share(s) in the company as a means to structure the business to secure and enhance its long-term profitability, which when considered with the two preceding matters - the character of the advantage sought and the way it is to be used - makes a persuasive case for the subscriptions for the shares to be distinguished as being on capital account.

Section 20-20 of the ITAA 1997 Assessable recoupments

Division 20 of the ITAA 1997 deals with amounts included to reverse the effect of past deductions and section 20-20 of the ITAA 1997 with assessable recoupments, which are described (at section 20-10 of the ITAA 1997) as 'an amount you receive by way of insurance, indemnity or other recoupment'.

The subscriptions received by the taxpayer from the EST are for shares and are integral to the arrangement whereby the acquisition and holding of the shares by the trustee and the allocation of shares to the participating employees are all interrelated components of the taxpayer's employee share plans. The character of the subscriptions paid to the taxpayer for shares is not one of 'insurance, indemnity or other recoupment'.

Therefore, the subscription amount does not constitute an assessable recoupment under section 20-20 of the ITAA 1997.

Division 104 of the ITAA 1997 CGT events

Given that a capital gain or capital loss is made only if a CGT event happens, the initial step is to ascertain whether such an event has occurred. Also, given that the transaction is the payment of subscriptions by the EST to the taxpayer for shares, the possible events are:

· D1 Creating contractual or other rights; or

· H2 Receipt for event relating to a CGT asset.

Event D1 applies in preference to event H2

Subsection 104-35(1) of the ITAA 1997 states that CGT event D1 'happens if you create a contractual right or other legal or equitable right in another entity'. However the legal or equitable right has actually been created at the time of the issuance of the rights, not upon the payment of the subscription proceeds to the taxpayer. Therefore no legal or equitable right is created and hence event D1 does not happen.

Also, paragraph 104-35(5)(c) of the ITAA 1997 states event D1 does not happen where a company issues or allots equity interests in the company, which is the case with this taxpayer's transactions.

As event DI is excluded, H2 is to be considered

Event H2 happens if an act, transaction or event occurs to a CGT asset owned by the taxpayer and the occurrence does not result in an adjustment to the cost base or reduced cost base (section 104-155(1) of the ITAA 1997).

Again, consideration of the subscriptions received by the taxpayer from the EST establishes that they are for shares and are integral to the arrangement whereby the acquisition and holding of the shares by the trustee and the allocation of shares to the participating employees are all interrelated components of the taxpayer's employee share plans. As part of the taxpayer's employee share plans, contractual rights of employees are exercised on their behalf to acquire shares in the taxpayer, rather than an act, transaction or event relating to a CGT asset owned by the taxpayer.

Further, paragraph 104-155(5)(c) of the ITAA 1997 states event H2 does not happen where a company issues or allots equity interests in the company, which is applicable to the payment of subscription proceeds to the taxpayer.

In summary, if the EST satisfies the relevant obligations of the taxpayer's employee share plans by subscribing for new shares in the taxpayer, the subscription proceeds will not be included in the assessable income of the taxpayer under sections 6-5 or 20-20 of the ITAA 1997, or trigger a CGT event under Division 104 of the ITAA 1997.

Question 5

Conclusion - the purpose of the scheme

A consideration of all the factors referred to in paragraph 177D(b) of the ITAA 1936 leads to the conclusion that the dominant purpose of the scheme is to provide remuneration to company X's employees who participate in the scheme in a form that promotes the company's business objectives, rather than to obtain a tax benefit. Accordingly, the Commissioner will not make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by company X in relation to irretrievable contributions made by the company to the EST to fund the acquisition of company X shares in accordance with the scheme as outlined above.

Question 6

The definition of fringe benefit in paragraph 136(1)(ha) of the FBTAA states that a benefit is not a fringe benefit where the benefit is constituted by the acquisition of a share or right under an employee share scheme within Division 13A of the ITAA 1936.

The proposed company X equity plans comply with the provisions of Division 13A of the ITAA 1936. A trustee will be appointed to administer the plans. The sole activities of the trustee will be to obtain shares or rights in company X for the benefit of the company X employees or associates of the employees. Under the employee share scheme the shares will be purchased, registered in the name of the trustee and held on trust for the benefit of participating employees or their associates.

As the employee acquires a beneficial or legal interest in a share or right, under the definitions contained in section 139G of the ITAA 1936, the provisions within Division 13A of the ITAA 1936, which deal with acquisition of a share or right, apply.

Therefore the benefit, represented by the acquisition of the beneficial or legal interest in a share or right which is provided to the employee by the entity that administers the scheme under the employee share scheme is excluded as a benefit, as defined under fringe benefit, in paragraph 136(1)(ha) of the FBTAA.

Application post 1 July 2009

In respect of ESS interests acquired post 30 June 2009, paragraph 136(1)(ha) of the FBTAA has been repealed and replaced by paragraph 136(1)(h) of the FBTAA. This paragraph states that a benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83A-B or 83A-C of the ITAA 1997 applies.

The new paragraph uses the term ESS interest and excludes such an interest from the definition of a fringe benefit where it is acquired under an employee share scheme.

In company X's case the rights and shares are all acquired at a discount and will be an excluded benefit.

Question 7

Application pre 1 July 2009

Section 40 of the FBTAA provides that where a person (the provider) provides property to another person (the recipient), the provision of property shall be taken to constitute a benefit provided by the provider to the recipient.

Section 136(1) of the FBTAA defines 'property benefit' as a benefit referred to in section 40 of the FBTAA.

The contribution by company X to the trustee of the EST under the equity plans will be a 'property fringe benefit' under sections 136 and 40 of the FBTAA because the trustee of a trust set up to provide benefits to employees and is an associate of each employee for the purposes of the FBTAA.

However, certain benefits are excluded from being fringe benefits within the meaning of the FBTAA. Paragraph 136(1)(hb) of the FBTAA extends this exclusion to include money or property given to a trust to obtain shares or rights to acquire shares, in a company (the employer) or a holding company of the employer on behalf of employees.

A payment of money by company X to the EST is therefore not subject to FBT provided that the sole activities of the trust 'are obtaining shares, or rights to acquire shares' in company X.

ATOID 2007/179 sets out the Commissioner's views on when an employee share trust satisfies the sole activities test. In particular, the Commissioner considers that activities that are a necessary function of managing an employee share scheme and administering a trust will satisfy the sole activities test. Such activities 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 trustee, and the retention of those dividends or their distribution to employee beneficiaries of the trust (unless to a default beneficiary - see below)

· dealing with shares forfeited under an employee share scheme including the sale of forfeited shares

· the transfer of shares to employee beneficiaries or the transfer to them of the proceeds from the sale of those shares on their behalf, at the time an employee calls on the trustee to either transfer or sell the shares, and

· 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.

Activities that the Commissioner considers will not satisfy the sole activities test include:

· any activities that are not a necessary function of managing an employee share scheme or administering a trust, and

· any activities which result in employees being provided with additional benefits (for example, the provision of a loan to acquire shares).

The sole activities of the trustee of the EST will be to obtain, hold and deal with shares in company X for the benefit of company X employees. Therefore the irretrievable contributions of money to the trustee of the EST will not be subject to fringe benefits tax.

Application post 1 July 2009

In respect of ESS interests acquired post 30 June 2009, paragraph 136 (1)(hb) of the FBTAA has been repealed and replaced with a new paragraph. Paragraph 136(1)(ha) of the FBTAA states a benefit constituted by the acquisition of money or property by an employee share trust (within the meaning of the Income Tax Assessment Act 1997).

An employee share trust is also defined in section 130-85(4) of the ITAA 1997.

As per reasons set out in relation to pre 1 July 2009, the company X employee share trust meets the definition of an employee share trust as discussed above. Accordingly payments to the trustee of the EST post 30 June 2009 will not be subject to fringe benefits tax.

Question 8

Section 67 of the FBTAA is the general anti-avoidance provision in the FBTAA. The operation of section 67of the FBTAA is comparable to Part IVA of the ITAA 1936, in that the section requires the identification of an arrangement and a tax benefit, it includes the sole or dominant purpose test and is activated by the making of a determination of the Commissioner.

Under the proposed company X employee equity plans, the benefits provided to employees will not be subject to FBT due to the definitions provided in section 136(1) of the FBTAA. Therefore, no amount could be reasonably expected to be included in the aggregate fringe benefits amount, attributable to the scheme, if the arrangement had not been entered into.

As no amount will be excluded from the aggregate fringe benefits amount of company X and it cannot be established that the dominant purpose in this arrangement is to avoid fringe benefits tax, the Commissioner will not seek to apply section 67 of the FBTAA to the new employee equity plans.

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