Edited version of your private ruling

Authorisation Number: 1012444027269

Ruling

Subject: Employee Share Trust

Question 1

Will the irretrievable cash contributions made by Company A to Company B as Trustee of the Employee Share Trust (EST) to fund the acquisition of Company A shares by the EST in accordance with the Trust Deed entered into between Company A and Company B be assessable income of the EST under sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will a capital gain or capital loss that arises for the Trustee of the EST at the time participants become absolutely entitled to the Company A shares under the EP1, the EP2 and the EP3 be disregarded under section 130-90 of the ITAA 1997 if the participant acquires the shares for the same or less than the cost base of the shares in the hands of the Trustee of the EST?

Answer

Yes

Question 3

In the event that the EST accumulates dividends received on shares held on behalf of employees during the vesting period under the EP2:

a. Will the accumulated dividends be taxable to the Trustee? And

b. Will the Trustee be entitled to a tax offset for the credits attaching to any franked dividends received during the vesting period?

Answer

Yes

This ruling applies for the following periods:

Income tax year ending 30 June 2013 to year ending 30 June 2017

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Background

1. Company A is a listed Australian company and the head company of an income tax consolidated group.

2. Company A maintains a strong focus on the retention of staff to facilitate the expected growth of the company over the short to medium term. Fundamental to this growth strategy is the implementation of various Equity Plans.

3. The Equity Plans were established as part of its remuneration policy with the intention of attracting and retaining suitable employees.

4. The subscription for new shares is also part of Company A's capital management strategy.

5. Company A established an EST to facilitate the provisions of shares in Company A to employees and executives under each of Company A's Equity Plans. Company A appointed Company B as Trustee for the EST. Company B is an independent third party.

6. The Plans and the EST are administered in accordance with their terms.

EQUITY PLAN 1 (EP1)

7. The purpose of the Plan is to:

· To provide a long-term incentive for senior managers.

· Align employee reward with shareholder wealth and both individual performance and company performance.

8. EP1 operates as follows:

· It is at the Board's discretion to extend an invitation to eligible employees to apply for a number of Performance Rights and/or Performance Options specified on the invitation.

· The number of Performance Rights and Performance Options made available to the eligible employee will depend on various factors such as their position within the company.

· Performance Rights are issued with no exercise price.

· Where eligible employees pay an exercise price to acquire shares under Performance Options, the exercise price will not exceed the share price paid by the EST to acquire those shares.

· If issued, the exercise price in respect of each Performance Option will be based on the weighted average market price of the shares in the 28 days prior to the issue.

· The Performance Rights and Performance Options will begin to vest if the eligible employee satisfies certain performance criteria and continue their service with Company A.

· Performance Rights and Performance Options are not exercisable unless the participant receives at least a satisfactory individual performance rating at the end of the measurement period.

· Accordingly, where certain performance criteria are met, eligible employees will receive ordinary shares in Company A.

· The EST will acquire shares to satisfy Performance Rights and Performance Options at or about the same time that the awards vest.

· The participant will forfeit his/her Performance Right and Performance Options where, for example, an employee commits an act of gross misconduct, cease employment with Company A or failed to meet the exercise requirements.

· However the Board may in their absolute discretion, decide to allow an employee that is no longer employed by Company A to exercise part or all of the Performance Rights and Performance Options held by that employee that had not yet been exercised.

· Performance Rights and Performance Options are not transferable without the written consent of the Board.

EQUITY PLAN 2 & EQUITY PLAN 3 (EP2 & EP3)

9. EP2 & EP3 operate as follows:

Both plans

· It is at the Board's discretion to extend an invitation to eligible employees to apply for a number of shares specified on the invitation under a salary sacrifice arrangement.

· The disposal restriction period, any vesting conditions, forfeiture conditions, the allocation price and the method of payment will be determined by the Board in its absolute discretion.

· Shares granted will be acquired at market value and held on behalf of participants by the trustee, using contributions from Company A that it has withheld from participants as part of the salary sacrifice arrangements.

· An allocation of shares may be made in one tranche or in several tranches through a financial year.

· The shares are subject to restrictions until the earlier of the expiry of the disposal restriction period or a disposal event or such other time as determined by the Board in its sole discretion.

· Restrictions may include the imposition of a holding lock on the shares which is currently used.

· Shares outstanding under all Equity Plans cannot exceed 10% of the issued shares in the company.

· The rights attaching to the shares under both plans will include rights provided for in the Constitution, the Corporations Act and Listing rules where applicable.

· Variation to the EP2 and EP3 plans can be made by the Committee subject to the approval of the Trustee of the EST. Where a proposed amendment or variation to EP2 and EP3 is likely to have a material adverse effect on the rights or interest of holders of the Shares, approval is required from the holders of more than 50% of the Shares in Company A.

EP2

· Employees can contribute up to a maximum of $5,000 of pre-tax base salary in EP2.

· The employee will forfeit his/her EP2 Shares where an employee commits an act of gross misconduct or ceases employment with Company A.

· Where restrictions have lifted under the EP2, the EST will continue to hold the shares on behalf of the shareholder until the shareholder directs otherwise.

EP3

· Employees can contribute up to a maximum of $1,000 of their pre-tax base salary into the EP3 and between $1,000.

Operation of the EST

10. The purpose of the EST is to acquire shares in Company A for delivery to Company A employees under Company A's Equity Plans.

11. The EST manages and administers EP1, EP2 and EP3.

Contributions made by the EST to Company A

12. Company A continues to make cash contributions to the EST on an ongoing basis. The EST must use these cash contributions exclusively to purchase shares in Company A for employees under the Equity Plans and, pending such an acquisition, form part of the EST's assets.

13. The amount of each cash contribution made by Company A to the EST is broadly equal to the market value of Shares to be acquired by the EST.

14. The EST will then allocate shares to the relevant participants, having subscribed for or acquired on-market sufficient shares to fulfill the obligation as necessary.

15. The Trustee of the EST holds all Company A Shares pursuant to each Equity Plan on capital account.

16. The Trustee accepts the Shares as bare trustee and nominee for the Principal on the terms of the Plan and has and will acquire no beneficial interest whatever in the Shares and the income and rights accruing from them.

Use of the EST to facilitate the Plan

17. The establishment of the EST provides Company A greater flexibility to accommodate the long term incentive arrangements of Company A. Similarly, it allows for a streamlined approach to the administration aspect of the Equity Plans. The EST can also be used to provide a range of incentives involving shares in Company A as circumstances change in the labour market that require different incentives to be provided in order to attract, reward and retain key executives and employees.

Costs incurred by Company A to administer the EST

18. Company A incurs various costs in relation to the implementation and on-going administration of the EST. Company A will incur costs associated with the services provided by the Trustee of the EST.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 1A of former Part IIIAA

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 subsection 139B(3)

Income Tax Assessment Act 1936 section 139C

Income Tax Assessment Act 1936 section 139E

Income Tax Assessment Act 1936 former section 160 APHD

Income Tax Assessment Act 1936 former subsection 160 APHJ(2)

Income Tax Assessment Act 1936 former section 160 APHO

Income Tax Assessment Act 1936 former subsection 160 APHO(2)

Income Tax Assessment Act 1936 former subsection 160 APHM(2)

Income Tax Assessment Act 1936 former subsection 160 APHN(2)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 subsection 6-10(1)

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 paragraph 83A-5(2)(a)

Income Tax Assessment Act 1997 subsection 83A-10(2)

Income Tax Assessment Act 1997 subsection 83A-20(1)

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 subsection 104-75(1)

Income Tax Assessment Act 1997 Subdivision 130-D

Income Tax Assessment Act 1997 subsection 130-85(1)

Income Tax Assessment Act 1997 subsection 130-85(2)

Income Tax Assessment Act 1997 subsection 130-85(4)

Income Tax Assessment Act 1997 section 130-90

Income Tax Assessment Act 1997 subsection 130-90(1)

Income Tax Assessment Act 1997 paragraph 130-90(1)(a)

Income Tax Assessment Act 1997 paragraph 130-90(1)(b)

Income Tax Assessment Act 1997 paragraph 130-90(1)(c)

Income Tax Assessment Act 1997 paragraph 130-90(1)(d)

Income Tax Assessment Act 1997 subsection 130-90(2)

Income Tax Assessment Act 1997 section 207-20

Income Tax Assessment Act 1997 subsection 207-35(3)

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 paragraph 207-145(1)(a)

Income Tax (Transitional Provisions) Act 1997 subsection 83A-5(1)

Income Tax (Transitional Provisions) Act 1997 subsection 83A-5(2)

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 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.

Subsection 6-10(1) of the ITAA 1997 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 Company A to the EST are unlike those provisions listed in section 10-5 of the ITAA 1997. Therefore irretrievable contributions made by Company A to the EST will not be assessable income under section 6-10 of the ITAA 1997. They will only be included in the calculation of the net income of the trust under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6-5 of the ITAA 1997.

Under the terms of the Trust Deed, all contributions by Company A to the EST for the purposes of acquiring Company A shares constitute accretions to the corpus of the EST. Furthermore, pursuant to the Trust Deed, the Trustee must, when directed by the Board, acquire Company A shares on behalf of participating employees and use the contributions made by Company A (and the employees, as the case may be) to do so.

The Trust Deed grants the trustee certain powers but these powers are subject to the general limitation that they may only be exercised for the sole purpose of discharging its obligations under the Trust Deed and Plan Rules. To this end, the contributions received from Company A and participating employees must, therefore, be used to acquire Company A shares in accordance with the terms of the Trust Deed and the relevant Equity Plan Rules.

Accordingly, the irretrievable contributions made by Company A to the Trustee to acquire Company A 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 Company A to the Trustee of the EST to fund the subscription for or acquisition of Company A shares by the EST in accordance with 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 Interpretative Decision ATO ID 2002/965.

Note also that income derived by the employment of the property that is the fund of the corpus of the trust and which the Trustee holds on trust will be income according to ordinary concepts. (See Federal Commissioner of Taxation 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

Preliminary - application of Division 83A of the ITAA 1997

Division 83A of the ITAA 1997 will apply to ESS Interests issued on or after 1July 2009 and also, in certain circumstances, to ESS Interests that were provided under an employee share scheme prior to 1 July 2009.

Equity Plans - ESS Interests issued on or after 1 July 2009

Pursuant to subsection 83A-5(1) of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A 1997), Division 83-A of the ITAA 1997 will apply to Performance Rights, Options and Shares issued under the Equity Plans on or after 1 July 2009.

Equity Plans - ESS Interests issued before 1 July 2009

The applicant has advised that Performance Rights, Options and Shares were issued under the previous Equity Plans before 1 July 2009. From 1 July 2009, Subdivision 83A-C of the ITAA 1997 will apply to these Performance Rights, Options and Shares if all of the following subparagraphs of paragraph 83A-5(2)(a) of the IT(TP)A 1997 are satisfied:

(i) at the pre-Division 83A time, former subsection 139B(3) of the Income Tax Assessment Act 1936 applied in relation to the interest;

(ii) the interest was acquired (within the meaning of former Division 13A) before 1 July 2009;

(iii) the cessation time mentioned in former subsection 139B(3) of the Income Tax Assessment Act 1936, as in force at the pre-Division 83A time, for the interest did not occur before 1 July 2009.

Section 130-90 of the ITAA 1997 states:

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.

Thus, under the Company A Equity Plans, where a participant becomes absolutely entitled to the shares as against the Trustee, CGT event E5 will occur and therefore under section 104-75 of the ITAA 1997, the Trustee will make a capital gain or capital loss. However, section 130-90 of the ITAA 1997 operates to disregard that gain or loss where the specified conditions are satisfied.

Employee share trust

The EST is an 'employee share trust' for the purposes of subsection 130-85(4) and subsection 130-90(1) of the ITAA 1997.

Subdivision 130-D of the ITAA 1997 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).

Paragraph 130-90(1)(a) of the ITAA 1997

CGT event E5 will happen under the terms of the Equity Plans at the time when the participant becomes entitled to the shares in Company A as against the trustee. Therefore paragraph 130-90(1)(a) of the ITAA 1997 will be satisfied.

Paragraph 130-90(1)(b) of the ITAA 1997

Section 995 of the ITAA 1997 defines a share to mean a share in the capital of a company. An ordinary share in Company A held by the Trustee of the EST and to which a participant is entitled to upon the vesting of a Performance Right or upon exercise of an Option is a share in the capital of Company A. Accordingly, paragraph 130-90(1)(b) of the ITAA 1997 is satisfied as CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c) of the ITAA 1997

Paragraph 130-90(1)(c) is satisfied as a participant will have acquired a beneficial interest in a share in Company A by the vesting of a Right or by exercising an Option granted under the Equity Plans.

Paragraph 130-90(1)(d) 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 scheme at a discount.

The term 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997. Subsection 83A-10(2) 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;….

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.

The Equity Plans are employee share schemes for the purposes of Division 83A of the ITAA 1997 as they are arrangements under which an ESS interest (i.e. a beneficial interest in a right or option to acquire a beneficial interest in a share of Company A), is provided to eligible employees in relation to their employment in Company A in accordance with the Trust Deed. The Performance Rights are issued under the EP1 at no cost/exercise price. The Options can be exercised upon the payment of an exercise price. The exercise price will not exceed the share price paid by the EST to acquire those shares. Shares will be acquired by the EST under the EP2 and EP3 on behalf of employees, using contributions from Company A that it has withheld from participants as part of the salary sacrifice arrangements.

Subdivision 83A-C of the ITAA 1997 will apply to rights, options and shares acquired before 1 July 2009 under EP1 and EP2, pursuant to subsection 83A-5(2) of the IT(TP)A 1997, 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. Under Subdivision 83A-C of the ITAA 1997, any such performance rights, options and shares acquired under EP1 and EP2 will be assessable at the ESS deferred taxing point.

Subdivision 83A-B will apply to shares acquired under the EP3 as pursuant to subsection 83A-20(1) of the ITAA 1997.

As the participant does not acquire the beneficial interest in a share in any of the Equity Plans 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.

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

Question 3

According to the terms of the EP2 a participant will have an absolutely vested and indefeasible entitlement to income until the earlier of seven years from the allocation date or the occurrence of a disposal event, unless the Board determines otherwise.

Therefore, during this vesting period, in accordance with subsection 207-35(3) of the ITAA 1997 the Trustee will include any franking credit and dividend in their assessable income and, if they satisfy the qualified person rules, will be entitled to a tax offset as set out in section 207-45 of the ITAA 1997.

Qualified person

Paragraph 207-145(1)(a) of the ITAA 1997 operates to deny a franking credit and a tax offset in relation to a franked dividend made to an entity where the entity is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Tax Determination 2007/11 states it is necessary to have regard to the rules in Division 1A of former Part IIIAA of the ITAA 1936 as in force at 30 June 2002, in determining whether an entity is a qualified person. A taxpayer is generally considered a qualified person and entitled to the franking credits attached to the shares if the shares, or an interest in the shares held satisfy both the holding period rule and the related payments rule.

Holding period rules

The holding period rule under the former subsection 160APHO(2) of the ITAA 1936 requires shareholders to hold the shares or the interests in the shares, on which the dividend is paid at risk for a continuous period of at least 45 days during the qualification period. In determining whether a shareholder has satisfied the holding period rule, any days during which there is a 'materially diminished risk' in relation to the relevant shares are not counted. The day of acquisition and the day of disposal of the relevant shares are also not counted.

To determine whether there has been a material diminution of risk, a taxpayer's net position (long or short positions) needs to be determined as per subsection 160APHJ(2) of the ITAA 1936. However, it should be noted that, if a share, or an interest in a share, is an employee share scheme security, a condition attached to the share or interest, or a term of the document that created the interest, that prevents the holder of the share or interest from disposing of it or could result in the share or interest being forfeited is not a position in relation to the share or interest.

The shares held by the EST will satisfy the definition of employee share scheme security under the former section 160APHD of the ITAA 1936, consequently the Trustee's ability to dispose or forfeit the shares as the terms and conditions of the Trust Deed and EP2, does not effect its position in relation to its interests in the shares as per the former subsection 160APHJ(2) of the ITAA 1936.

Also, under former subsection 160APHM(2) of the ITAA 1936, a shareholder is taken to have materially diminished the risks of loss and opportunities for gain with respect to shares or interests in shares if the 'net position' of the shareholder results in the shareholder having less than 30% of the risks and opportunities relating to the shares or interest in shares.

Essentially, the risks and opportunities in relation to shares will be diminished if an entity enters into a position, for example, a hedge that would change the net position on those shares. Consequently, based on the EP2's conditions under which the Trustee and participants (indirectly) are granted shares, there is no position entered into over the shares as part of the transaction. As such, the Trustee and the participants (indirectly) will have held the shares at risk for the qualification period.

Related payments rule

Former section 160APHO of the ITAA 1936 further provided that an entity would not be a qualified person where a related payment of the dividend was paid in respect of a share. 'Related payment' was defined in former subsection 160APHN(2) of the ITAA 1936 as having an obligation to pass the benefit of the dividend or distribution to one or more others.

Based on the information provided, none of the payments in the scheme have the effect of passing on Company A's benefit of the dividends on the shares to another party other than the participant. Accordingly, the Trustee is entitled to the franking tax offset under section 207-20 of the ITAA 1997 in respect of franked dividends received on the Company A shares.

Therefore in accordance with subsection 207-35(3) of the ITAA 1997 the trustee will include any franking credit and accumulated dividends in their assessable income and will be entitled to a tax offset for the credits attaching to any franked dividends received during the vesting period as set out in section 207-45 of the ITAA 1997.

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