Edited version of private ruling

Authorisation Number: 1011811671789

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Ruling

Subject: Employee share scheme

Relevant facts and circumstances

In its capacity as trustee of the Employee Share Trust (EST), the Trustee requested a private binding ruling, in respect of tax matters relating to the operation of an employee share scheme (ESS).

The ESS is comprised of several plans providing options, rights or shares.

For certain employees and executives, the remuneration strategy includes participation in the plans and thereby performance-linked payments of both cash and shares.

All ESS interests offered to participants are provided at a discount and in connection with the participants' employment.

In its letter of application, the employer (taxpayer company) states that the trustee and the EST facilitates the operation of the ESS, by providing commercial benefits, as follows:

· flexibility to accommodate the long term incentive arrangements as the group continues to expand

· capital management flexibility for the taxpayer company to acquire shares on market, or alternatively to subscribe for new shares in the employer

· the provision of an arm's-length vehicle through which shares in the employer can be acquired and held to satisfy corporate law requirements relating to the company dealing in their own shares.

The plans operate broadly as follows:

Options

· to encourage participation in the company through share ownership to attract, motivate and retain eligible participants

· taking into account skills, experience, length of service with the company and other criteria as considered appropriate

· options will be issued for no consideration

· options will not be quoted on the Australian Securities Exchange (ASX)

· an offer must be made using an offer document

· an offer is personal and not assignable

· exercise of options is limited to X% in the first 12 months; X% in the first 24 months; and X% in the first 36 months

· participants may exercise their options from the date the exercise conditions are satisfied and notice is provided to the employer

· unless otherwise determined by the board, unexercised options will lapse and all rights to them will be lost, subject to certain exercise conditions, if the participant:

o ceases employment

o dies, becomes permanently disabled, retires or is made redundant

o the exercise conditions are unable to be met; or

o when the lapsing date has passed (5 years from grant of options)

· each option entitles the holder to one share

· options granted to a participant may only be exercised by delivery to the company secretary of the certificate issued for them and payment of the exercise price

· within 10 business days of receipt of a certificate the board will instruct the trustee to acquire and allocate the shares and hold them on behalf of a participant

· the Trust Deed requires the employer to provide funds to the Trustee in order to allow it to acquire shares to be held on behalf of the participants

· from the date on which the Trustee holds any shares on behalf of a participant, the latter will be the beneficial owner of them and entitled to deal with them

· while shares are held in trust in the EST on behalf of participants, the participants will be entitled to dividend and voting rights.

Rights

· this is a plan for executives in which the number of performance rights is determined by dividing some of the executive's incentive under the plan by a volume weighted average share price of the company at the start of the financial year.

· the rights vest at the end of a performance period, subject to the participant satisfying the performance conditions (one ordinary share for every right). The shares are held in the EST on behalf of the participant who will be eligible to withdraw them, once the conditions are satisfied.

· the board, on recommendations from its remuneration committee (the committee) will consider the grant of performance rights annually, unless otherwise determined

· entitlement of eligible participants is to be determined by the board, on criteria as considered appropriate

· the invitation to participate will set out the performance condition applicable

· an invitation is not transferable

· following an invitation, an application for performance rights may be made by the eligible participant by sending an application to the company secretary

· performance rights granted under the plan will be free of charge

· at the end of each performance period the board, on recommendations from the committee will determine the performance rights that vest and advise the participant in writing

· unless otherwise designated by the company, the performance rights will vest at the end of the performance period

· performance rights will vest immediately (to the extent that the performance condition has been met):

o if there is a change of control event

o upon the retirement or retrenchment of the participant; or

o upon the death of the participant

· at the time the performance rights vest, the employer must direct the Trustee to subscribe for, acquire and/or allocate to the participant the number of shares specified in the notice and hold those shares in the EST on behalf of the participant

· the Trust Deed directs the taxpayer company to provide funds to the Trustee to allow it to subscribe for and/or acquire shares to be held on behalf of the participants

· the shares allocated will rank pari passu with other shares

· unless otherwise determined by the board, on recommendation from the committee, performance rights that do not vest will lapse

· if a participant ceases employment their performance rights may lapse, unless the board, on recommendation from the committee otherwise determines

· while shares are held in trust, the participants will be entitled to dividend and voting rights

· from and including the date on which the Trustee holds any shares on behalf of a participant, the latter will be the beneficial owner of them and entitled to deal with them

· the board must ensure that it does not grant performance rights under the plan if, when added to the number of options granted under the plan, they would exceed X% of the taxpayer company's issued capital.

Shares

· he plan provides eligible employees with an opportunity to acquire an ownership interest in the taxpayer company

· this plan provides guidance to employees as to their eligibility to receive a cash bonus and the election available to receive the bonus as shares in the taxpayer company

· the shares will vest when the participant's application to be issued shares in lieu of a cash bonus has been accepted. The shares will be held in the EST on behalf of the participant, as specified in the rules (i.e. disposal restrictions). When these conditions are satisfied, the participant will become eligible to withdraw the shares from the EST.

· from time to time the taxpayer company may invite eligible employees to participate in the plan on such terms and conditions as its board decides in regard to:

o number of shares

o amount payable; and

o any bonus election arrangement

· the invitation to the participant must be accompanied by an application form

· by submitting an application form each participant is deemed to agree to be bound by the terms of the invitation, the provisions of the rules and the constitution of the taxpayer company

· the Trust Deed requires the taxpayer company to provide funds to the Trustee in order to allow it to subscribe for and/or acquire shares

· all shares issued will be transferred or allocated to the Trustee to be held on behalf of the participant and will rank pari passu with shares of the same class

· the employer must ensure that a participant is notified when shares are acquired and registered in the name of the Trustee on behalf of that participant

· while shares are held in trust in the EST on behalf of participants, the participants will be entitled to dividend and voting rights

· a participant may submit a withdrawal notice to the employer in respect of some or all of their shares, that are not restricted shares

· the board may approve the withdrawal of shares from the Trust, if any of the following applies:

o the participant has submitted a withdrawal notice

o the participant ceases to be an employee

o the last withdrawal date has been reached

· the Trustee must administer the EST and hold shares under the plan in accordance with this plan, the Trust Deed and as agreed to between the board and the trustee

· where the shares are held by the Trustee on behalf of a participant, they will be registered in the name of the Trustee

· the board must ensure that it does not grant shares under the plan if, when added to the number of options granted under its other plans, they would exceed X% of its issued capital.

EST

The EST is intended to co-operate as follows:

· its sole purpose is to obtain shares for the benefit of employees pursuant to the plans described in the ruling application

· it is to be funded by the taxpayer company

· contributions to the EST are likely to occur subsequent to a participant's valid request to exercise their options

· under the other plans it is likely to contribute funds to the EST when the performance rights vest to the participant

· contributions to the share plan are likely to be made after the participant's application is accepted by the board

· the funds contributed to the EST will be used by the Trustee to acquire shares either on-market or via a subscription for new shares

· shares acquired by the Trustee will be immediately allocated to the relevant employees and held on their behalf

· the structure of the EST and the plans are such that shares may be dealt with at any time after the restrictive period lapses

· the Trustee is an external trustee acting independently on behalf of its beneficiaries.

Question 1

Will the irretrievable cash contributions to the Trustee of the EST be assessable income to the EST?

Answer

No

Detailed reasoning

It is pertinent to initially consider whether the EST is an employee share trust within the meaning of subsection 130-85(4) of the ITAA 1997.

Employee share trust

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

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

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

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

(i) the company; or

(ii) a subsidiary of the company; and

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

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

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

The plans comprise an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which options and rights to acquire shares and invitations to acquire shares in the taxpayer company are provided to employees in relation to the employees' employment (see below for further discussion of term 'employee share scheme' under the heading 'Paragraph 130-90(1)(d) of the ITAA 1997').

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

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

· the EST acquires shares in the company,

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

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

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

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

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

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

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

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

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

· receiving and immediately distributing shares under a demerger.

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

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

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

Irretrievable cash contributions

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:

net income , in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions …

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

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

and subsection 6-10(1) states:

Your assessable income also includes some amounts that are not *ordinary income.

Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.

The irretrievable contributions made by the taxpayer company to the EST are unlike those provisions listed in section 10-5 of the ITAA 1997. Therefore, irretrievable contributions made by the taxpayer company to the EST will not be assessable income under section 6-5 (ordinary income) and section 6-10 (statutory income) of the ITAA 1997.

Pursuant to clause 6.4(b) of the Trust Deed, all contributions by the taxpayer company to the EST for the purpose of acquiring its shares constitute accretions to the corpus of the EST. Furthermore, pursuant to clauses of the Trust Deed the Trustee must, when directed by the Board, acquire shares on behalf of participating employees and use the contributions made by the taxpayer company and the employees to do so.

The general powers granted to the Trustee pursuant to the Trust Deed are restricted by paragraphs within it (see discussion on the meaning of the term 'employee share trust' above). The paragraphs require that the powers must be exercised only for the purposes of the EST and only to give effect to the plans which the EST supports. To this end, the contributions received from the taxpayer company and participating employees must, therefore, only be used to acquire shares in accordance with the terms of the Trust Deed and the plans' rules.

Accordingly, the irretrievable contributions made by the taxpayer company to the Trustee to acquire its shares will not be assessable income under section 6-5 of the ITAA 1997 but constitute capital receipts of the Trustee. Therefore, the irretrievable cash contributions made by the taxpayer company to the Trustee of the EST to fund the acquisition of its shares by the EST in accordance with the Trust Deed of the EST will not be assessable income of the EST pursuant to sections 6-5 or 6-10 of the ITAA 1997. This accords with the view expressed in ATO ID 2002/965.

Note that a clause of the Trust Deed provides that whilst the Trustee is not entitled to receive any fees, commissions or remuneration in respect of the performance of its obligations as Trustee of the EST, the taxpayer company may pay to the Trustee from its own resources any fees, commission or remuneration as it and the Trustee may agree from time to time. Such receipts will be assessable income of the Trustee in contrast to the irretrievable contributions made to facilitate the acquisition of the taxpayer company's shares.

Note also that income derived by the employment of the property that is the fund or corpus of the trust and which the Trustee holds on trust will be income according to ordinary concepts (see Federal Commissioner of v. Everett (1980) 143 CLR 440; (1980) 10 ATR 608; 80 ATC 4076 for a discussion of the distinction between the trust income and corpus).

Question 2

When the participants become absolutely entitled to the shares under the terms of the options and rights plans, will any capital gain or capital loss made by the Trustee under CGT Event E5 be disregarded?

Answer

Yes

Detailed reasoning

Section 130-90 of the ITAA 1997 operates to ensure that any capital gain or loss made by an EST is disregarded if it arises as a result of a beneficiary of the trust becoming absolutely entitled to an employee share scheme share, or as a result of a disposal of an employee share scheme share or right to a beneficiary.

Subsections 130-90(1) and 130-90(2) of the ITAA 1997 state:

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.

As discussed in the answer to question 1, the Trustee is an EST for the purposes of subsection 130-85(4) of the ITAA1997.

Section 104-75 of the ITAA 1997 contains the rules dealing with CGT event E5 which happens if a beneficiary of a trust becomes absolutely entitled to an asset of the trust as against the trustee of the trust (subsection 104-75(1) of the ITAA 1997).

In determining whether a beneficiary is absolutely entitled to the asset, any legal disability, e.g. if the beneficiary is under 18, is ignored. In Draft Taxation Ruling TR 2004/D25, the Commissioner stated his view that the core principle underlying the concept of absolute entitlement in the CGT rules 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 as they so direct.

Subdivision 130-D treats an employee who acquires an ESS interest through an ESS to be 'absolutely entitled' to the share or right to which the ESS interest relates, from the time that they acquire the ESS interest (subsections 130-85(1) and 130-85(2) of the ITAA 1997).

A clause of the Trust Deed states that the Trustee declares and agrees that each participant is, subject to the relevant plan rules and relevant terms of participation the beneficial owner of the shares and absolutely entitled to them.

CGT event E5 will happen under the terms of the options and rights plans at the time when the participant becomes entitled to the shares in the taxpayer company as against the Trustee of the EST (paragraph 130-90(1)(a)) of the ITAA 1997.

Subsection 995-1(1) of the ITAA 1997 defines a share to mean a share in the capital of a company. An ordinary share in the taxpayer company held by the Trustee of the EST and to which a participant is entitled upon exercise of an option or right is a share in the capital of the employer, a company (paragraph 130-90(1)(b) of the ITAA 1997).

A participant will have acquired a beneficial interest in a share in the taxpayer company by exercising a right or option granted under the plans (paragraph 130-90(1)(c) of the ITAA 1997.

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

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

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

An employee share scheme is a *scheme under which *ESS interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:

(a) the company; or

(b) *subsidiaries of the company;

in relation to the employees' employment.

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

scheme means:

(a) any ^*arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Both the options and rights plans define "trust" to mean: an employee share trust established by the taxpayer company for the sole purpose of acquiring and holding shares for the benefit of participants.

The purpose of the plans is to encourage participation and attract and motivate participants.

The plans are employee share schemes for the purposes of Division 83A as they are arrangements under which an ESS interest, i.e. a beneficial interest in an option or right to acquire a beneficial interest in a share of the taxpayer company, is provided to eligible participants in relation to their employment by the taxpayer company or its subsidiaries in accordance with the Trust Deed. The options and rights are acquired under the plans at no cost.

Subdivision 83A-B will apply to options or rights acquired before 1 July 2009 where an election (under former section 139E of the ITAA 1936) has not been made by the participant and the cessation time mentioned in former subsection 139B(3) of the ITAA 1936 has not occurred prior to 1 July 2009, as pursuant to subsection 83A-20(1) of the ITAA 1997, the ESS interest will be acquired under an employee scheme at a discount (paragraph 130-90(1)(d) of the ITAA 1997).

Subdivision 83A-B will apply to options or rights acquired under the plans as pursuant to subsection 83A-20(1) of the ITAA 1997 as the ESS interest will be acquired under an employee scheme at a discount (paragraph 130-90(1)(d) of the ITAA 1997).

It should be noted however that whether a participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. Accordingly, all the conditions in subsection 130-90(1) of the ITAA 1997 have been satisfied.

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

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

Question 3

When the participants become absolutely entitled to the shares under the terms of the share plan, will the Trustee make a capital gain or capital loss under CGT Event E5?

Answer

No

Detailed reasoning

In the answer to Question 2 the application of section 130-90 of the ITAA 1997 was discussed. Section 130-90 of the ITAA 1997 operates to disregard any capital gain or loss made by an EST, if it arises as a result of a beneficiary of the trust becoming absolutely entitled to an employee share scheme share, or as a result of a disposal of an employee share scheme share or right to a beneficiary.

The reasoning provided in answer to Question 2 is applicable as to whether the Trustee makes a capital gain or capital loss under CGT event E5, when the participants become absolutely entitled to the shares under the terms of the share plan.

As is the case in the context of the option and rights plan, so too for the share plan: provided that the participant does not acquire the beneficial interest in the share for more than its cost base in the hands of the EST at the time that CGT event E5 happens, subsection 130-90(2) of the ITAA 1997 will also have been satisfied.

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

Question 4

In respect of shares disposed of by the Trustee of the EST under the terms of the plans, will the Trustee make a capital gain or capital loss under CGT Event E7?

Answer

No

Detailed reasoning

As discussed in the answers to questions 2 and 3, section 130-90 of the ITAA 1997 operates to ensure that any capital gain or loss made by an EST is disregarded if it arises as a result of a beneficiary of the trust becoming absolutely entitled to an ESS share, or as a result of a disposal of an ESS share or right to a beneficiary.

As discussed in the answer to question 1, the EST is an employee share trust within the meaning of subsection 130-85(4).

Section 104-85 of the ITAA 1997, Disposal to beneficiary to end capital interest: CGT event E7, happens if the trustee of a trust (except a unit trust or a trust to which Division 128 of the ITAA 1997 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it in the trust capital. The time of CGT event E7 is when the asset is disposed of by the trustee to the beneficiary (subsection 104-85(2) of the ITAA 1997).

In regard to the plans, the transfer of Trust shares is contained in Clause 12 of the Trust Deed, which states:

12.1 Sales of Trust Shares by Trustee

Subject to clause 11, if the relevant Plan Rules and/or relevant Terms of Participation permit, the Trustee may at the direction of the Participant, sell any of the Trust Shares to which the Participant is entitled. On sale of any such Trust Shares, subject to any Plan Rules and/or relevant Terms of Participation, the Trustee will apply the proceeds of sale (and pay to the Participant any other monies held on the account for the Participant):

(a) first, in payment of any brokerage and other costs and expenses of the sale incurred by the Trustee (including an amount sufficient to meet the Tax liability (if any) incurred by the Trustee resulting from that sale); and

(b) second, the balance (if any) in payment to the relevant Participant.

12.2 Trustee to transfer

Subject to clause 11, the Trustee must do all things required by it to transfer legal title in Trust Shares to a Participant on whose behalf Trust Shares are held or to any third party as directed by the relevant Participant (and pay to the Participant any other monies held on the account for the Participant):

(a) where required to do so, or permitted, by the relevant Plan Rules and/or relevant Terms of Participation as soon as reasonably practicable;

(b) it the Trust is terminated under clause 17; or

(c) otherwise where the Board in its discretion determines.

Upon transfer of the legal title in those Trust shares, in accordance with the relevant plan rules, CGT event E7 will occur at the time legal title in the shares is transferred to either the participant, or to a third party, as directed by the participant (paragraph 130-90(1)(a) of the ITAA 1997).

A capital gain arises to the Trustee if the market value of the share at the time of disposal to the participant is more than the share's cost base (subsection 104-85(3) of the ITAA 1997). A capital loss arises to the Trustee if the market value of the share at the time of disposal to the participant is less than the share's reduced cost base (subsection 104-85(3) of the ITAA 1997).

As discussed in answers 2 and 3, in regard to the taxpayer company's plans, paragraphs 130-90(1)(b) to (d) of the ITAA 1997 are satisfied, accordingly, all the conditions in subsection 130-90(1) of the ITAA 1997 have been satisfied.

Provided the participant in the taxpayer company's plans does not acquire the beneficial interest in the share for more than its cost base in the hands of the EST, at the time that CGT event E7 happens, subsection 130-90(2) of the ITAA 1997 will also have been satisfied. Under these circumstances, section 130-90 of the ITAA 1997 operates to disregard a CGT event E7 capital gain or capital loss made by the Trustee.

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