Edited version of your private ruling

Authorisation Number: 1012554632863

Ruling

Subject: Employee Share Plan Scheme (company aspects)

Question 1

Will the irretrievable capital contributions made by the taxpayer to the Trustee of its employee remuneration trust (ERT) for the purposes of enabling the Trustee to acquire the shares be an allowable deduction for the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answers

Yes

Question 2

Will the deduction for taxpayer in respect of the irretrievable capital contributions be allowable in the year of income in which the participating employee acquires the relevant shares, in accordance with section 83A-210 of the ITAA 1997?

Answers

Yes

This ruling applies for the following periods:

01 October 20XX to 30 September 20YY

The scheme commences on:

01 October 20XX

Relevant facts and circumstances

Overview of the ERT

1. The taxpayer is the head company of its tax consolidated group.

2. The ERT was established by the ERT trust deed (Trust Deed) to assist in the retention and motivation of employees of the taxpayer group by providing an additional mechanism for rewarding employees and non-executive directors of the taxpayer.

3. The Trustee is a wholly owned subsidiary company of the taxpayer and a member of the taxpayer tax consolidated group. However, the ERT is not a member of the taxpayer tax consolidated group and the taxpayer is not a beneficiary of the ERT.

4. Taxpayer makes non-refundable irretrievable capital contributions to the ERT for the purpose of enabling the Trustee to acquire shares in the taxpayer.

5. The taxpayer shares held under the Trust Deed are fully paid ordinary shares.

6. The Trustee will acquire taxpayer shares and hold those shares on behalf of employees who participate in the ERT. The Trustee will also acquire the taxpayer shares and will procure the transfer of those shares (when directed by the taxpayer to do so) to an employee upon the exercise by the employee of an option or performance right.

7. The participating employees generally do not pay or give any consideration to acquire the shares. In the case of options, the employees are required to pay an exercise price to the taxpayer (not the Trustee) when the employees notify the taxpayer of their intention to exercise the option. No exercise price is payable upon the exercise of performance rights.

8. The Trust Deed provides that the taxpayer may direct the Trustee to acquire the shares by way of purchase or subscription and the Trustee must acquire the shares in accordance with that direction.

9. The funding option determined by the taxpayer will take into account a number of factors prevalent at the time. Where taxpayer provides funds for the purpose of enabling the Trustee to acquire the shares, this payment is made as a contribution of capital to the ERT.

Acquisition of shares by Trustee

10. Trust Deed allows the Trustee to acquire taxpayer shares either by on market purchase or directly subscribing for new shares issued by taxpayer.

11. In the case of subscription, the taxpayer will issue the requisite number of shares upon receipt of a subscription application and subscription proceeds from the Trustee. The Trustee funds the acquisition using the irretrievable capital contributions made by taxpayer and any other available funds held by the Trustee (i.e. the Trustee may have received cash dividends on forfeited shares which may also be applied towards the subscription cost).

12. The subscription price of taxpayer shares will be equal to the market value of the taxpayer shares on the date of the subscription. The acquisition of taxpayer shares will generally be undertaken contemporaneously with the receipt of the irretrievable contributions paid by taxpayer.

13. The taxpayer shares are registered in the name of the Trustee on acquisition. Other than option and performance right shares, the Trustee holds the shares on behalf of the participating employees who are the beneficial owners of the shares.

14. The Trustee allocates the shares to an account held for each participating employee so that the employee acquires a beneficial interest in their taxpayer shares. Taxpayer has engaged its share registry provider to provide reports to employees in relation to the amount of employee trust held shares and any corresponding dividend entitlements.

15. Employees are entitled to receive all cash dividends paid on the shares held by the Trustee on their behalf in accordance the Trust Deed. Employees are also entitled to any benefits which accrue to taxpayer shares.

16. The Trustee is not permitted to transfer to an employee any share issued under the ERT (i.e. excluding option and performance right shares), or otherwise dispose of or deal with the taxpayer shares until the end of any relevant share restriction period. At the end of any relevant share restriction period, the vesting conditions will have been met and any disposal restriction will have ceased and the employee will become absolutely entitled to the shares held by the Trustee on their behalf.

17. Option and performance right shares are transferred to the employee upon the direction of taxpayer when an employee exercises the option or performance right. Prior to any transfer by the Trustee the employee does not have any beneficial interest in the option or performance right shares held by the Trustee.

18. If taxpayer makes a direction to the Trustee in relation to the manner of acquisition of the taxpayer shares, the reason for a direction to purchase or subscribe would be based on a number of commercial, regulatory and legal considerations. These considerations included capital management issues, regulatory requirements, the accounting treatment of the award and other administrative issues.

19. The ERT is "employee share schemes" which comply with the provisions of Division 83A of the 1997.

20. The taxpayer will not provide loan funds to the Trustee to acquire any taxpayer shares. Any funds provided by the taxpayer to the Trustee to acquire any taxpayer shares will be provided as a capital contribution by the taxpayer.

21. Upon termination of the ERT, the balance of the capital or income of the ERT to which no participant is entitled would be distributed to a charity which is a gift deductible recipient for the purposes of Division 30 of the ITAA 1997.

22. No offers will be made by taxpayer under the ERT which are eligible for the $1,000 reduction to taxable income for certain employees whose adjusted taxable income does not exceed $180,000.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Subsection 8-1(2)

Income Tax Assessment Act 1997 Subsection 83A-10(1)

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

Income Tax Assessment Act 1997 Section 83A-210

Income Tax Assessment Act 1997 Section 701-1

Income Tax Assessment Act 1997 Subsection 960-100(3)

Income Tax Assessment Act 1997 Subsection 960-100(4)

Reasons for decision

Question 1

Will the irretrievable capital contributions made by the taxpayer to the Trustee of its employee remuneration trust (ERT) for the purposes of enabling the Trustee to acquire the shares be an allowable deduction for the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The capital contributions made by taxpayer will be allowable deduction for taxpayer under section 8-1 of the ITAA 1997.

Detailed reasoning

1. When a consolidated group is formed, the group is treated as a single entity for income tax purposes. Section 701-1 of the ITAA 1997 provides that

If an entity is a subsidiary member of a consolidated group for any period, it and any other subsidiary member of the group are taken for the purposes covered by subsections (2) and (3) to be parts of the head company of the group, rather than separate entities, during that period.

Under the single entity rule (SER), actions of a subsidiary are treated as actions of the head entity which is the only entity recognised for working out the income tax liabilities of a consolidated group. As a result, the intra-group transactions would have no income tax consequences for the head entity.

A consequence of the SER is that the contributions of money from the taxpayer to the Trustee may be recognised as intra-group transactions and would be disregarded for tax purposes (i.e. not deductible to taxpayer).

2. However, subsection 960-100(3) of the ITAA 1997 provides that a legal entity may act in different capacities. In each of those capacities, the legal entity is taken to be a different entity. Subsection 960-100(4) of the ITAA 1997 specifies that if a provision refers to an entity of a particular kind, it refers to that entity in its capacity as that kind of entity, not to that entity in any other capacity.

3. In this case, the Trustee was appointed by taxpayer to act on the terms of the Trust Deed. Therefore, despite being a member of the taxpayer group, for the purposes of subsection 960-100(3) of the ITAA 1997, the Trustee is taken to be a different entity. Therefore, the contributions paid to the Trustee in respect of the ERT would be taken to be the contributions paid to an entity outside the taxpayer consolidated group.

General deduction

4. The contributions of capital made by the taxpayer to the Trustee may be deductible if the requirements in subsection 8-1 of the ITAA 1997 are satisfied.

5. Section 8-1provides that

8-1(1)  You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

8-1(2)  However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c)  it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

These requirements are considered below.

Necessarily incurred in carrying on a business (subsection 8-1(1) of the ITAA 1997)

6. The irretrievable contributions made by taxpayer are used for the purposes of providing employees with the taxpayer shares under the Trust Deed. The taxpayer's equity based programs offered to its employees form part of the taxpayer group's remuneration strategy in rewarding current and future contributions to the group's performance and strengthening the link between the value created for shareholders and rewards for employees. The taxpayer's irretrievable capital contributions to the ERT is to:

· create value for shareholders by rewarding employees based on enhancement of sustainable shareholder value;

· align employee rewards to business performance and sustainable returns for shareholders;

· create an environment that will attract top talent and where people can be motivated with energy and passion to deliver superior performance;

· appropriately capture the business risks related to achievement of business outcomes and reflect these in variable rewards;

· recognise capabilities and promote opportunities for career and professional development;

· provide rewards, benefits and conditions that are competitive within the global markets in which the group operates; and

· provide fair and consistent rewards across the group, which support corporate principles.

7. There has been a desire to link senior management employee remuneration with the longer term goals of the organisation rather than focus on the past or current financial year result.

8. Having regard to stated purposes of the ERT, it is considered that the contributions are necessarily incurred in carrying on taxpayer's business. The taxpayer provides irretrievable cash contributions or other properties to the Trustee to be used in accordance with the Trust Deed. Therefore, the contributions made by the taxpayer are incurred in the course of carrying on its business for the purpose of subsection 8-1(1) of ITAA 1997.

Not a loss or outgoing of capital or of a capital nature (subsection 8-1(2) of the ITAA 1997)

9. A taxpayer cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of capital, or of a capital nature and does not relate to the earning of exempt income or non-assessable non-exempt income.

10. Even if a contribution was incurred in carrying the taxpayer's business, it may still be capital or of capital in nature.

11. In Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634, the characterisation of an outgoing depends on what it "is calculated to effect", to be judged from "a practical and business point of view". The character of the advantage sought by the making of the expenditure is critical.

12. In Sun Newspapers Limited & Anor v The Federal Commissioner of Taxation (1938) 61 CLR 337, Dickson J discussed the three tests:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

13. The character of the advantage sought from the payment to an employee benefit fund was examined in Spotlight Stores & Anor Pty Ltd v FC of T [2004] FCA 650, 2004 ATC 4674.. In that case, the Federal Court held that contribution was deductible where the purpose of the Trust was to reward and provide an incentive for Spotlight's employees over the five years the contribution was drawn upon. The contribution was enduring to the extent that for a good number of years, a large lump sum contribution was in substitution for the annual contributions it would otherwise have had to make over the years.

14. In determining the character of the contributions, the critical question is whether the contribution provided by taxpayer is applied by the Trustee to secure an asset or advantage for taxpayer.

15. Under the rules of the ERT:

· The irretrievable capital contributions are made by taxpayer for the sole purpose of acquiring shares in taxpayer. The contributions are not made for any other purpose.

· Taxpayer only contributes the necessary amount of cash to enable the Trustee to fund a particular share allocation. The amount of capital to be contributed to the Trust are determined after taking into account the number of shares required for a particular allocation and the number of unallocated shares (the forfeited shares being reverted to being unallocated shares held by the Trustee) and any excess cash funds arise from the unallocated shares.

· The shares are acquired and allocated to employees within days of the contribution being made to the Trust.

· Where shares are held by the Trustee on behalf of participating employees until the end of the vesting period where all the relevant forfeiture conditions are satisfied. If shares are forfeited by employees, the forfeited shares remain in the Trust and will be allocated to other employees under the next eligible share offer.

· For options and rights, the contribution is not made to the Trust until around the time when the options or rights vest and the options or rights are then capable of being exercised by the employees.

· Therefore, 100% of the contribution will result in an employee taking ownership in a share. In some cases, it may not be the original employee who is allocated the share initially, but another employee if the share is forfeited by the original employee. There is no intention for the Trust to accumulate and hold unallocated shares and excess cash.

16. The Trust Deed provides that taxpayer may direct the Trustee to apply the capital for the purpose of acquiring shares whether by purchase taxpayer shares on market or by direct subscription. The method chosen will depend upon the legal and commercial considerations. Further, the preferred method will also minimise the potential brokerage costs of acquiring the shares on market.

17. Having regard to terms of the ERT, we are of the view that the irretrievable capital contributions are primarily intended to be applied in the providing of direct benefits to the employees. As the capital contributions would ultimately result in an employee taking ownership of the shares, the advantage obtained by taxpayer in providing the cash contribution to the ERT is remunerating and retaining its existing employees in accordance with the taxpayer's remuneration strategy. Any other benefits obtained by taxpayer in making the choice in relation to the acquisition of the shares are an incidental feature of the ERT.

18. Further, as the total number of shares issued in the last five years under taxpayer's share schemes cannot exceed 5% of the number of shares in the issued share capital of the taxpayer at the time of the offer, the advantages obtained by taxpayer in making a capital contribution would be insignificant and consequently does not detract it from the main purpose of the ERT - being for the direct benefit of the employees.

19. Accordingly, the irretrievable capital contributions are not capital or capital in nature under subsection 8-1(1) of the ITAA 1997. The capital contributions are deductible under section 8-1 of the ITAA 1997.

Question 2

Will the deduction for taxpayer in respect of the irretrievable capital contributions be allowable in the year of income in which the participating employee acquires the relevant shares, in accordance with section 83A-210 of the ITAA 1997?

Summary

Deduction for the irretrievable capital contributions made by taxpayer to the ERT will be allowable in the year of income in which the participating employees acquires the relevant shares.

Detailed reasoning

20. The timing of the deduction for the contributions is specifically determined under section 83A-210 of the ITAA 1997.which 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 purposes 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 purposes 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.

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

22. An option granted to an employee under the scheme will be an ESS interest as it is a right to acquire a beneficial interest in a share in a company (ATOID 2010/103)

23. Under the ERT, taxpayer makes irretrievable capital contributions to the Trustee for the purposes of enabling the participating employees of the taxpayer to acquire an ESS interest under the terms of the Trust Deed. Therefore, subsection 83A-210(a) of the ITAA 1997 is satisfied.

24. The provision of money to the Trustee for the purposes of enabling the participating employees of taxpayer to acquire share under the ESS, in relation to the employee's employment occurs before the time the employee acquires the shares (subsection 83A-210(b) of the ITAA 1997).

25. Therefore, for the purposes of section 83A-210 of the ITAA 1997, the deduction in respect of the irretrievable capital contributions made by taxpayer to the ERT will not be available to taxpayer until the time that the participating employees (being the ultimate beneficiary) acquire the relevant shares under the terms of the ERT.

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