Edited version of private ruling

Authorisation Number: 1011564645637

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Ruling

Subject: Employee equity program

Question 1

Will the irretrievable contributions to the trustee of the trust be income of the trust?

Answer

No.

Question 2

Will a capital gain or capital loss arise to the trustee of the trust at the time when the employees become absolutely entitled to the 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 July 2008

Relevant facts and circumstances

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

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

The taxpayer operates an Australian based business and has implemented employee share schemes.

The purpose of the employee share schemes can be summarised as follows:

· to drive continuing improvement in the taxpayer's performance

· to encourage retention and assist in attracting new employees

· aligning rewards and interests of eligible employees with the longer term growth and success of the taxpayer, and

· to encourage share ownership amongst the taxpayer's employees in a tax effective manner.

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 130-85(4) of the Income Tax Assessment Act 1997 (ITAA 1997).

The EST will be funded by contributions from the taxpayer 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 as soon as practicable.

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

It is common for taxpayers to use a trust to facilitate the provision of shares to employees as part of equity based employee incentive strategies.

The commercial benefits of using a trust includes:

· 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 shares to be acquired by the EST

· a means to give effect to disposal restrictions after vesting, and

· a flexible arrangement for long term incentive schemes.

Reasons for decision

Question 1

Subsection 6-5(1) of the ITAA 1997 provides that assessable income includes income according to ordinary concepts.

In Scott v. Federal Commissioner of Taxation HCA 48, Windeyer J held that the concept of ordinary income depends upon its quality in the hands of the recipient.

In G.P. International Pipecoaters Pty Ltd v. FC of T 90 ATC 4420, the High Court considered the following factors were important in determining the nature of the receipt:

To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity, recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

In Campbell and Anor v. Inland Revenue Commissioner 1970 AC 77, the House of Lords considered that covenanted payments made to a trust for the purposes of buying property were not income of the trustee. The payments were held to be instalments of capital in the hands of the trustee as they were paid under a contract that required those payments to be applied to the purchase of property.

In addition the House of Lords held that:

…contributions or accretions to the capital stock or endowment of the trust were just as truly receipts on capital account and not on account of income as instalments of the proceeds of sale of a capital asset would be.

In trustee of the Estate Mortgage Fighting Fund EST v. FCT 2000 ATC 4525 the Federal court considered that funds contributed to the Fighting Fund trust for the purposes of funding litigation for beneficiaries, upon solicitation by the trustee, were capital in nature.

The purpose of the contributions by company X to the trust is to procure shares to satisfy awards made to employees under a company X equity plan. The trust deed deems all funds received by the trustee from company X as corpus of the trust, which is consistent with the views outlined in the cases above.

Whilst the above factors suggest that the contributions made to the trustee of the trust are non assessable, the following ATO Interpretative Decisions have also been taken into consideration when making the decision:

ATO ID 2002/965 Income tax - trustee not assessable on employer contributions made to it under the employer's employee share scheme.

In this case, the Commissioner held that:-

…the trustee of the employee share scheme trust will not be assessed under sections 6-5 or 6-10 of the ITAA 1997 on contributions made to it by an employer for the purpose of and under the employer's employee share scheme.

The facts of ATO ID 2002/965 appear to directly align with the facts present in this case. Accordingly, the funds contributed to the trust are not considered to be a reward for services provided by the trust nor a gain realised in relation to an asset.

Instead, the funds will be used in accordance with the trust deed and plan rules for the sole purpose of providing shares for the benefit of employees. In receiving the contributed amounts, it is considered that the trustee of the trust has not derived assessable income pursuant to section 6-5 of the ITAA 1997.

Question 2

Application of former section 130-90 of the ITAA 1997 and specifically subsection130-90(3) of the ITAA 1997 for application from 7.30 p.m. on 13 May 2008.

An employee becomes absolutely entitled to the shares when they are acquired by the trustee and allocated to the employee such that the shares are held on the employee's behalf by the trustee.

In these circumstances, under section 104-75 of the ITAA 1997, CGT Event E5 applies at the time the employee becomes absolutely entitled to the shares as against the trustee - which will be when those shares are allocated to the employee. A capital gain or capital loss will arise in circumstances where the market value of the shares at the time that the employee becomes absolutely entitled to the shares is different to the cost base of the shares held by the trustee.

However, there should be no capital gain or loss to the trustee on the basis that the cost base of the shares acquired by the trustee (that is, the amount paid for the shares) should be equal to the market value of the shares since the trustee will acquire the shares on market for their market value which becomes the shares cost base and immediately allocate those shares to employees giving rise to a deemed sale price of their market value at that time.

Alternatively, the trustee will acquire the shares via a new issue from company X, the acquisition price being equal to the market value of the shares as determined by the board which again, becomes the shares cost base and immediately allocate those shares to employees giving rise to a deemed sale price of their market value at that time.

Therefore no capital gain should arise to the trustee of the trust due to the acquisition price of the shares to the trustee and the market value of the shares at the time the employees become absolutely entitled to the shares being the same.

In addition, section 130-90 of the ITAA 1997 should also apply to exempt any capital gains tax liability to the trustee.

Section 130-90 of the ITAA 1997 provides that:

130-90 (1) A capital gain or a capital loss a trustee or a beneficiary makes when the beneficiary becomes absolutely entitled to a share or right in a company is disregarded if these conditions are satisfied.

130-90 (1A) The beneficiary must be:

(a) an individual who receives (or is entitled to receive) withholding payments covered by subsection (5) from the company or from another company (at the time the beneficiary first became beneficially entitled to the *share or right); or

(b) an associate or affiliate company of such an individual; or

(c) an individual who is engaged in foreign service (within the meaning of section 139GBA of the Income Tax Assessment Act 1936), or an associate or affiliate company of such an individual.

130-90 (2) The terms of the trust must have required or authorised the trustee to transfer the share or right to the individual, associate or affiliate company.

 130-90 (3) One of the following paragraphs must apply:

(a) the individual, associate or affiliate company must have acquired the share or right:

(i) under an employee share scheme; or

(ii) alternatively in the case of a share as a result of exercising a right acquired under an employee share scheme; or 

(b) the share or right must, because of section 139DQ of the Income Tax Assessment Act 1936, be a share or right that is treated, for the purposes of Division 13A of Part III of that Act, as if it were a continuation of a share or right acquired under an employee share scheme;

(c) if the share was acquired as a result of exercising a right, the right must, because of section 139DQ of the Income Tax Assessment Act 1936, be a right that is treated, for the purposes of Division 13A of Part III of that Act, as if it were a continuation of a right acquired under an employee share scheme.

130-90 (4) The individual, associate or affiliate company must not have acquired the share or right for more than the cost base of the share or right (in the hands of the trustee) at the time of the transfer. 

On the basis of the following, we consider that the employee becoming absolutely entitled to the shares under the company X equity plans will not cause the trustee of the trust to have a capital gain or loss:-

· as the employees will be receiving salary and wages when they become beneficially entitled to the share, the requirement of paragraph 130-90(1A)(a) of the ITAA 1997 will therefore be satisfied

· in respect of foreign employees, they qualify as 'an individual engaged in foreign service' under paragraph 130-90(1A)(c) of the ITAA 1997

· as the trust deed authorises the trustee to transfer the shares to the employee, the requirements of sub-section 130-90(2) of the ITAA 1997 are satisfied

· in respect of a company X equity plan, each share to which an employee has become presently entitled was either acquired under an employee share scheme or as a result of exercising a right acquired under an employee share scheme per subparagraph 130-90(3)(a)(i) of the ITAA 1997

· in respect of a company X equity plan, the performance rights had a nominal or nil exercise price. Under the plan involving shares there is no acquisition price for shares. Therefore, it is not possible for employees to acquire the shares to which they are absolutely entitled at more than the cost base to the trustee. Subsection 130-90(4) of the ITAA 1997 is satisfied, and

· Furthermore, ATO ID 2008/149 (withdrawn 19 February 2010) confirms that where an employee acquires a share in a company from a trustee of an employee share trust, and as consideration for that share pays an amount to the company as a contribution to share capital, that payment is not taken in to account in calculating the amount for which the employee acquired the share for the purposes of subsection 130-90(4) of the ITAA 1997. This ATOID remains relevant in interpreting the former section 130-90 of the ITAA 1997 applicable to rights acquired prior to 1 July 2009.

It is noted that amendments to subsection 130-90(3) of the ITAA 1997 from 13 May 2008 brought shares acquired from exercising a right under an employee share scheme within the provisions of former section 130-90 of the ITAA 1997.

For the reasons detailed above, it is submitted that there should be no capital gain or capital loss to the trustee of the trust when the shares are transferred by the trustee of the trust to the executives and/or employees under each of the company X equity plans.

Application of the new section 130-90 of the ITAA 1997 to employee share rights

The new section 130-90 of the ITAA 1997 was introduced as part of the Taxation Laws Amendment (2009 Budget Measures No. 2) Bill and applies in relation to the ESS interests mentioned in subsections 83A-5(1) and 83A-5(2) of the Income Tax Transitional Provisions Act 1997 (ITTPA 1997).

The new section 130-90 of the ITAA 1997 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.

Subsections 83A-5(1) and 83A-5(2) of the ITTPA 1997 provide that:

83A-5(1)

Division 83A of the Income Tax Assessment Act 1997 applies in relation to an ESS interest if:

(a) the interest was acquired on or after 1 July 2009; and

(b) the relevant share or right (within the meaning of Division 13A of Part III of the Income Tax Assessment Act 1936, as in force at the time (the pre-Division 83A time) occurring just before Schedule 1 to the Tax Laws Amendment (2009 Budget Measures No 2) Act 2009 commenced, (former Division 13A) was not acquired (within the meaning of former Division 13A) before 1 July 2009.

83A-5(2)

Furthermore, Subdivision 83A-C of the Income Tax Assessment Act 1997 (and the rest of Division 83A of that Act, to the extent that it relates to that Subdivision) also applies in relation to an ESS interest if:

(a) all of the following subparagraphs apply:

(i) at the pre-Division 83A time, subsection 139B(3) of the Income Tax Assessment Act 1936 applied in relation to the interest;

(ii) the interest was acquired (within the meaning of former Division 13A) before 1 July 2009;

(iii) the cessation time mentioned in subsection 139B(3) of the Income Tax Assessment Act 1936, as in force at the pre-Division 83A time, for the interest did not occur before 1 July 2009; or

(b) all of the following subparagraphs apply:

(i) at the pre-Division 83A time, section 26AAC of the Income Tax Assessment Act 1936, as in force at that time, (former section 26AAC) applied in relation to the interest;

(ii) the interest was acquired (within the meaning of former section 26AAC) before 1 July 2009;

(iii) an amount has not been included in a person's assessable income under former section 26AAC in relation to the interest before 1 July 2009.

Therefore rights issued to employees of company X under a company X rights plan before 1 July 2009 will fall within the application of subsections 83A-5(1) and 83A-5(2) of the ITTPA 1997 where, in broad terms, the cessation time mentioned in subsection 139B(3) of the ITAA 1936 had not occurred prior to 1 July 2009.

Employee share trust

Subsection 130-85(4) of the ITAA 1997 defines an employee share trust as:

130-85(4)

An employee share trust, for an *employee share scheme, 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).

ATO ID 2010/108 is relevant to the Commissioner's views on whether a trust is an employee share trust within the meaning of subsection 130-85(4) of the ITAA 1997.

The trust is an employee share trust, as defined in subsection 995-1 of the ITAA 1997 as the activities of the trust 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 to paragraph 130-85(4)(c) of the ITAA 1997.

This conclusion is supported by the trust deed which stipulates that the trustee must manage the trust as to satisfy the sole activities test under Division 13A of the ITAA 1997 and be an employee share trust as defined.

The trust deed outlines the permitted activities of the trust. The functions of the trust are limited to those activities mentioned in paragraph 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997, or are merely incidental activities as per paragraph 130-85(4)(c) of the ITAA 1997.

Disregarding the capital gain or loss

Paragraph 130-90(1)(a) of the ITAA 1997 requires the capital gain or capital loss made by the employee share trust to result from either CGT event E5 or E7.

CGT event E5 will occur at the time when the beneficiary becomes presently entitled to a CGT asset (subsection 104-75(2) of the ITAA 1997). Where shares are allocated to employees on the exercise of rights under rights plans, CGT event E5 occurs at this time.

Paragraphs 130-90(1)(b), 130-90(1)(c) and 130-90(1)(d) of the ITAA 1997 are satisfied on the basis that the employees become absolutely entitled to shares by exercising rights which are subject to taxation under Subdivision 83A-C of the ITAA 1997.

Subsection 130-90(2) of the ITAA 1997 is satisfied on the basis the beneficiary will 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 of CGT event E5.

Therefore, there will be no capital gain or loss to the trustee of the trust at the time the employee becomes absolutely entitled to the shares arising form company X equity plans provided subsection 130-90(2) of the ITAA 1997 is satisfied.

Tax treatment of shares under the new law

Subsection 130-85(2) of the ITAA 1997 applies to interests in employee share trusts. It will apply to the employee deferred share plan (DSP) because:

· the shares will be acquired by the employee under an employee share scheme in accordance with paragraph 130-85(1)(a) of the ITAA 1997

· Subdivision 83A-B or 83A-C of the ITAA 1997 applies to the ESS interest pursuant to paragraph 130-85(1)(b) of the ITAA 1997, and

· the ESS interest (the shares) will be an interest that is held by the employee (beneficially) in an employee share trust pursuant to paragraph 130-85(1)(c) of the ITAA 1997.

As discussed above, the trust is considered to qualify as an employee share trust, as defined.

Subsection 130-85(2) of the ITAA 1997states:

Division 83A (Employee share schemes), Part 3-1 (Capital gains and losses: general topics) and this Part apply as if you were absolutely entitled to the relevant share or right:

(a) from the time of acquisition of the ESS Interest; and

(b) until you no longer have an ESS Interest in the share or right.

The effect of subsection 130-85(2) of the ITAA 1997 is that the employee is taken to be absolutely entitled to the share from the time that it is acquired by the employee under the employee share scheme.

The time of acquisition occurs when:

· in the case of on-market acquisition, the time the contract to acquire the shares is entered into by the trustee (Event A1 in subsection 109-5(2) of the ITAA 1997), and

· in the case of shares issued to the trustee by company X, at the time the contract to issue or allot the shares is entered into by the trustee (item 2, section 109-10 of the ITAA 1997).

As you have advised that the shares acquired by the trustee in respect of the deferred share plan are to be allocated by the trustee to the employees at the same time as the trustee enters into the contract to acquire the shares, the time of acquisition of the shares by the trustee and the time of CGT event E5 will be the same.

There should be no capital gain or loss under CGT event E5 at the time the employee becomes presently entitled to the shares in company X, on the basis that there will be no change in market value.

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