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Edited version of private ruling

Authorisation Number: 1011775226875

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Ruling

Subject: Employee Share Trust

Question 1

Will the irretrievable cash contributions to the Trustee by the companies subsidiaries be assessable income of the Trust pursuant to section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Part A. Will the irretrievable cash contributions to the Trustee by the companies subsidiaries be assessable income of the Trustee pursuant to section 44, via the application of Section 109C of the Income Tax Assessment Act 1936 (ITAA 1936)?

Part B. Will the irretrievable cash contributions to the Trustee by the companies subsidiaries be assessable income of the Trustee pursuant to section 44, via the application of Section 318 of the ITAA 1936?

Answer

Part A. No

Part B. No

Question 3

Will a capital gain tax (CGT) event arise for the Trustee of the Trust at the time when the employees become absolutely entitled to the shares under section 104-75 of the ITAA 1997?

Answer

Yes

Question 4

Will the acquisition of a Share in the company in return for payment of market value consideration be subject to Division 83A of the ITAA 1997 to the Trustee?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1st July 2011

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 company is a privately owned company which has three wholly owned operating subsidiaries.

The company is the head entity of the tax consolidated group including itself and the subsidiaries.

The Trustee is currently owned by the company however it is intended that prior to implementation of the arrangements that its ownership will be changed such that the shares in the Trustee will be owned by two directors of the company. The Directors will jointly own the only share of the Trustee and will be its only directors. The Trustee is currently a non-operating company.

These two Directors will have no influence over the arrangement. The Trustee is bound to act in accordance with the Plan Rules and Trust Deed. The Trustee will only act in accordance with its fiduciary duties which are stipulated in the Plan Rules and the Deed and cannot perform actions or duties unless authorised to do so under the Plan Rules and Trust Deed.

These two Directors will not be able to benefit from this arrangement as the intention of the arrangement is to offer shares to employees who are not shareholders.

One Director does not directly own any shares however he does have an indirect interest in the shares in the company via various other entities. The other Director does not own any shares in the organisation.

The arrangement proposes to offer Class B shares in the company to selected employees. Shares will be funded through contributions made by the companies subsidiaries to the Trustee which in turn will make loans to employees for this purpose. Shares acquired through such loans will be held by the Trustee absolutely on behalf of the employees. This arrangement is referred to as the Loan Share Plan (Plan).

The companies' subsidiaries will irretrievably contribute money to the Trust as the need to fund the acquisition of shares by employees participating in the Plan arises. The potential beneficiaries of the Trust will be the employees of the company group.

The Board will determine which employees will be eligible to participate in the Plan. None of those employees will be current shareholders of the company nor related to any of the shareholders.

Offers will be made to eligible employees.

Once offers are accepted, the Trustee will lend funds on an interest-free basis to those employees who have accepted. The loans will generally be full recourse loans although the Trustee will have the ability to make loans on a partial or limited recourse basis. The Trustee will have security over the Shares beneficially held by the employees.

Employees must use the loan funds received to acquire an interest in the Trust at fair market value, with the interest corresponding to underlying Shares in the company.

The Trust will then subscribe for new Shares in the company at the fair market value and designate particular shares as allocated to particular employees corresponding to the employee's share interest in the Trust. The employees will be absolutely entitled to the Shares from the time of allocation.

Dividends may be paid of the Shares held by the Trust and flow through to the employees, although part or all of the dividend payment may be used to repay the loans.

The shares will be held in the Trust for the employees with each employee having a beneficial interest in a number of shares and absolute entitlement to those shares. The trustee will be the registered legal owner of the Shares.

Upon meeting the relevant vesting conditions, the directors would then use their best efforts to provide liquidity so that the employees' interests in the shares could be cashed out and the remaining balance of the related loan repaid to the Trustee.

Employee's who leave the employ of the group of companies prior to the vesting, will be classified as either good or bad leavers which will determine how many of the Shares vest and the payout value.

Employees are liable for the full loan balance outstanding at vesting, unless the Board exercises its discretion to waive any shortfall between the payout value of the Shares and the remaining balance of the related loan at vesting.

Once the employee has repaid the loan they become the owner of the shares unless the employees are "other leavers", who are required to hand back their shares in satisfaction of their loans.

Taxation of the employees will depend on how the liquidity is provided e.g. sale to other employees or share buy-back.

The Trust will be established in the current financial year (2011). Its purpose will be to make loans to employees to enable them to acquire Shares via the Trust and hold those Shares on their behalf.

The amount of the cash contribution made by the company to the Trust is equal to the fair market value of Shares that are to be offered to employees by the Trust through the Loan Plan.

The B Class Shares will have the following features:

Further facts relating to the scheme will not be provided due to there commercial in-confidence nature.

Relevant legislative provisions

Section 95 of the ITAA 1936

Section 6-5(1) of the ITAA 1997

Section 6-10(1) of the ITAA 1997

Section 10-5 of the ITAA 1997

Division 7A of the ITAA 1936

Subsection 44(1) of the ITAA 1936

Section 109C(1) of the ITAA 1936

Section 109Z of the ITAA 1936

Section 318(1) of the ITAA 1936

Section 318(2) of the ITAA 1936

Section 318(3) of the ITAA 1936

Section 109ZB(3) of the ITAA 1936

Section 109ZB(1) of the ITAA 1936

Section 109ZE of the ITAA 1936

Subdivision E in Division 7A of the ITAA 1936

Section 109T of the ITAA 1936

Section 104-75(1) of the ITAA 1997

Section 104-75(3) of the ITAA 1997

Section 104-75(5) of the ITAA 1997

Section 109-5(2) of the ITAA 1997

Section 15-2 of the ITAA 1997

Section 110-25 of the ITAA 1997

Section 104-5 of the ITAA 1997

Division 115 of the ITAA 1997

Subsection 207-50(3) of the ITAA 1997

Subsection 207-150(1)(a) of the ITAA 1997

Section 207-45 of the ITAA 1997

Section 160APHP of the ITAA 1936

Division 1A of former Part IIIAA of the ITAA 1936

Subsection 960-100(4) of the ITAA 1997

Reasons for decision

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

Summary

No

Detailed reasoning

Section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) defines net income in relation to a trust as follows insofar as it is relevant:

 Subsection 6-5(1) of the ITAA 1997 states:

 And subsection 6-10(1) states:

None of the provisions listed in section 10-5 of the ITAA 1997 are relevant in this situation and therefore irretrievable contributions will be net income of the trust only if they are income according to ordinary concepts.

The trust deed obliges the Trustee to hold the trust fund on trust for the beneficiaries in the manner required by the Plan Rules. It must, subscribe for or acquire and hold Class B shares in the Company for the benefit of Participants under the terms of the Plan and for holding shares on behalf of participants in any other employee equity plans established by the Company.

Consistent with ATO ID 2002/965, as contributions to the Trustee are used in accordance with the Trust Deed and Plan Rules for the sole purpose of providing shares under the employee share schemes, contributions will constitute capital receipts of the Trustee, and will not be assessable under sections 6-5 or 6-10 of the ITAA 1997.

Question 2

Summary

Part A. No

Part B. No

Detailed reasoning

Although the contributions are not assessable under section 6-5 or 6-10 of the ITAA 1997 as determined above, this does not disqualify the amount from being considered a payment and assessable under Division 7A.

Division 7A of the ITAA 1936 was introduced to ensure that all advances, loans, and other credits (unless they come within specified exclusions) by private companies to shareholders (and their associates), are treated as assessable dividends to the extent that there are realised or unrealised profits in the company. In addition, debts owed by shareholders (or associates) which are forgiven by private companies are treated as dividends.

Subsection 44(1) of the ITAA 1936 requires that the assessable income of a resident shareholder in a company include dividends that are paid to the shareholder by the company out of profits derived by it from any source.

A private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:


(a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or


(b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time.

Where sub-section 109C(1) applies, then section 109Z of the ITAA 1936 will apply as follows:

If a private company is taken under this Division to have paid a dividend to an entity, the dividend is taken for the purposes of this Act to be paid:


(a) to the entity as a shareholder in the private company; and


(b) out of the private company's profits.

In this case when we consider sub-section 109C(1) it does not apply for the following reasons.

(i) Payment not received by a Shareholder.

The Trustee is currently owned by the company however it is intended that prior to implementation of the arrangements that its ownership will be changed. Therefore the Trustee is not the shareholder of the company or its subsidiaries.

(ii) Payment not received by an associate of a shareholder.

We need to examine subsection 318(2) of the ITAA 1936, associates of a company, to determine if the Trustee is an associate of the company shareholder. This subsection states the following:

318(2)  Associates of a company  

For the purposes of this Part, the following are associates of a company (in this subsection called the "primary entity"):


(a) a partner of the primary entity or a partnership in which the primary entity is a partner;

(b) if a partner of the primary entity is a natural person otherwise than in the capacity of trustee - the spouse or a child of that partner;


(c) a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;


(d) another entity (in this paragraph called the "controlling entity") where:

Paragraphs 318(2)(a) and (b) do not apply in this case as the entities involved are not partners or a partnership.

Paragraph 318(2)(c) will apply if the company or any of its associates under paragraphs 318(2)(a), (b), (d), (e) or (f) benefit under the trust. You have stated that only eligible employees can benefit under the Trust and none of those employees will be shareholders of the company or associates of the company. None of the Participants in the Plan will be shareholders of the company or associates of the company.

With respect to paragraph 318(2)(d). Presently the company has four Directors and an alternate director, of which two are said to own shares in the trustee company under the structure when it is approved. The two Directors who will be shareholders of the Trustee will have no influence over the arrangement. The Trustee is bound to act in accordance with the Plan rules and the Trust Deed. The Trustee will only act in accordance with its fiduciary duties which are stipulated in the Plan rules and the Trust Deed and cannot perform actions or duties unless authorised under the Plan rules and the Deed.

You have advised that the company has a controlling shareholder who has control over the company, and that the Trustee is not an associate of the controlling shareholder. Where this is the case, paragraph 318(2)(d) will not have any application, to payments made to the trust, or subsequent amounts that the eligible employees are made presently entitled.

You have advised that it is intended that the maximum amount of equity available under the Plan will be 10%, given that the equity being issued is non-voting class b shares, Division 7A will not have any application to shares issued to employees, excluding the two directors of the trust, under the plan.

Section 109ZE of the ITAA 1936 and subsection 960-100(4) of the ITAA 1997 clarify that paragraph 318(2)(e) does not apply as the entity referred to in this paragraph is a company and not the trustee of a trust.

For paragraph 318(2)(f) to apply, the Trustee would have to be an associate of a third entity under subsection 318(1) or subsection 318(3) or another paragraph of subsection 318(2), where the third entity was an associate of the company because of paragraph 318(2)(d). You have advised that the company has a controlling shareholder, and that the Trustee is not an associate of the controlling shareholder. Therefore, paragraph 318(2)(f) does not apply.

We need to explore further subsection 318(3) of the ITAA 1936 as we are talking about a Trust. This subsection states the following:

For the purposes of this Part, the following are associates of a trustee (in this subsection called the "primary entity"):


(a) any entity that benefits under the trust;


(b) if a natural person benefits under the trust - any entity that, if the natural person were the primary entity, would be an associate of that natural person because of subsection (1) or because of this subsection;


(c) if a company is an associate of the primary entity because of paragraph (a) or (b) of this subsection - any entity that, if the company were the primary entity, would be an associate of the company because of subsection (2) or because of this subsection.

This subsection applies to determine if someone is associated with the Trustee of a trust. In this case the Trustee and the beneficiaries being the employees are unrelated to the controlling shareholder and cannot benefit from the Trust of which the controlling shareholder is a Trustee.

From the above analysis of section 318 of the ITAA 1936, it is evident that the Trustee is not as associate of the companies subsidiaries. Furthermore, as the Trustee is not a shareholder of the company or its subsidiaries, section 109C(1) of the ITAA 1936 does not apply. Consequently section 109Z of the ITAA 1936 does not apply to make the payment a dividend to the Trustee.

Question 3

Summary

No

Detailed reasoning

Section 104-75(1) of the ITAA 1997 states that a CGT Event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee.

The Trust Deed at clause 3.1(b) states the following:

The Trustee declares and agrees that:

In your client's case, it is necessary to determine when absolute entitlement occurs for the purpose of ascertaining whether the capital gains or losses are accepted.

The term " absolutely entitled" is not defined in the CGT legislation. However, there have been a number of UK decisions. In Saunders v Vautier(1841) 49 ER 282 absolute entitlement was described as the situation where the beneficiary is entitled to call for the transfer of the asset, or to require it to be dealt with in accordance with his/her directions.

In Hoare Trustees v Gardner (1978) STC 89, Brightman J, in considering a comparable provision in the United Kingdom legislation, said (at p 108) that the description of a person as being "absolutely entitled to an asset as against the trustee'' carries the implication that the expression is being used in the sense that that person is not necessarily absolutely entitled as against everyone else. Earlier, his Lordship had said that the concept of a person being absolutely entitled to an asset as against the trustee of the asset would not seem to pose great difficulties in most cases and went on to say:

If property is held by T, the trustee, in trust for L for life with remainder to R, R, if living at L's death, would then be absolutely entitled to that property as against T. If R were dead, one would think that R's executor would similarly be absolutely entitled to that property as against T, even if the executor is not beneficially entitled. If R's estate is fully administered and there has been an assent in favour of the trustees of R's will, one would think that the trustees of R's will had become absolutely entitled to the property as against T or as against R's executor, as the case might be. If R, in the lifetime of L, assigned his remainder interest to X, on L's death X would become absolutely entitled to the property as against T. The answer should be the same whether X is a person who became beneficially entitled by virtue of the assignment or whether he is the trustee of some new settlement. The absolute entitlement of the propositus as against T, the trustee, would appear to be reasonably clear in those cases as a matter of simple language. There is no particular reason to equate absolute entitlement with beneficial ownership in such cases, but rather with the ability to give a good discharge.

The above passage indicates that a person is absolutely entitled to property only if a good discharge can be given by the person on disposal of the interest in the property. In the above passage, L is never absolutely entitled to the property because any disposal of the life interest will be subject to the remainder passing to R on the death of L. On the other hand, R will only be absolutely entitled to the property once L dies because, before then, any disposal of the property by R can only be made subject to L's life interest.

Core principle of absolute entitlement

The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction. This derives from the rule in Saunders v. Vautier (1841) 4 BEAV 115 (Saunders v. Vautier) applied in the context of the CGT provisions. 

Rule in Saunders v. Vautier

Under the rule in Saunders v. Vautier, the courts do not regard as effective a direction from the settlor of the trust that purports to delay the beneficiary's full enjoyment of an asset. However, if there is some basis upon which a trustee can legitimately resist the beneficiary's call for an asset, then the beneficiary will not be absolutely entitled as against the trustee to it.  

Core principle: applying it in practice

The most straight forward application of the core principle is one where a single beneficiary has all the interests in the trust asset. Generally, a beneficiary will not be absolutely entitled to a trust asset if one or more other beneficiaries also have an interest in it.

One beneficiary with all the interests in a trust asset

A beneficiary has all the interests in a trust asset if no other beneficiary has an interest in the asset (even if the trust has other beneficiaries).

Such a beneficiary will be absolutely entitled to that asset as against the trustee for the purposes of the CGT provisions if the beneficiary can (ignoring any legal disability) terminate the trust in respect of that asset by directing the trustee to transfer the asset to them or to transfer it at their direction.

You have provided that the Trustee will hold the shares on behalf of the participants and that the participants are absolutely entitled to the shares, however this is subject to the Plan Rules and relevant Terms of Participation.

The Plan Rules at Clause X define the vesting conditions which provide for when the shares become vested to the participant.

Clause X of the Plan rules states that the vesting conditions means any time based and/or performance based criteria, requirements or conditions (as specified in the invitation letter and determined by the Board in its sole and absolute discretion) which must be met in order for the class B shares to become vested to a Participant.

In the example letter sent in by applicant, the vesting conditions state that the employee must remain employed for three years from the acquisition date before the Class B shares will be transferred from the Trustee to the employee.

Furthermore clause Y (a) and (b) provide that the vesting conditions as outlined in the invitation letter to the employee need to be satisfied or waived before the shares vest to a participant.

Clause Z(a) provides that the Trustee will be the registered, legal owner of all of the Class B shares held by it under clause Z(b) unless and until those Class B shares are vested in a Participant and withdrawn from the Plan or become Forfeited shares and are sold, disposed of otherwise dealt with in accordance with these Rules.

In addition clause 15.1 supports that the vesting conditions must be satisfied prior to the Class B shares being allocated to the participant.

Clause AA of the Plan Rules states that the beneficiary will not be absolutely entitled to the shares due to forfeiture.

As outlined in the Plan Rules and in particular the vesting conditions and forfeiture conditions it is evident that the employee is not absolutely entitled to the shares at the time they acquire a fixed interest in the trust. As the shares are held by the Trustee and there are vesting and forfeiture conditions, the employee or participant does not have the requisite vested and indefeasible interest in the asset of the Trust at that time.

Absolutely entitled beneficiary is the relevant taxpayer

Broadly, the provisions dealing with capital gains and losses treat an absolutely entitled beneficiary as the relevant taxpayer in respect of the asset. This means that if a CGT event happens in relation to the asset, such a beneficiary (and not the trustee) is responsible for any resulting capital gain or loss.

Where a beneficiary is absolutely entitled to an asset of a trust as against the trustee, section 106-50 of the ITAA 1997 treats an act done by the trustee as if the beneficiary had done it. Therefore, if section 106-50 applies, the disposal by the trustee is regarded as a disposal by the beneficiary.

CGT event E5

CGT event E5 happens, if a beneficiary becomes absolutely entitled to a CGT asset of a trust (subsection 104-75(1) of the ITAA 1997). In this case, the employee will be absolutely entitled to the CGT asset being the shares, from the time the shares become vested.

Section 104-75(3) of the ITAA 1997 goes on to say that the capital gain or loss to the Trustee will be equal to the market value of the asset at the time the beneficiary becomes absolutely entitled to the CGT asset less the Trustee's cost base in the asset.

This CGT event could result in the Trustee making a capital gain under section 104-75(3) of the ITAA 1997. You make a capital gain if the market value of the shares at the time of the event is more than the cost base of the shares, and you make a capital loss if the market value is less than the reduced cost base of the shares under subsection 104-75(3). As the Trustee acquired the shares after 20 September 1985, the Trustee could make a capital gain or loss at the time the beneficiary becomes absolutely entitled to the shares under subsection 104-75(2). 

Question 4

Summary

No

Detailed reasoning

Subject to the exceptions in section 83A-20, a taxpayer who acquires an Employee Share Scheme (ESS) interest at a discount must include the discount in assessable income, in the income year that the taxpayer acquires the ESS interest as defined in section 83A-25 of the ITAA 1997.

As the payment for the shares are made by the Trustee to pay full market value for the shares, then any interest that the Trustee acquires in the shares is not acquired at a discount, thus section 83A-25 of the ITAA 1997 will not apply.

Under section 83A-10(2) of the ITAA 1997,

(b) subsidiaries of the company;

in relation to the employees' employment".

While the shares acquired by the employees of the company and its subsidiaries are ESS as defined in the legislation, as the shares are acquired for the market value consideration, no discount is provided on acquisition of the shares. Therefore section 83A-25 of the ITAA 1997 will not apply.

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