Edited version of private ruling

Authorisation Number: 1011812361480

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Ruling

Subject: Employee share scheme

Relevant facts and circumstances

The taxpayer company (employer) is an Australian listed company.

The taxpayer company lodged an application for a private binding ruling, as did the Trustee of its employee share trust (EST) in respect of tax matters relating to an employee share scheme (ESS).

The ESS is comprised of several plans providing either 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 states that the Trustee and the EST facilitate 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 25% in the first 12 months; 50% in the first 24 months; and 75% in the first 36 months

· the participant 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:

· ceases employment

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

· the exercise conditions are unable to be met; or

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

· each option entitles the holder to one share

· 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

· 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.

· 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

· 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):

· if there is a change of control event

· upon the retirement or retrenchment of the participant; or

· 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 the Trustee 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 5% of the taxpayer company's issued capital.

Shares

· the 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:

· number of shares

· amount payable; and

· 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 the Trustee 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:

· the participant has submitted a withdrawal notice

· the participant ceases to be an employee

· 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 5% 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 taxpayer company obtain an income tax deduction, pursuant to section 8-1 of the ITAA 1997 in respect of the irretrievable cash contributions made by it to the Trustee of the EST to fund the subscription for or acquisition on-market of its shares by the EST?

Answer

Yes

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 is a general deduction provision. Broadly, the provision provides an entitlement to a deduction from assessable income for any loss or outgoing, to the extent that it is incurred in gaining or producing your assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, subsection 8-1(2) of the ITAA 1997 (so far as it is relevant) prevents such a deduction to the extent that it is a loss or outgoing of capital, or of a capital nature.

Losses or outgoings

Pursuant to its Trust Deed, the taxpayer company must provide the Trustee with all the funds (contributions) required to enable it to subscribe for, or acquire shares in the taxpayer company in accordance with clauses of the Trust Deed. The Trustee will, in accordance with instructions received pursuant to the relevant plan rules, acquire, deliver and allocate shares for the benefit of participants provided that the Trustee receives sufficient payment to subscribe for or purchase shares and/or has sufficient unallocated trust shares available.

These contributions made to the Trustee by the taxpayer company will be irretrievable and non-refundable to the taxpayer company ( the Trust Deed states that funds provided to the Trustee will not be repaid to the taxpayer company and no participant shall be entitled to receive the funds). On this basis, it is concluded that the irretrievable contributions made by the taxpayer company are considered to be a loss or outgoing for the purpose of subsection 8-1(1) of the ITAA 1997.

The contributions made by the taxpayer company will be recurrent and part of its overall employee remuneration costs and therefore not capital in nature.

Question 2

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

Answer

Yes

Detailed reasoning

The taxpayer company will incur various costs in relation to the implementation and on-going administration of the plans. For example, the taxpayer company will incur costs associated with the services provided by the Trustee of the EST. These costs are likely to include:

· Employee plan record keeping;

· Production and dispatch of holding statements to employees;

· Provision of annual income tax return information;

· Acquisition of shares and allocation to participants; and

· Management of employee termination.

In addition to the services to be provided by the Trustee of the EST, the taxpayer company will also incur various implementation costs, including the services provided by the company's accounting and legal advisors, in accordance with the Trust Deed.

The costs incurred by the taxpayer company in relation to administration of the EST are deductible under section 8-1 of the ITAA 1997 as either:

· costs incurred in gaining or producing its assessable income; or

· costs necessarily incurred in carrying on its business for the purpose of gaining or producing its assessable income.

The view that the costs incurred by the taxpayer company are deductible under section 8-1 of the ITAA 1997 is consistent with the analysis in Question 1, above, and ATO ID 2002/961 in which it was decided that such costs are regular and recurrent employment expenses, and are deductible under section 8-1 of the ITAA 1997.

Question 3(a)

Are irretrievable cash contributions made by the taxpayer company to the Trustee of the EST, to fund the subscription for or acquisition on-market of its shares by the EST, deductible to the taxpayer company at a time determined by section 83A-210 of the ITAA 1997 in respect of ESS interests that have a deferred taxing point arising after 30 June 2009?

Answer

Yes

Detailed reasoning

The provision of money to the Trustee of the EST by the taxpayer company for the purpose of remunerating its employees under its plans is an outgoing in carrying on its business and is deductible under section 8-1 of the ITAA 1997.

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

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

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

(i) under an *arrangement; and

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

(b) that particular time occurs before the time (the acquisition time) the ultimate beneficiary acquires the *ESS interest;

then, for the purpose of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time.

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

The granting of the beneficial interests in the options/rights, the provision of the money to the trustee under the arrangement, the acquisition and holding of the shares by the trustee and the allocation of shares to the participating employees are all interrelated components of long-term incentive plans. All the components of the scheme must be carried out so that the scheme can operate as intended. As one of those components, the provision of money to the trustee, necessarily allows the scheme to proceed.

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

Under the plans, the shares ultimately acquired by employees are themselves ESS interests acquired under an employee share scheme in relation to the employees' employment. Contributions will not be 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, until such time as the offer is formally accepted by the employees. To the extent that the shares may be so acquired before the employees acquire a beneficial interest in the shares, section 83A-210 will operate to deny a deduction until that beneficial interest is acquired (in practice this should usually be in the same income year that the contribution has been made).

Question 3(b)

Are irretrievable cash contributions made by the taxpayer company to the Trustee of the EST, to fund the subscription for or acquisition on-market of its shares by the EST, deductible to the taxpayer company at a time determined by section 139DB of the ITAA 1936 in respect of ESS interests that have a deferred taxing point arising before 30 July 2009?

Answer

Yes

Detailed reasoning

Former section 139DB of the ITAA 1936 applies in relation to the timing of the irretrievable cash contributions made by the taxpayer company to the Trustee of the EST regarding options or performance rights where participants had made section 139E elections before 1 July 2009, a section of the legislation subsequently repealed.

The issue had previously been considered in ATO Interpretative Decision ATO ID 2005/181 Income Tax- Deductibility of money provided to the trustee of an employee share trust (withdrawn). In the circumstances provided and in accordance with the previous legislation the timing of the deduction is determined by former section 139DB of the ITAA 1936 which provides that:

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

(a) under an arrangement; and

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

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

Former subsection 139C(4) of the ITAA 1936 provides that a taxpayer does not acquire a share under an employee share scheme if the taxpayer acquires the share as the result of exercising a right that the taxpayer acquired under an employee share scheme. By the operation of former subsection 139C(4) of the ITAA 1936, the shares transferred to an employee when the vesting conditions have been satisfied are not acquired by the employee under an employee share scheme. Therefore, section 139DB of the ITAA 1936 will only apply if there is the relevant connection between the money provided by the taxpayer to the trustee under the arrangement and the acquisition of the rights by the participating employees (the ultimate beneficiaries) under the plan.

Consistent with the Commissioner's position in ATO ID 2005/181 (withdrawn), the granting of the rights, the providing of the money to the trustee, the acquisition and holding of the shares by the trustee and the allocation of shares to the participating employees are all interrelated components of the plan. All the components of the plan must be carried out so that the plan can operate as intended. As one of those components, the providing of money to the trustee necessarily allows the plan to proceed. Consequently, the providing of money to the trustee is considered to be for the purpose of enabling the participating employees, as part of the plan, to acquire the rights available under the plan.

As stated above, in the answer to Question 3(a), former section 139DB of the ITAA 1936 determines the time when a deduction is allowable to the taxpayer under section 8-1 of the ITAA 1997 in respect of the provision of money to the trustee of the employee share trust, and that a deduction is allowable at the time the rights are acquired by participating employees and only to the extent of that amount of the money provided to acquire shares to satisfy the obligations in relation to the rights acquired. Accordingly, any contribution by the taxpayer company in respect of rights that have previously been granted will be an allowable tax deduction at the time it is made.

Question 4

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

Answer

No

Detailed reasoning

Section 6-5 Income according to ordinary concepts (ordinary income)

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

Income according to ordinary concepts is not defined in the ITAA 1997 however; there is a substantial body of case law that discusses factors which indicate whether an amount has the character of income according to ordinary concepts. For instance, Dixon J in Sun Newspapers Limited & Associated Newspapers Ltd v FCT (1938) 61 CLR 337 (Sun Newspapers) outlined the three matters to be considered in determining whether a payment is on capital or revenue account, as follows:

· the character of the advantage sought by the payment

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

· the means adopted to obtain it.

The character of the advantage sought by the payment

The stated purpose of the taxpayer company in establishing and funding its plans is to encourage participation in the company through share ownership to attract, motivate and retain employees and consultants and thereby to enhance the profitability of the group's business. Therefore the character of the advantage sought is one of reward and retention of the human resources of the business, as a contribution to its long term success, which distinguishes it as capital in nature.

The way it is to be used or enjoyed

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

The means adopted to obtain it

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

Section 20-20 Assessable recoupments

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

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

Also, the table at section 20-30 of the ITAA 1997 which shows the deductions for which recoupments are assessable does not include provision for subscriptions for funding an EST to acquire shares for employees.

Division 104 CGT events

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

· D1 Creating contractual or other rights; or

· H2 Receipt for event relating to a CGT asset.

Event D1 applies in preference to event H2.

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

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

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

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

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

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

Question 5

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

Answer

No

Detailed reasoning

Part IVA of the ITAA 1936 is a general anti-avoidance provision which gives the Commissioner the discretion to cancel a 'tax benefit' that would be obtained or has been obtained by a taxpayer, in connection with a scheme. The discretion is found in subsection 177F of the ITAA 1936.

Before the Commissioner can exercise the discretion in respect of Part IVA, under subsection 177F(1) of the ITAA 1936, three requirements must be met. These are:

· there must be a scheme within the meaning of section 177A of the ITAA 1936

· a tax benefit arises that was obtained or would be obtained in connection with the scheme but for Part IVA; and

· having regard to the matters in paragraph 177D(b) of the ITAA 1936, the scheme is one to which Part IVA applies.

The Scheme

The definition of scheme in subsection 177A(1) of the ITAA 1936 states:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express, or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

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

It is considered that this definition is sufficiently wide to cover the proposed arrangement under the relevant taxpayer company's plans, which utilise a payment made by it to the Trustee of an EST (in accordance with the Trust Deed), to fund the Trustee's acquisition of the taxpayer company's shares on behalf of participating employees.

Tax Benefit

'Tax benefit' is defined in subsection 177C(1) of the ITAA 1936 of which the relevant paragraph is:

Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

(a) …

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or …

In order to determine the tax benefit that would be derived by the taxpayer company from this scheme, it is necessary to examine alternative hypotheses or counterfactuals, that is, other schemes the company might reasonably have been expected to enter into to achieve its aims in relation to employee remuneration.

The applicant has provided possible counterfactuals, such as if the ESS were not entered into and it simply chose to issue new shares, it might not receive a tax deduction for the expense. However, it would still be entitled to a deduction if it simply bought shares for employees on market or alternatively remunerated employees by other means, such as cash bonuses.

A comparison between these counterfactuals/alternative forms of remuneration and the proposed scheme would likely reveal no tax benefit because the deductible amounts under both of them would be the same or similar from the taxpayer company's tax perspective. However, there is at least one other reasonable counterfactual to the scheme the taxpayer company proposes to establish. If it were to issue new shares, it would not be entitled to any deduction unless section 83A-205 of the ITAA 1997 were satisfied. This provision requires that:

· the taxpayer company must have provided an ESS interest to an individual under an employee share scheme

· it must have done this as the individual's employer (or as the holding company of the employer)

· with the exception of paragraph 83A-35(2)(b) of the ITAA 1997, section 83A-35 must have applied to reduce the amount included in that individual's assessable income under subsection 83A-25(1).

If the shares did meet these conditions, the company would be entitled to a deduction equal to the amount of the reduction allowable to the individual under section 83A-35 of the ITAA 1997 (a maximum deduction of $1000).

By contrast, the use of the EST arrangement permits the taxpayer company, subject to the requirements of sections 8-1 and section 83A-210 of the ITAA 1997, to claim a deduction for the full amount of the contributions it makes to the EST. It is probable that this amount would exceed that which would be allowable under section 83A-205 of the ITAA 1997 in the counterfactual above. Therefore, to the extent of any increased deductions because of the trust arrangement, the taxpayer company obtains a tax benefit.

While, for the reasons noted above by the applicant it is unlikely that it would choose any other incentive plan that did not give rise to an allowable deduction (and therefore there would not be the necessary tax benefit), the analysis below proceeds on the assumption that the Commissioner would in fact be able to identify a relevant tax benefit.

Paragraph 177D(b) of the ITAA 1936

Paragraph 177D(b) of the ITAA 1936 sets out the following factors that must be considered in deciding whether a scheme was entered into for the purpose of obtaining a tax benefit:

(i) the manner in which the scheme was entered into or carried out;

(ii) the form and substance of the scheme;

(iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(vi) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)

Subsection 177A(5) of the ITAA 1936 requires the purpose to be the dominant purpose.

(i) The Manner of the Scheme

In considering whether Part IVA applies or not, the necessary comparison to be made in relation to the factors listed in paragraph 177D(b) of the ITAA 1936 is between the scheme as proposed and the relevant counterfactual. The inclusion of the EST in the scheme does give rise to a tax benefit, but the taxpayer company contends that the presence of the EST provides other commercial benefits, including: capital management flexibility; administrative efficiency; compliance with Corporations Act requirements; and it facilitates the disposal of shares under the plans.

Further, it is noted that the arrangement is not deliberately and intentionally established close to the end of the taxpayer company's income year nor with a large up-front payment intended to provide for the trust's operations for several years into the future, as happened in Pridecraft Pty Ltd v FC of T [2004] FCAFC 339; 2005 ATC 4001; 58 ATR 210.

The taxpayer company intends to fund the EST on a recurring basis (as required, to satisfy the provision of shares in accordance with the terms of its plans). It is accepted that the EST provides benefits to the operation of the scheme that would not be available if the shares were provided directly by it in the relevant counterfactual.

(ii) The Form and Substance

The substance of the scheme is the provision of remuneration in the form of shares to eligible employees who participate in the plans. It takes the form of payments by the taxpayer company to the Trustee that acquires the shares and transfers them to participants.

While existence of the trust confers a tax benefit, it cannot be concluded that is the only benefit provided as outlined above. The taxpayer company has argued that the form of the arrangement with the trust provides the scheme with non-tax benefits and this is accepted.

(iii) The Timing of the Scheme

As noted above, the scheme has not been established at a time to provide a substantial year-end deduction to the company nor with a contribution sufficiently large to fund the trust for several years, but by recurring contributions. There is nothing in this factor to suggest a dominant purpose of seeking to obtain a tax benefit in relation to the scheme.

(iv) The Result of the Scheme

The result of the scheme is to provide the taxpayer company with allowable deductions for the contributions it makes to the EST. However, it is noted that the contributions are irretrievable and reflect a genuine non-capital outgoing on the part of the taxpayer company to achieve a business outcome. It is to be expected that a deduction would normally be allowable in these circumstances.

(v) Any Change in the Financial Position

As noted above, the taxpayer company makes irretrievable contributions to the EST and those contributions constitute a real expense, with the result that the taxpayer company's financial position is changed to that extent. While it is arguable that the quantum of the deductions is higher with a trust as part of the scheme than would be the case if the taxpayer company provided shares to participants directly, there is nothing artificial, contrived or notional about its expenditure.

(vi) Any Change in the Financial Position of other Entities or Persons

The contributions by the taxpayer company to the Trustee will form part of the corpus of the trust and must be dealt with by the Trustee in accordance with the terms of the Trust Deed; i.e. for the acquisition of shares to ultimately be provided to participants in the plans. The taxpayer company is not a beneficiary of the trust and its contributions cannot be returned to it in any form except where the Trustee acquires shares from it by subscribing for new issues at market value. Therefore, the contributions made by the taxpayer company amount to a real change to the financial position of the Trustee. The financial position of participants in the schemes will also undergo a real change. There is nothing artificial, contrived or notional about these changes.

(vii) Any Other Consequence

Not relevant to this scheme.

(viii) The Nature of any Connection between the taxpayer company and any Other Persons

The relationship between the taxpayer company and the participants in its plans is one of employer/employee. Whilst the Trustee is a member of the same tax consolidated group, for the purposes of this scheme it will be acting solely in its capacity as trustee, and as the beneficiaries of the trust estate (i.e. employee participants) are not members of the tax consolidated group, the trust estate also will not be a member of that tax consolidated group.

The contributions made by the taxpayer company to the Trustee are commensurate with its stated aim of providing the participants with remuneration in a form that aligns their personal financial rewards with the risks and returns of its shareholders. There is nothing to suggest that the parties to the employee share schemes are not acting at arm's length to one another. Accordingly, there is nothing in relation to this factor to indicate a dominant purpose of obtaining a tax benefit.

Conclusion - the Purpose of the Scheme

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

Question 6

Is the provision of performance rights, options or shares by the companies to participants under the plans a fringe benefit within the meaning of subsection 136(1) of the FBTAA 1986?

Answer

No

Detailed reasoning

An employer's liability to FBT arises under section 66 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer for the relevant year of tax. The fringe benefits taxable amount is calculated under the FBTAA 1986 by reference to the taxable value of each fringe benefit provided.

No amount will be subject to FBT unless a 'fringe benefit' is provided.

In general terms, 'fringe benefit' is defined in subsection 136(1) of the FBTAA 1986 as being a benefit provided to an employee or an associate of an employee 'in respect of' the employment of the employee.

However, certain benefits are excluded from being a 'fringe benefit' by virtue of paragraphs (f) and (s) of the 'fringe benefit' definition.

Paragraph (h) of the definition of 'fringe benefit' states that a fringe benefit does not include:

(h) a benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83A-B or 83A-C of that Act applies;

Furthermore, section 83A-5 of the ITAA 1997 notes that one of the objects of Division 83A of the ITAA 1997 is to ensure that benefits provided to employees under employee share schemes are subject to income tax at the employees' marginal rates under income tax law (instead of being subject to fringe benefits tax law).

Transitional provisions

Options that satisfy subsection 83A-5(1) or subsection 83A-5(2) of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997) are excluded from being a fringe benefit under paragraph (h) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA 1986 as they are an acquisition of an ESS interest under an employee share scheme to which Subdivision 83A-B or 83A-C of the ITAA 1997 applies.

ESS interests

The taxpayer company has stated that it will grant ESS interests to the participants of its plans. The ESS interests offered to participants in the plans are provided at a discount and in connection with the participants' employment. In turn those ESS interests, subject to certain conditions, are convertible to shares.

The Commissioner accepts that the plans described in this private ruling comprise an employee share scheme (as discussed in the answer to the previous question) and incorporate the use of an EST that is an employee share trust within the meaning of subsection 130-85(4) of the ITAA 1997 (as discussed in the related ruling on the EST).

Accordingly, the acquisition of ESS interests pursuant to the plans will not be subject to fringe benefits tax on the basis that they are part of an employee share scheme and thereby excluded from the definition of a 'fringe benefit' pursuant to subsection 136(1) of the FBTAA 1986.

Question 7

Will the irretrievable cash contributions made by the taxpayer company to the Trustee of the EST, to fund the subscription for or acquisition on-market of the taxpayer company's shares, be treated as a fringe benefit within the meaning of subsection 136(1) of the FBTAA 1986?

Answer

No

Detailed reasoning

Paragraph (ha) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA states that a fringe benefit does not include:

(ha) a benefit constituted by the acquisition of money or property by an employee share trust (within the meaning of the Income Tax Assessment Act 1997);

An employee share trust (EST) is defined in subsection 995-1(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 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).

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

· the EST acquires shares in the company; and

· the EST ensures that the ESS interests being beneficial interests in those shares, are provided under an employee share scheme, to the employees in accordance with the Trust Deed and relevant rules of the option plans.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will also require that the Trustee undertake incidental activities that are a function of managing the option plans and administering the EST.

For the purposes of paragraph 130-85(4)(c) of the ITAA 1997, the Commissioner considers that 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 EST 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; and

· 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.

Based on the above, it is accepted that the EST is an employee share trust, as defined in subsection 995-1(1) of the ITAA 1997. The functions of the Trustee of the EST (acquiring and allocating ESS interests) are limited to those activities mentioned in paragraphs 130-85(4)(a) and (b) of the ITAA 1997, or are merely incidental activities as referred to in paragraph 130-85(4)(c) of the ITAA 1997.

Paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA 1986 excludes the contributions to the Trustee of the EST from being a fringe benefit. The taxpayer company will not be required to pay FBT in respect of the irretrievable cash contributions it makes to the Trustee of the EST to fund the acquisition of its shares in accordance with the Trust Deed.

Former Division 13A of the ITAA 1936

Although contributions made by the taxpayer company to the EST will be made after 1 July 2009, it is appropriate to consider the application of former paragraph 136(1)(ha) of the FBTAA 1986, as outlined above, to contributions made in respect of all options or rights issued by the taxpayer company.

Accordingly, the contributions to the EST in relation to options issued prior to 1 July 2009 to which former Division 13A of the ITAA 1936 still applies should also not be subject to FBT on the basis that the sole activities of the EST are "obtaining shares or rights to acquire shares" in the company for employees or their associates. The analysis above regarding satisfaction of the sole activities test is equally relevant to the application of the former provision, paragraph 136(1)(hb) of the FBTAA 1986.

Former paragraph 136(1)(hb) of the FBTAA 1986 excluded from the definition of a 'fringe benefit' the following:

a benefit constituted by the acquisition by a trust of money or other property where the sole activities of the trust are obtaining shares, or rights to acquire shares, in a company or a holding company..., of the first-mentioned company, and providing those shares or rights:

(i) To employees, or associates of employees, of the first-mentioned company; or

(ii) to persons who are engaged in foreign service (within the meaning of section 139GBA of the ITAA 1936) for the first-mentioned company, or associates of those persons;"

To the extent it is determined that the former paragraph 136(1)(hb) of the FBTAA 1986 should be applied in respect of contributions in relation to options issued to which former Division 13A of the ITAA 1936 still applies, it is accepted that the EST will satisfy the requirements in this provision such that these payments would also not be subject to FBT.

Question 8

Will the Commissioner seek to make a determination that section 67 of the FBTAA 1986 applies to increase the fringe benefits taxable amount to the Companies by the amount of tax benefit gained from irretrievable cash contributions made by the taxpayer company to the Trustee of the EST, to fund the subscription for or acquisition on-market of the taxpayer company's shares?

Answer

No

Detailed reasoning

Section 67 is the general anti-avoidance provision in the FBTAA 1986. The operation of section 67 is comparable to Part IVA of the ITAA 1936, in that the section requires the identification of an arrangement, a tax benefit obtained by the employer that was the sole or dominant purpose for a person entering into the arrangement and is activated by the making of a determination by the Commissioner.

PS LA 2005/24 provides guidance on the application of section 67 of the FBTAA 1986. Paragraphs 145-148 state:

145. Section 67 is the general anti-avoidance provision in the FBTAA. The operation of section 67 is comparable to Part IVA, in that the section requires the identification of an arrangement and a tax benefit, includes a sole or dominant purpose test and is activated by the making of a determination by the Commissioner. The definition of 'arrangement' in subsection 136(1) of the FBTAA is virtually identical to the definition of 'scheme' in section 177A of Part IVA.

146. Subsection 67(1) of the FBTAA is satisfied where a person or one of the persons who entered into or carried out an arrangement or part of an arrangement under which a benefit is or was provided to a person, did so for the sole or dominant purpose of enabling an eligible employer or the eligible employer and another employer(s) to obtain a tax benefit.

147. An objective review of the transaction and the surrounding circumstances should be undertaken in determining a person's sole or dominant purpose in carrying out the arrangement or part of the arrangement. Section 67 differs from paragraph 177D(b) in Part IVA in that it does not explicitly list the factors that should be taken into account in determining a person's sole or dominant purpose.

148. Subsection 67(2) of the FBTAA provides that a tax benefit arises in respect of a year of tax in connection with an arrangement if under the arrangement:

(i) a benefit is provided to a person;

(ii) an amount is not included in the aggregate fringe benefits amount of the employer; and

(iii) that amount would have been included or could reasonably be expected to have been included in the aggregate fringe benefits amount, if the arrangement had not been entered into.

The Commissioner will only make a determination under section 67 of the FBTAA 1986 if the arrangement resulted in the payment of less FBT than would be payable but for entering into the arrangement. In Miscellaneous Taxation Ruling MT 2021 under the heading "Appendix, Question 18" on the application of section 67, the Commissioner states:

…As mentioned in the explanatory memorandum to the FBT law, section 67 may only apply where there is an arrangement under which a benefit is provided to a person and the fringe benefits taxable amount in respect of that benefit is either nil or less than it would have been but for the arrangement...

PS LA 2005/24 provides instructions and practical guidance to Tax officers on the application of Part IVA and other General Anti-Avoidance Rules. Paragraph 151 of PS LA 2005/24 states:

151. The approach outlined in this practice statement (refer to paragraphs 69 to 113) to the counterfactual and the sole or dominant purpose test in Part IVA is relevant and should be taken into account by Tax officers who are considering the application of section 67 of the FBTAA.

In the present case, the benefits provided to the Trustee by way of irretrievable contributions to the EST, and to participants by way of the provision of options, rights and shares under the plans are excluded from the definition of a fringe benefit for the reasons given above. However, it is not possible to identify an amount that would have been included or could reasonably be expected to have been included in the aggregate fringe benefits amount if the arrangement had not been entered into. Therefore, the fringe benefits tax liability is not any less than it would have been but for the arrangement.

Accordingly, the Commissioner will not make a determination that section 67 of the FBTAA 1986 applies to include an amount in the aggregate fringe benefits amount of the taxpayer company, in relation to a tax benefit obtained under the plans.

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