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Ruling

Subject: Employee Share Trust

Question 1

Will the irretrievable cash contributions to the Trustee by one or more Subsidiary Members increase the net income of the Trust pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the irretrievable cash contributions to the Trustee by one or more Subsidiary Members be assessable income of the Trustee pursuant to section 44 of the Income Tax Assessment Act 1936 (ITAA 1936), via the application of Division 7A of the ITAA 1936?

Answer

No.

Question 3

Will a capital gain or capital loss arise for the Trustee of the Trust at the time when the Employee becomes absolutely entitled to the Shares in circumstances where:

· The shares are acquired by the Trustee at market value; and

· The employee's interest in the Trust is acquired at market value?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 September 2011

Year ended 30 September 2012

Year ended 30 September 2013

Year ended 30 September 2014

Year ended 30 September 2015

Year ended 30 September 2016

The scheme commences on:

Year ended 30 September 2011

Relevant facts and circumstances

The scheme the subject of this Ruling has been ascertained from the following documents:

· Application for Private Ruling

· Plan Rules

· The Trust Deed of the Trust

· Shareholders Agreement

· Offer documents

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 6-10 of the Income Tax Assessment Act 1997

Section 104-75 of the Income Tax Assessment Act 1997

Section 960-100 of the Income Tax Assessment Act 1997

Section 44 of the Income Tax Assessment Act 1936

Division 7A of the Income Tax Assessment Act 1936

Section 95 of the Income Tax Assessment Act 1936

Section 109C of the Income Tax Assessment Act 1936

Section 109Z of the Income Tax Assessment Act 1936

Section 318 of the Income Tax Assessment Act 1936

Reasons for decision

Question 1

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 was 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.

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 shares in the Company for the benefit of Participants under the terms of the Plan.

Consistent with ATO Interpretative Decision 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 scheme, 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

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.

Subsection 109C(1) of the ITAA 1936 provides the following in respect to when a private company is taken to pay a dividend:

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 of the Trust is not the shareholder of the Subsidiary Members that are making the contributions, nor has it ever been such a shareholder. Nor will it, as a result of the Plan, become a shareholder of any of the Subsidiary Members.

(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:

(i) the primary entity is sufficiently influenced by:

(A) the controlling entity; or

(B) the controlling entity and another entity or entities; or

(ii) a majority voting interest in the primary entity is held by:

(A) the controlling entity; or

(B) the controlling entity and the entities that, if the controlling entity were the primary entity, would be associates of the controlling entity because of subsection (1), because of subparagraph (i) of this paragraph, because of another paragraph of this subsection or because of subsection (3);

(e) another company (in this paragraph called the "controlled company") where:

(i) the controlled company is sufficiently influenced by:

(A) the primary entity; or

(B) another entity that is an associate of the primary entity because of another paragraph of this subsection; or

(C) a company that is an associate of the primary entity because of another application of this paragraph; or

(D) 2 or more entities covered by the preceding sub-subparagraphs; or

(ii) a majority voting interest in the controlled company is held by:

(A) the primary entity; or

(B) the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the other paragraphs of this subsection; or

(C) the primary entity and the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the other paragraphs of this subsection;

(f) any other entity that, if a third entity that is an associate of the primary entity because of paragraph (d) of this subsection were the primary entity, would be an associate of that third entity because of subsection (1), because of another paragraph of this subsection or because of subsection (3).

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 a Subsidiary Member or any of its associates under paragraphs 318(2)(a), (b), (d), (e) or (f) benefit under the trust. This will not be the case as only eligible employees can benefit under the Trust and neither Subsidiary members nor their associates are eligible employees.

Paragraph 318(2)(d) is not applicable as the Trustee does not have sufficient influence over a Subsidiary Member, nor a controlling interest in these companies. The maximum amount of equity available under the Plan will be less than 10%, so the Trustee will neither control nor be in a position to sufficiently influence the Subsidiary Members. As a result paragraph 318(1)(d) will not apply.

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). The Company has a controlling shareholder who has control over it, but the Trustee (in its capacity as 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 subsidiaries. Furthermore, as the Trustee is not a shareholder of the Company or the subsidiaries, subsection 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

Subsection 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.

It is necessary to determine when absolute entitlement occurs to ascertain whether capital gains or losses happen.

Draft Taxation Ruling TR 2004/D25 Income Tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 provides 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 a trust asset to call for the asset to be transferred to them as they so direct.

Paragraph 74 of TR 2004/D25 provides:

74. A vested interest is one that is bound to take effect in possession at some time and is not contingent upon an event occurring that may or may not take place. A beneficiary's interest in an asset is vested in possession if they the right to immediate possession or enjoyment of it.

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

Subsection 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) of the ITAA 1997. 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) of the ITAA 1997.

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