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Ruling

Subject: Employee Share Scheme

Question 1

Is the Employee Share Scheme (ESS) Plan, a deferred tax scheme pursuant to Subdivision 83A-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

For the purposes of meeting the reporting obligations contained in Division 392 of the Taxation Administration Act 1953 (TAA), when will the deferred taxing point for the ESS interests occur pursuant to section 83A-120 of the ITAA 1997 if the employee exercises the vested option through payment of the exercise price (i.e. the fair market value (FMV) of the value of the share at the date the option was granted) with either cash or via the cashless option?

Answer

The deferred taxing point for an option occurs at the vesting time for that option.

This ruling applies for the following period

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

The scheme commenced on

1 July 2012

Relevant facts

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

· Application for the Private Ruling

· Plan rules

· Shareholders agreement

· Other documents

Assumptions

The fair market value of the options and shares will always be greater than nil.

Relevant legislative provisions

Income Tax Assessment Act 1997

Division 83A

Subsection 83A-10(1)

Subsection 83A-10(2)

Subdivision 83A-B

Section 83A-20

Subdivision 83A-C

Section 83A-105

Paragraph 83A-105(3)(b)

Section 83A-120

Section 83A-315

Income Tax Assessment Regulations 1997

Div 83A

Taxation Administration Act 1953

Division 392

Reasons for decision

Issue 1

Question 1

Is the Employee Share Scheme (ESS) Plan a deferred tax scheme and subject to Subdivision 83A-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Division 83A of the ITAA 1997 provides for the taxation of shares and rights acquired under an employee share scheme on or after 1 July 2009.

An employee share scheme (ESS) interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 to mean a beneficial interest in the share of the company or a right to acquire a beneficial interest in a share of the company. An employee share scheme is defined in subsection 83A-10(2) as a scheme under which the ESS interests in a company are provided to employees, or associates of employees, of the company or subsidiaries of the company in relation to the employees' employment.

The options to shares in the ordinary stock of the parent company offered under the Plan by the taxpayer provide the employee (subject to meeting certain conditions of employment) or their associates, with a beneficial interest in a right to a acquire a beneficial interest in a share, that is, an ESS interest.

Is the Plan a taxed upfront scheme as described in subdivision 83A-B of the ITAA 1997?

Subdivision 83A-B includes a discount received by a taxpayer on an ESS interest they acquire under an employee share scheme in their assessable income for the financial year in which they acquire the interest.

Section 83A-20 of the ITAA 1997 provides that Subdivision 83A-B applies to an ESS interest if an employee acquires the interest under an employee share scheme at a discount, unless Subdivision 83A-C applies to the interest. (Note 1 to section 83A-20 provides that Subdivision 83A-B does not apply if Subdivision 83A-C applies)

The Commissioner accepts that the rights granted an employee under the Plan, are acquired at a discount.

Therefore, unless subdivision 83A-C of the ITAA 1997 applies to the rights, subdivision 83A-B of the ITAA 1997 will apply and the rights will be subject to tax on acquisition.

Is the Plan a tax deferred scheme to which subdivision 83A-C of the ITAA 1997 applies?

Subdivision 83A-C of the ITAA 1997 includes in the assessable income of an employee for the year in which the deferred taxing point for the interest occurs an amount (the discount amount) which is calculated as the market value of the interest at the deferred taxing point less the cost base of the interest.

Section 83A-105 of the ITAA 1997 provides that Subdivision 83A-C applies and Subdivision 83A-B does not apply to an ESS interest that is a beneficial interest in a right to acquire a beneficial interest in a share if all of the following conditions are satisfied:

1. Subdivision 83A-B would apart from this section apply to the interest.

2. When the employee acquires the interest they are employed by the company.

3. When the employee acquires the interest all the interests available for acquisition under the employee share scheme relate to ordinary shares.

4. When the employee acquires the interest the predominant business of the company is not the acquisition, sale or holding of shares, securities or other investments.

5. Immediately after the employee acquires the interest they do not hold a beneficial interest in more than 5% of the shares in the company and are not in a position to cast or control the casting of more than 5% of the maximum number of votes that might be cast at a general meeting of the company.

6. When the employee acquires the interest there is a real risk that under the conditions of the scheme they will forfeit or lose the interest (other than by disposing of it, exercising the right or letting the right lapse) or forfeit or lose the beneficial interest in the share (other than by disposing of it).

The Plan provides for the granting of options to acquire ordinary shares in the parent company to the Australian subsidiary's employees and their associates at a discount. Neither the parent company nor any of its subsidiaries is a share trading or investment company. No Australian employee holds or controls the right to cast more that 5% of the votes at an annual general meeting of the parent. With five of the six conditions above satisfied we must consider whether a real risk of forfeiture exists for the options as required in paragraph 83A-105(3)(b) which states:

(b) if the ESS interest is a beneficial interest in a right to acquire a beneficial interest in a share:

(i) there is a real risk that, under the conditions of the scheme, you will forfeit or lose the ESS interest (other than by disposing of it, exercising the right or letting the right lapse); or

(ii) there is a real risk that, under the conditions of the scheme, if you exercise the right, you will forfeit or lose the beneficial interest in the share (other than by disposing of it).

Is the Plan a tax-deferred scheme with a real risk of forfeiture?

Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009 which inserted Division 83A, explains the real risk of forfeiture test at paragraph 1.156 as follows:

'The 'real risk of forfeiture test' does not require employers to provide schemes in which their employee share scheme benefits are at a significant or substantial risk of being lost. However, real is regarded as something more than a mere possibility. Something is not a real risk if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility. '

It is further explained at paragraph 1.158 of the Explanatory Memorandum that the 'real risk of forfeiture' test is intended to provide for deferral of tax when there is a real alignment of interests between the employee and employer, through the employee's benefits being at risk.

Real risk of forfeiture in a scheme may include conditions where retention of the ESS interests is subject to performance hurdles or a minimum term of employment. In cases where an employee share scheme has both employment and performance conditions to be met, and one of these conditions satisfies the 'real risk of forfeiture' test, it is not necessary to consider whether the other condition also satisfies the test.

Where there is some doubt whether a condition will satisfy the 'real risk of forfeiture' test then the other condition will also be examined.

ATO Interpretative Decision ATO ID 2010/61 Income tax: Employee share scheme: real risk of forfeiture-minimum term of employment and good leaver provisions provides the Commissioner's view of when the conditions of a scheme determine that the rights will be forfeited. When an employee acquires rights under an employee share scheme, the Commissioner considers that there is a real risk of forfeiture if, under the conditions of the scheme, the employee will forfeit or lose the rights if they cease employment before the vesting date of the rights where that date is 12 months or more from the date the rights were granted. He elaborates on the real risk of forfeiture by stating:

'In considering whether a condition in a scheme imposes a real risk of forfeiture, regard should be had to whether a reasonable person would consider that there is a genuine connection between the forfeiture condition and aligning the interests of the employee and employer. If the risk of forfeiture is over a very short period of time to gain access to a relatively long period of deferral the risk will not be considered real.'

The Plan does not allow an employee to dispose of the option other than by exercising the right or allowing the option to lapse. All options are non-transferable. The Plan does not identify any performance conditions but not all eligible employees will be offered options in the parent company as a motivation and reward to retain employees. Once a grant of options is made to an employee, a minimum service period must elapse before options may be vested in the employee who may then either exercise the rights to the first tranche or allow the rights to lapse within a specified exercise period. The remaining four tranches will become vested on each anniversary of the first tranche.

If at any time the employee leaves the company over that five year period all the unvested rights are forfeited. Presuming an employee is given a further grant of options in a latter year, there will be more options to forgo should the employee resign.

All unvested options carry a real risk of forfeiture. It is only the vested options, where the service period has already been met, that may be exercised within three months of a triggering event or within six months of vesting. The scheme encourages employees to exercise the rights and obtain shares in the company rather than forfeit the rights if the rights are not exercised within the prescribed period. The Plan encourages long term employment aligned with the employer's interests through the use of the staggered allocation of non-transferable options with a 'use it or lose it' policy on exercise of the options. We consider the Plan to be a tax-deferred scheme with a real risk of forfeiture.

Question 2

For the purposes of meeting the reporting obligations contained in Division 392 of the Taxation Administration Act 1953 (TAA), when will the deferred taxing point for the ESS interests occur pursuant to section 83A-120 of the ITAA 1997 if the employee exercises the vested option through payment of the exercise price (i.e. the fair market value (FMV) of the value of the share at the date the option was granted) with either cash or via the cashless option?

As Subdivision 83A-C of the ITAA 1997 applies to the rights granted under the Plan and Subdivision 83A-B does not apply, participants in the Plan will need to include in their assessable income the market value of the rights at the deferred taxing point reduced by the cost base of the rights in the income year in which the deferred taxing point occurs in accordance with section 83A-110 of the ITAA 1997.

Section 83A-120 of the ITAA 1997 provides that the 'ESS deferred taxing point' for rights to acquire shares occurs at the earlier of the following times:

1. when the right has not been exercised, there is no real risk of forfeiting the right, and the scheme no longer genuinely restricts disposal of the right (subsection 83A-120(4));

2. when the participant ceases the employment in respect of which they acquired the rights within the meaning of section 83A-330 (subsection 83A-120(5));

3. seven years after the participant acquired the rights (subsection 83A-120(6));

4. when there is no real risk of forfeiting the right or underlying share, and the scheme no longer genuinely restricts exercise of the right or disposal of the resulting share (subsection 83A-120(7));

Once the employee fulfils the 12 months service condition, the non-transferable option will then be vested in the employee. At vesting the employee has a maximum period of six months in which to choose to exercise the right or to allow the right to lapse. However the employee is unable to dispose of the right until the choice is made.

The vested option may be converted into a share subject to the employee:

· becoming a party to the Shareholders Agreement (SA)

· completing the relevant paperwork to exercise the rights.

· providing consideration at the FMV for the shares.

Consideration may be provided in two ways;

· as a straight out payment for the shares at the FMV as at the date the options were granted (cash exercise)

· by cashing in a portion of the shares at the FMV as at the date the options were granted, sufficient to cover the balance of the shares the employee wishes to hold (cashless exercise).

The employee may also choose a combination of both the cash and cashless exercise.

Subsequently the shares acquired from the exercise of the options can only be sold in a trading window subject to the employee:

· Holding the shares for a minimum of 12 months.

· Not selling more than a certain portion of their maximum share ownership in any one year

· Retaining a certain ratio of shares to salary for some employees

Deferred taxing point 1

The options are non-transferable until vested in the employee. At vesting, the employee has either a six month period (or three months if a triggering event occurs), in which to make the choice of exercising the rights to obtain the underlying share or to forfeit the rights. Between vesting and the date the exercise choice is made the employee is genuinely unable to dispose of the rights but there is no longer a real risk of forfeiture until the exercise choice is made. Subsection 83A-120(4) will not apply to establish a deferred taxing point before the right has been exercised, because the Plan still restricts the employee from disposing of the right before the right is exercised.

Deferred taxing point 2

When an employee ceases their service with the Australian subsidiary and does not take up employment with the parent or other subsidiaries, a triggering event occurs. All unvested options will immediately lapse but the employee or his successors may choose to exercise any vested options to acquire shares within three months of ceasing employment. Vested options held by the employee at the date employment is ceased will have the cessation date as the deferred taxing point by virtue of subsection 83A-120(5). The earliest cessation date that could be a deferred taxing point under this subsection would occur when the options vest in the employee after 12 months and simultaneously the employee ceases employment.

Deferred taxing point 3

Subsection 83A-120(6) provides a maximum time period for deferral of a taxing point as seven years from the date the rights were acquired.

Deferred taxing point 4

Once the employee fulfils the 12 months service condition, the first tranche of options is vested in the employee and there is no longer a real risk of forfeiture of the right or underlying share of that tranche of options. The employee is immediately free to exercise the rights within an exercise period of three or six months, during which a choice is made to acquire shares under the cash or the cashless methods of payment or a combination of both or, the employee may simply forfeit the options. The cashless payment method requires the employee to choose to dispose of some shares immediately to cover the cost of the number of shares the employee wishes to retain from the tranche.

The applicant has stated that the Plan rules impose disposal restrictions on shares acquired upon exercise of the options. However the existence of the "cashless" exercise facility effectively means that all the shares could theoretically be cashed in to facilitate the exercise of the options. The Commissioner is therefore of the view that any disposal restrictions which may apply to shares acquired under either form of exercise are in fact only imposed after the shares have been acquired. Therefore it is at the date of vesting, that there are no longer any genuine disposal restrictions on the shares.

Restrictions imposed after the ESS interest is acquired are ignored when determining the ESS deferred taxing point. In the case of a right, the only relevant restrictions are those imposed when the right is acquired. Restrictions imposed at the time of exercising the right do not affect the ESS deferred taxing point.

Therefore at the date of vesting all of the conditions in sub-section 83A-120(7) of the ITAA 1997 will have been met.

We have established that deferred taxing point 1 (subsection 83A-120(4)) cannot apply to the options granted under the Plan. Deferred taxing point 3 (subsection 83A-120(6)) will never be the earliest point as both deferred taxing points 2 and 4 occur within seven years of the options being granted. The earliest date at which the deferred taxing point occurs is twelve months after the rights are granted and the first tranche of options is vested in the employee. This deferred taxing point may be reached pursuant to subsection 83A-120(5) if the employee immediately ceases employment at the vesting date (deferred taxing point 2). However, it is consistently arrived at when the conditions under subsection 83A-120(7) of the ITAA 1997 (deferred taxing point 4) are fulfilled and there is no longer any risk of forfeiture of the right or disposal restrictions on the rights or the underlying share.

Therefore the Plan is a tax deferred scheme with the earliest deferred taxing point being the date the options are vested.

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