Edited version of private ruling

Authorisation Number: 1011772434742

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Ruling

Subject: Executive Share Trust

Question 1

To the extent that the dividends distributed to the employee constitute franked distributions for the purposes of Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997), will the employee be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997?

Answer

No

Question 2

In the event that the employee will not be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997, will the Commissioner determine that his interest in the allocated shares is to be taken to be vested and indefeasible in accordance with subsection 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following periods:

Income Tax Year ended 30 June 2011

Income Tax Year ended 30 June 2012

Income Tax Year ended 30 June 2013

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The Employer intends to implement a long term equity plan for the purpose of providing a long term equity incentive structure to deliver equity based benefits to the Employee and other employees selected by the board of the Employer.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 1A Part IIIAA.

Income Tax Assessment Act 1936 Section 160APHD.

Income Tax Assessment Act 1936 Subsection 160APHJ(5).

Income Tax Assessment Act 1936 Section 160APHL.

Income Tax Assessment Act 1936 Subsection 160APHL(1).

Income Tax Assessment Act 1936 Subsection 160APHL(2).

Income Tax Assessment Act 1936 Subsection 160APHL(3).

Income Tax Assessment Act 1936 Subsection 160APHL(4).

Income Tax Assessment Act 1936 Subsection 160APHL(5).

Income Tax Assessment Act 1936 Subsection 160APHL(6).

Income Tax Assessment Act 1936 Subsection 160APHL(7).

Income Tax Assessment Act 1936 Subsection 160APHL(10).

Income Tax Assessment Act 1936 Subsection 160APHL(11).

Income Tax Assessment Act 1936 Subsection 160APHL(12).

Income Tax Assessment Act 1936 Subsection 160APHL(13).

Income Tax Assessment Act 1936 Subsection 160APHL(14).

Income Tax Assessment Act 1936 Subsection 160APHM(2).

Income Tax Assessment Act 1936 Subsection 160APHM(3).

Income Tax Assessment Act 1936 Section 160APHO.

Income Tax Assessment Act 1936 Subsection 160APHO(3).

Income Tax Assessment Act 1936 Section 160APHP.

Income Tax Assessment Act 1936 Subsection 160APHP(2).

Income Tax Assessment Act 1997 Subsection 130-85(4).

Income Tax Assessment Act 1997 Section 207-45.

Income Tax Assessment Act 1997 Subsection 207-50(3).

Income Tax Assessment Act 1997 Subsection 207-150(1).

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the employee.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

To the extent that the dividends distributed to the employee constitute franked distributions for the purposes of Subdivision 207-B of the ITAA 1997, will the employee be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997?

No.

Pursuant to subsection 207-50(3) of the ITAA 1997, a franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

(d) the distribution is made to the trustee of the trust, or flows indirectly to the trustee from another trust distribution;

(e) the beneficiary has a share of the trust net income for that year; and

(f) the beneficiary's share of the franked distribution is positive.

Therefore, if a franked distribution is made to the trustee and the employee receives a share of the trust net income for that income year, a franked distribution is taken to flow indirectly to the employee.

Entities to whom a franked distribution flows indirectly in an income year may be entitled to a tax offset for that income year, equal to the amount of their share of the franking credits attached to the distribution as provided under section 207-45 of the ITAA 1997, subject to the operation of subsection 207-150(1) of the ITAA 1997.

Qualified person

Where a franked distribution flows indirectly to an entity in an income year, subsection 207-150(1) of the ITAA 1997 will deny the tax offset otherwise provided under section 207-45 of the ITAA 1997 if the taxpayer is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Broadly, to be a qualified person in relation to a distribution, a taxpayer as a beneficiary of a trust must satisfy the holding period rule under either former section 160APHO or former section 160APHP of the ITAA 1936. To satisfy the holding period rule as a beneficiary of a non-widely held trust, the interest in the ordinary shares to which a distribution relates must be held at risk for a period of at least 45 days for the purposes of former section 160APHO. In the scenario of a widely held trust, the interest in the shares contained in the trust holding must also be held at risk for a period of at least 45 days for the purposes of former section 160APHP. Further, in determining whether the holding period requirements are satisfied for the prescribed minimum period, no account is taken of any days on which the taxpayer has materially diminished risks of loss and opportunities for gain in respect of the shares as prescribed under either former subsections 160APHP(2) or 160APHO(3) of the ITAA 1936, as the case may be.

A taxpayer is taken to have materially diminished risks of loss and opportunities for gain with respect to shares if their net position results in them having less than 30 per cent of the risks and opportunities relating to the shares, as provided by former subsection 160APHM(2) of the ITAA 1936. A taxpayer's net position is defined at former subsection 160APHJ(5) of the ITAA 1936 and is worked out using the financial concept known as delta (former subsection 160APHM(3) of the ITAA 1936). Broadly, to have a net position equal to 30 per cent of the risks and opportunities with respect to a share requires a delta of +0.3.

As the employee will be a beneficiary of the Trust, former section 160APHL of the ITAA 1936 is the relevant provision to determine his interest in the shares held by the trust. However, as we have been advised that the number of potential participants may be anywhere between X and X0 persons, it is necessary to canvass both the widely held and non-widely held scenarios of former section 160APHL. In this context, it should be noted that the term 'widely held trust' is defined in former section 160APHD of the ITAA 1936 as a trust that is neither a 'closely held fixed trust' nor a 'non-fixed trust' (as those terms are themselves defined in former section 160APHD). For the purposes of former section 160APHL, if a trust is not a widely held trust it is treated as 'other than a widely held trust', referred to as the non-widely held scenario under this ruling.

The widely held scenario

As is made clear in the explanatory memorandum (EM) that accompanied the introduction of the qualified person rules, in the widely held scenario it is necessary to examine the nature of the interest a beneficiary has in all the shares held by the trust, as stated at paragraph 4.78 of the EM:

"…for beneficiaries of a widely held trust, it is the interest in all the shares held from time to time by the trust that is relevant in determining whether a beneficiary holds an interest at-risk for the requisite period. … Therefore the interest in shares of a beneficiary of a widely-held trust is taken to be that beneficiary's share of the dividend income from all shares held by the trust in respect of which the beneficiary receives a distribution, expressed as a proportion of the total dividend income received by the trust in relation to those shares."

This process as described in the EM is achieved through the combined operation of former subsections 160APHL(2), (4) & (6) of the ITAA 1936, where the trust holding is defined and a taxpayer's interest in the trust holding is calculated.

The next step is to allocate a 'position' to the interest pursuant to former section 160APHL of the ITAA 1936. Accordingly, former subsection 160APHL(7) of the ITAA 1936 operates to attribute a delta of +1 to the interest in the shares held by a beneficiary of a widely held trust. Therefore, the Employee will have a long position with a delta of +1 in relation to any shares held by the trust under this provision.

However, as a family trust election has not been and will not be made and the trust arrangement does not give rise to an employee share scheme security, former subsection 160APHL(10) of the ITAA 1936 may attribute additional positions to the employee. These additional positions are:

(e) a short position equal to his long position, as determined under former subsection 160APHL(7) of the ITAA 1936; and

(f) a long position equal to so much of the employee's interest in the trust holding that is a fixed interest.

In this context, the trust arrangement is not considered to give rise to an 'employee share scheme security' as it fails the sole activity test of the definition of that term contained in former section 160APHD of the ITAA 1936. In particular, the trust deed indicates that any money the trust receives from the employer shall be applied by the trustee in making loans to eligible employees to facilitate the acquisition of units in the trust. This provision of financial accommodation is considered to provide employees with an additional benefit that is inconsistent with the sole activity test of the definition. This conclusion is consistent with ATO Interpretative Decision ATO ID 2010/108, which reaches a similar conclusion in the context of the definition of 'employee share trust' contained in subsection 130-85(4) of the ITAA 1997, even though that definition contains an exclusion for other activities that are merely incidental. Further, given that it appears that the intent of the trust, as confirmed within the application for this ruling, is to include the redemption of units held by employee participants rather than issue shares to them, it is questionable that the sole activity test would be satisfied in any event.

Accordingly, as the employee has a long position with a delta of +1 in relation to the shares under former subsection 160APHL(7) of the ITAA 1936, he will have a corresponding short position with a delta of -1 under former subsection 160APHL(10) of the ITAA 1936.

Under former subsection 160APHL(10) of the ITAA 1936, an additional long position will arise in relation to so much of the employee's interest in the trust holding as is a fixed interest. Former subsection 160APHL(11) of the ITAA 1936 states that a beneficiary's interest in a trust is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding. For these purposes, the trust holding is the shares or interest in shares that has paid the trust a dividend (see former subsections 160APHL(2) and (4) of the ITAA 1936). The interest being tested under former subsection 160APHL(11) is the actual interest held by the employee in so much of the corpus of the trust as is comprised by the shares.

Vested and indefeasible interest

Pursuant to former subsection 160APHL(12) of the ITAA 1936, subject to subsection 160APHL(13) of the ITAA 1936, the interest held by the employee will be taken to be defeasible if the interest in the trust holding may be redeemed for less than its value, or if the value of the interest in the trust holding may be materially reduced by the issue of further units. However, under subsection 160APHL(13) of the ITAA 1936, where the units in the trust are redeemable or further units are able to be issued for a price determined on the basis of the trust's net asset value, according to Australian accounting principles, at the time of the redemption or issue, this does not mean the taxpayer's interest is defeasible.

Pursuant to the trust deed, the trustee is empowered to issue additional units to unit holders, referred to as bonus units. Such bonus units are issued for no consideration. Accordingly, the exclusion in former subsection 160APHL(13) of the ITAA 1936 does not apply as the bonus units are not issued for a price determined based on the trust's net assets. Further, having regard to the manner in which the trust deed provides for the cancellation entitlement of each bonus unit (determined by reference to its redemption distribution which is determined by reference to the lower of the issue price or share unit distribution entitlement of the unit) to effectively match the value of the original unit in respect of which the bonus unit was issued, it is considered that this is a situation in which the value of the existing interests may be materially reduced. This conclusion is reinforced by the operation of the trust deed, which allows the trustee to meet any cancellation entitlements (including those for the bonus units) out of the trust fund (which itself is widely defined to encompass all property of the trust).

In simple terms, it is considered that the issue of the bonus units creates something of value for a holder in that it gives rise to the cancellation entitlement. The trustee is allowed recourse to the trust fund to meet the cancellation entitlement. As nothing of value is provided for the issue of the bonus unit, this recourse to the trust fund to meet the cancellation entitlement is considered to materially reduce the value of the existing units on issue which would constitute the interest being defeasible for the purposes of former subsection 160APHL(12) of the ITAA 1936. Accordingly, in and of itself this would lead to the employee's interest not being regarded as a fixed interest from a legislative perspective, and thus other elements of potential defeasibility from a general trust law perspective have not been considered.

The non-widely held scenario

Under the non-widely held scenario, it is necessary to examine the nature of the interest a beneficiary has in the shares that comprise the trust holding in which the beneficiary has an indirect interest. This is determined by the operation of former subsections 160APHL(1), (3) and (5) of the ITAA 1936 by reference to the beneficiary's proportionate share of the dividend income derived by the trust. In the current circumstances, the employee's interest in the trust holding is the allocated shares referable to his units. In this instance, it will be the employee's interest in the specific shares held by the trustee for his benefit that will be tested for the purposes of former Division 1A of Part IIIAA of the ITAA 1936.

The next step is to allocate a 'position' to the interest pursuant to former section 160APHL of the ITAA 1936. Accordingly, former subsection 160APHL(7) of the ITAA 1936 operates to attribute a delta of +1 to the interest in the shares held by a beneficiary of a non-widely held trust. Therefore, the employee will have a long position with a delta of +1 in relation to any shares held by the trust under this provision.

However, as a family trust election has not been and will not be made and the trust arrangement does not give rise to an employee share scheme security (as examined above), former subsection 160APHL(10) of the ITAA 1936 may attribute additional positions to the employee. These additional positions are:

(g) a short position equal to his long position, as determined under former subsection 160APHL(7) of the ITAA 1936; and

(h) a long position equal to so much of the employee's interest in the trust holding that is a fixed interest.

Accordingly, as the employee has a long position with a delta of +1 in relation to the shares under former subsection 160APHL(7) of the ITAA 1936, he will have a corresponding short position with a delta of -1 under former subsection 160APHL(10) of the ITAA 1936.

Under former subsection 160APHL(10) of the ITAA 1936, an additional long position will arise in relation to so much of the employee's interest in the trust holding as is a fixed interest. Former subsection 160APHL(11) of the ITAA 1936 states that a beneficiary's interest in a trust is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding. For these purposes, the trust holding is the allocated shares held by the trustee and which has paid the trust a dividend (see former subsections 160APHL(1) and (3) of the ITAA 1936). The interest being tested under former subsection 160APHL(11) of the ITAA 1936 is the actual interest held by the employee in the allocated shares referable to the units that form the employee's proportionate interest in the trust holding.

Vested and indefeasible interest

Pursuant to former subsection 160APHL(12) of the ITAA 1936, subject to subsection 160APHL(13) of the ITAA 1936, the interest held by the employee will be taken to be defeasible if the interest in the trust holding may be redeemed for less than its value, or if the value of the interest in the trust holding may be materially reduced by the issue of further units. However, under former subsection 160APHL(13) of the ITAA 1936, where the units in the trust are redeemable or further units are able to be issued for a price determined on the basis of the trust's net asset value, according to Australian accounting principles, at the time of the redemption or issue, this does not mean the taxpayer's interest is taken to be defeasible.

Subsequent to the making of a loan to the employee for units in the trust, pursuant to the trust deed, the trustee shall designate the shares acquired under the trust deed as allocated shares referable to the employee's units. It is the employee's interest in these allocated shares that is subject to testing under former section 160APHL of the ITAA 1936. Further, the trust deed is intended to 'effectively staple' the allocated shares to the units through conferring a fixed interest in the allocated share.

However, as examined above, pursuant to the trust deed, the trustee is empowered to issue bonus units to unit holders for no consideration, for which the cancellation entitlement on redemption of the bonus units will effectively match the value of the original unit in respect of which the bonus unit was issued. Accordingly, this is a situation in which the value of the existing interests may be materially reduced. This conclusion is reinforced by the operation of the trust deed, which allows the trustee to meet any cancellation entitlements out of the property of the trust. The practical effect of this is that the employee's entitlement to his interest in the trust holding comprised of allocated shares is capable of divestment through the redemption of bonus units. The issue and redemption of bonus units provides a favourable outcome to the unit holder in which they were issued as examined above and as such must be considered likely for the purposes of this analysis.

Accordingly, notwithstanding the employee's units are not subject to vesting conditions, his interest in the trust holding is indefeasible and as such, the interest will not be a fixed interest under former subsection 160APHL(11) of the ITAA 1936.

Conclusion

The employee will have a long position with a delta of +1 under former subsection 160APHL(7) of the ITAA 1936 and a short position with a delta of -1 under former subsection 160APHL(10) of the ITAA 1936, resulting in a net position of zero in relation to the shares held by the trust. The employee will not have an additional long position under former subsection 160APHL(10) and will consequently have materially diminished risks of loss or opportunities for gain in relation to the shares.

As a result, the employee will not be able to satisfy the holding period rule of former section 160APHP of the ITAA 1936 and will not be capable of being considered a qualified person in relation to the distribution on the shares for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. Accordingly, pursuant to the operation of subsection 207-150(1) of the ITAA 1997, the employee will not be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997.

Question 2

In the event that the employee will not be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997, will the Commissioner determine that his interest in the allocated shares is to be taken to be vested and indefeasible in accordance with subsection 160APHL(14) of the ITAA 1936?

No.

As the arrangement falls within the specific statutory provision that provides that certain interests are taken to be defeasible, it is considered that it would be inconsistent with the statutory regime of former section 160APHL of the ITAA 1936 to exercise the discretion in former subsection 160APHL(14) of the ITAA 1936.

Having regard to the overall arrangement as provided in the trust deed, it would seem that the intent would be for defeasance to take place on a regular basis. Absent the issue of the bonus unit with its attendant cancellation entitlement, it would appear that the employee would receive little in the way of incentive to participate in the arrangement, apart from potential upside from increases in the value of a share. However, if the employee also receives bonus units, then the cancellation entitlement of these units (met out of trust property generally as no contribution was made for these units) would cover his initial loan liability and leave him with his original unit cancellation entitlement (potentially as a CGT disposal rather than salary and wages). In these circumstances, given the superior outcome to the Employee of the issue and redemption of bonus units it must be regarded as a likely outcome of the arrangement and thus it is considered likely that the defeasance spoken about previously would be likely to happen. This would be another factor that would mitigate against the Commissioner exercising his discretion in former subsection 160APHL(14) of the ITAA 1936 in these circumstances.

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