Edited version of private advice

Authorisation Number: 1012622767664

Ruling

Subject: Income tax assessable income employee share schemes

Question 1

Will The Company obtain an income tax deduction, pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), in respect of the irretrievable cash contributions made by The Company to The Trustee to fund the subscription for or acquisition on-market of The Company shares by the Employee Share Trust (EST)?

Answer

Yes

Question 2

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

Answer

Yes

Question 3

Are irretrievable cash contributions made by The Company to The Trustee, to fund the subscription for or acquisition on-market of The Company shares by the EST, deductible to The Company at a time determined by section 83A-210 of the ITAA 1997?

Answer

Yes

Question 4

If the EST satisfies its obligation under the Employee Share Option Plan (The Plan) by subscribing for new shares in The Company, will the subscription proceeds be included in the assessable income of The 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

Question 5

Will the Commissioner seek to make a determination that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applied to deny, in part or full, any deduction claimed by The Company to The Trustee to fund the subscription for or acquisition on-market of The Company shares by the EST?

Answer

No

Question 6

Will the provision of options or shares to participants under The Plan be a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No

Question 7

Will the irretrievable cash contributions made by The Company to The Trustee, to fund the subscription for or acquisition on-market of The Company shares, be treated as a fringe benefit within the meaning of section 136(1) of the FBTAA?

Answer

No

Question 8

Will the Commissioner seek to make a determination that section 67 of the FBTAA applies to increase the aggregate fringe benefits amount of The Company, by the amount of tax benefit gained from irretrievable cash contributions made by The Company to The Trustee, to fund the subscription for or acquisition on-market of The Company shares?

Answer

No

This ruling applies for the following periods:

Income tax years ended:

• 1 October 2008 - 30 September 2009

• 1 October 2009 - 30 September 2010

• 1 October 2010 - 30 September 2011

• 1 October 2011 - 30 September 2012

• 1 October 2012 - 30 September 2013

• 1 October 2013 - 30 September 2014

• 1 October 2014 - 30 September 2015

• 1 October 2015 - 30 September 2016

• 1 October 2016 - 30 September 2017

Fringe benefits tax years ended:

• 1 April 2009 - 31 March 2010

• 1 April 2010 - 31 March 2011

• 1 April 2011 - 31 March 2012

• 1 April 2012 - 31 March 2013

• 1 April 2013 - 31 March 2014

• 1 April 2014 - 31 March 2015

• 1 April 2015 - 31 March 2016

• 1 April 2016 - 31 March 2017

• 1 April 2017 - 31 March 2018

The scheme commences on:

1 October 2008

Relevant facts and circumstances

1. Copies of the following have been provided:

• the Employee Share Trust Deed, and

• a copy of the Employee Share Option Plan (The Plan) rules.

2. The Plan is part of the remuneration strategy of the Company and aims to recognise long-term performance by rewarding participants with Options which allow them to share in the growth and in the value of the business.

Employee Share Option Plan (The Plan)

3. Pursuant to the rules of The Plan, eligible participants may be granted Options at the Board's discretion. The Options may be subject to the satisfaction of certain pre-determined vesting hurdles and/or conditions prior to exercise.

4. The Plan broadly operates as follows:

• It is at the Board's discretion to extend an invitation to certain employees to apply for a number of Options specified on the invitation.

• Invitations will be extended on such terms and conditions as the Board decides, from time to time, including:

• The number of Options which may be applied for;

• The Grant Date;

• The Exercise Date;

• The Expiry Date

• Any Exercise Condition; and

• Any supplementary terms and conditions attaching to the Options.

• The exercise price of the Option will be specified in the invitation and may reflect a discount.

• The Options will become exercisable on the Exercise Date, specified in the invitation, subject to the participant remaining an employee as at the Exercise Date.

• In certain circumstances, the Options will immediately lapse (for example, where the participant is lawfully terminated or the participant resigns from employment.

• Options are not transferable without the permission of the Board.

Employee Share Trust (EST)

5. The EST has been established as a sole purpose trust to acquire shares for employees of the Company pursuant to the Company equity plans.

6. The EST operates as follows:

• The EST is funded by cash contributions from the Company for the purchase of shares in accordance with the Trust Deed, the relevant Plan Rules or relevant Terms of Participation.

• These funds will be used by The Trustee to acquire shares in The Company either on-market or via a subscription for new shares in the Company.

• The structure of the EST and The Plan are such that shares allocated on exercise of Options post vesting will be held by The Trustee. At the direction of the participant, the shares may be sold by The Trustee or transferred into the name of the participant.

• At no time will any member of the Company or The Trustee have or be entitled to obtain any beneficial interest in the Trust Assets.

• Upon termination of the EST any surplus of the trust must not be paid to any member of the Company.

• The Trustee is a party external to the Company.

7. The period between contributions to the EST and the allocation of shares to participants in The Plan will be less than six months.

Use of a Share Trust to facilitate The Plan

8. The applicant has stated that the establishment of the EST provides the Company greater flexibility to accommodate the long term incentive arrangements. Similarly, it allows for a streamlined approach to the administration aspect of its equity plans. The EST can also be used to provide a range of incentives involving shares in the Company 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.

9. The applicant considers that the commercial benefits of using the EST include:

• Greater flexibility for The Company to accommodate the long term incentive arrangements both now and into the future as the Company continues to expand operations and therefore employee numbers.

• Capital management flexibility for the Company, in that the EST can use the contributions made by the Company either to acquire shares in the Company on market, or alternatively to subscribe for new shares in the Company.

• Providing an arm's-length vehicle through which shares in the Company can be acquired and held on behalf of the relevant employee. This assists the Company to satisfy corporate law requirements relating to a company dealing in their own shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 20-20

Income Tax Assessment Act 1997 Section 20-25

Income Tax Assessment Act 1997 Section 20-30

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-210

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 104-155

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

Income Tax Assessment Act 1997 Section 974-75

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Fringe Benefits Tax Assessment Act 1986 Section 66

Fringe Benefits Tax Assessment Act 1986 Section 67

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Reasons for decision

Issue 1

Question 1

Summary

Payments by the Company to the EST in relation to The Plan form part of the remuneration package of Company Employees. These payments are irretrievable and necessarily incurred in carrying on the business of the Company. They are not capital or a capital nature, nor is there anything to indicate that they are otherwise excluded by subsection 8-1(2) of the ITAA 1997. As such they are deductible under Section 8-1 of the ITAA 1997.

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 is a general deduction provision. It states that:

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.

Subsection 8-1(2) of the ITAA 1997 then states:

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.

Losses or outgoings

Where a sufficient connection exists between outgoings constituting contributions made to the EST to purchase shares and the derivation of assessable income a deduction may be available under section 8-1 of the ITAA 1997 (Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113; Amalgamated Zinc (De Bavay's) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295; W Nevill & Co Ltd v Federal Commissioner of Taxation (1937) 56 CLR 290; Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 78 CLR 47; and Charles Moore & Co (WA) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344).

The EST is established with the sole purpose of acquiring and holding shares on trust for employees of the Company and their associates (Participants) in accordance with the terms of the EST, relevant Plan Rules and Terms of Participation. The EST exists to satisfy the Company's obligations in relation to options provided under an employee share scheme to Participants in accordance with the specified Company equity plans. The EST is funded by irretrievable cash contributions from the Company such that once funds are paid to the EST, the Company has no further beneficial interest in the funds.

The purpose of The Plan is to provide a benefit to Participants by granting them an option to obtain shares in the Company at a discount. Under The Plan, the Company contributes funds to enable the EST to purchase shares in order to fulfil the Company's obligations arising from the issue of options to Participants. The Trustee of the EST, having subscribed for or acquired on-market, sufficient shares to fulfil the obligations, as necessary then allocates shares to the relevant Participants upon the exercise of their options. The Plan rules indicate that the irretrievable contributions made to the EST by the Company are made to enable the Company to meet its obligations arising from the grant to Participants of options to acquire shares. Therefore, irretrievable contributions to the EST used to acquire shares form part of the overall employee remuneration costs of the Company.

Contributions made to the EST in relation to The Plan, will be irretrievable and non-refundable to the Company and have sufficient connection to the income producing activities of the Company to be considered a loss or outgoing for the purpose of subsection 8-1(1) of the ITAA 1997.

Capital or revenue?

In Spotlight Stores Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 745 and Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 58 ATR 210 (Pridecraft) it was determined that payments by an employer company to an employee share trust established for the purpose of providing incentive payments to employees were on revenue account and not capital or of a capital nature.

In ATO Interpretative Decision ATO ID 2002/1074 Income Tax - deductibility - irretrievable employer contributions paid to the trustee of its employee share scheme to acquire a share or right under the employee share scheme; the view is expressed that a company will be entitled to a deduction for irretrievable contributions made to the trustee of its employee share scheme under section 8-1 of the ITAA 1997.

Contributions made by the Company to The Trustee of the EST for the purposes of administering The Plan are primarily outgoings incurred by the Company in the ordinary course of carrying on its business. Such contributions are not capital in nature or any capital component is sufficiently small or trifling such that the Commissioner would not seek to apportion the deduction.

Nothing in the facts suggests that contributions made by the Company to the EST are private or domestic in nature, or are incurred in gaining or producing exempt income, or are otherwise prevented from being deductible under a specific provision of the ITAA 1936 or the ITAA 1997.

Conclusion deduction under section 8-1 of the ITAA 1997

Thus, subject to the timing rule in section 83A-210 of the ITAA 1997 (dealt with further in question 3), the Company would be entitled to a deduction under section 8-1 of the ITAA 1997 for irretrievable cash contributions made by the Company to The Trustee of the EST to fund the subscription for or acquisition on-market of Company shares by the EST.

Question 2

Summary

The Company will incur costs associated with the on-going administration of the EST these costs are part of the ordinary recurring cost to the Company of remunerating its employees and are therefore deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

As discussed in question 1 above, section 8-1 of the ITAA 1997 provides that you can deduct from your assessable income 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.

The Company will incur costs associated with the on-going administration of the EST. These costs will include payments to The Trustee for:

n employee plan record keeping;

n production and dispatch of holding statements to employees;

n provision of annual income tax return information for employees; Costs incurred in the acquisition of Shares on market;

n management of employee termination; and

n other trust expenses.

Consistent with the ATO view expressed in ATO Interpretative Decision ATO ID 2002/961 Income Tax: employer costs for the purpose of administering its employee share scheme are deductible; these costs are part of the ordinary recurring cost to the Company of remunerating its employees and are therefore deductible under section 8-1 of the ITAA 1997.

Question 3

Summary

Section 83A-210 of the ITAA 1997 may determine the timing of the deduction under section 8-1 of the ITAA 1997 relating to irretrievable cash contributions made by the Company to The Trustee to fund the acquisition of shares under The Plan.

Section 83A-210 of the ITAA 1997 will operate in circumstances where a contribution is made prior to the provision of a relevant ESS interest. In this circumstance it will operate to delay any deductions under section 8-1 of the ITAA 1997 available to the Company under The Plan to the income year that the options are granted.

Detailed reasoning

As explained in question 1, the provision of money to The Trustee of the EST by the Company for the purpose of remunerating its employees under an employee share scheme is an outgoing in carrying on the business of the Company and as such 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 employer 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 states 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.

Section 83A-210 of the ITAA 1997 applies if there is a relevant connection between the money provided to The Trustee and the acquisition of ESS interests (directly or indirectly) by the employee under an employee share scheme in relation to the employee's employment.

An ESS interest in a company 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.

Thus section 83A-210 of the ITAA 1997 will operate in circumstances where the contribution occurs before the provision of the relevant ESS interest. In such circumstances it will operate to delay a deduction under section 8-1 of the ITAA 1997 until such time as the relevant ESS interest is acquired by the employee.

As ESS interest includes:

n a beneficial interest in a right to acquire a beneficial interest in a share in the company, or

n a beneficial interest in a share of the company,

Thus, a deduction under section 8-1 of the ITAA 1997 for contributions to an employee share trust are only available once an employee has a beneficial interest in an option or share in the company.

Any money provided to the trustee of an employee share scheme to purchase excess shares intended to meet obligations arising from a future grant of options occurs before the employees acquire the relevant options under the scheme. In such cases section 83A-210 of the ITAA 1997 will apply and the excess payment will be deductible to the employer in the year of income when the relevant options are subsequently granted to the employees.

Where contributions of money by the Company to the EST are made:

n in income years prior to the income year in which options are granted, section 83A-210 of the ITAA 1997 will operate to delay the deduction under section 8-1 of the ITAA 1997 to the income year in which the option is granted to the employee under The Plan,

n in the same income year in which the option is granted to the employee under The Plan, the deduction under section 8-1 of the ITAA 1997 will be available in the income year in which the option is provided.

Question 4

Summary

Subscriptions for the issue of new shares received by the Company from the EST are:

n considered to be capital in nature and as such are not included in assessable income under section 6-5 of the ITAA 1997 as ordinary income,

n not, recoupments by way of insurance or indemnity, or other recoupment as specified, so they are not included in assessable income by section 20-20 of the ITAA 1997, and

n excluded from being a CGT event by subsections 104-35(5)(c) and 104-155(c) of the ITAA 1997.

Detailed reasoning

Ordinary Income

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts which is called ordinary income. The classic definition in Australian law was given by Chief Justice Jordan in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215. Chief Justice Jordan considered that:

The word 'income' is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

The leading case on ordinary income is Eisner v Macomber 252 US 189 (1919). It was said in that case that:

The fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being 'derived' that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; …that is income derived from property. Nothing else answers the description.

In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. They further stated at page 138 that:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

In accordance with an employee share scheme, the trustee subscribes to the company for an issue of shares, it pays the full subscription price for the shares and the company receives a contribution of share capital from the trustee.

The character of the contribution of share capital received by the Company from The Trustee of the EST can be determined by the character of the right or thing disposed of in exchange for the receipt. Here, the Company is issuing The Trustee with new shares in itself. The character of the newly issued share is one of capital. Therefore, it can be concluded that the receipt, being the subscription proceeds, takes the character of share capital, and accordingly, is also of a capital nature.

Accordingly, when the Company receives proceeds from The Trustee of the EST as subscriptions for new shares in the Company to satisfy obligations to employees, the subscription price received by the Company is a capital receipt. That is, it will not be on revenue account, and will not be ordinary income under section 6-5 of the ITAA 1997.

Section 20-20 of the ITAA 1997

Subsection 20-20(2) of the ITAA 1997 provides that if you receive an amount as a recoupment of a loss or outgoing:

n it will be assessable income if you received it by way of insurance or indemnity, and

n that amount can be deducted as a loss or outgoing in the current year or earlier income year.

Insurance or indemnity

The Company will receive an amount for the subscription of shares by The Trustee of the EST, in this instance:

n There is no insurance contract so the amount is not received by way of insurance.

n The amount is not an indemnity because the receipt does not arise under a statutory or contractual right of indemnity, and the receipt is not in the nature of compensation.

Therefore it cannot be said that the subscription proceeds are by way of insurance or indemnity under subsection 20-20(2) of the ITAA 1997.

Recoupment of a loss or outgoing

Subsection 20-20(3) of the ITAA 1997 makes assessable a recoupment of a loss or outgoing that is deductible, or has been deductible or deducted in a previous income year, where the deduction was claimed under a provision listed in section 20-30 of the ITAA 1997.

The Explanatory Memorandum to the Tax Law Improvement Bill 1997 states that the ordinary meaning of recoupment encompasses any type of compensation for a loss or outgoing. The ordinary meaning of recoupment is extended by subsection 20-25(1) of the ITAA 1997 to include

(a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and

(b) a grant in respect of a loss or outgoing.

The Trustee of the EST in subscribing for new shares in the Company is acquiring new equity in the Company, this cannot be said to be a recoupment under subsection 20-25(1) of the ITAA 1997.

As the subscription proceeds are not a recoupment, as defined in subsection 20-24(1) of the ITAA 1997, they will not be an assessable recoupment under section 20-20 of the ITAA 1997.

Capital Gains Tax

Section 102-20 of the ITAA 1997 states that:

You make a capital gain or loss if and only if a CGT event happens.

The relevant CGT events that may be applicable when the subscription proceeds are received by The Company are CGT events:

• D1 (creating a contractual or other rights), and

• H2 (receipt for event relating to a CGT asset).

With regard to:

• CGT event D1, paragraph 104-35(5) of the ITAA 1997 states that:

CGT event D1 does not happen if:

….

(c) a company issues or allots equity interests or non-equity shares in the company...

• CGT event H2, paragraph 104-155(5) of the ITAA 1997 states that:

CGT event H2 does not happen if:

….

(c) a company issues or allots equity interests or non-equity shares in the company...

In this case, the Company is issuing shares, being equity interests as defined in section 974-75 of the ITAA 1997, to The Trustee, therefore neither CGT event D1 or H2 happens. Since no CGT event occurs, there is no amount that will be an assessable capital gain to the Company.

Conclusion

When The Trustee of the EST satisfies its obligations under The Plan by subscribing for new shares in the Company, the subscription proceeds will not be included in the assessable income of the Company under section 6-5 or section 20-20 ITAA 1997, nor trigger a CGT event under Division 104 of the ITAA 1997.

Question 5

Summary

The EST represents a scheme as defined in part IVA of the ITAA 1936 and the Company does obtain a tax advantage, in that it receives a tax deduction for contributions made to the EST used to subscribe for the Company shares that would otherwise be unavailable.

Objective consideration of the matters contained in subsection 177D(2) of the ITAA 1936 supports a conclusion that the dominant purpose of the Company entering into the scheme was not to obtain a tax benefit.

The Commissioner will not make a determination under section 177F of the ITAA 1936 in respect of the Company, to deny, in part or full, any deduction claimed by them in respect of the irretrievable cash contributions they make to The Trustee of the EST to fund the subscription for or acquisition on-market of Company Shares.

Detailed reasoning

Law Administration Practice Statement PS LA 2005/24 Application of the General Anti-Avoidance Rules deals with the application of the general anti-avoidance rules, including Part IVA 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:

(i) there must be a scheme within the meaning of section 177A of the ITAA 1936;

(ii) a tax benefit arises that was obtained or would be obtained in connection with the scheme but for Part IVA of the ITAA 1936; and

(iii) having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies.

The Scheme

Subsection 177A(1) of the ITAA 1936 defines a 'scheme' as:

(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.

The establishment of The Plan and EST as well as the payment of irretrievable cash contributions to The Trustee is considered a scheme for the purposes of subsection 177A(1) of the ITAA 1936.

Tax Benefit

Relevantly, a tax benefit is defined in subsection 177C(1) of the ITAA 1936 as:

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:

….

(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; ….

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

Under the scheme the Company receives an income tax deduction arising from the payment of an amount to The Trustee. If the scheme was not entered into and the Company simply chose to issue new shares to employees, the Company may not receive a tax deduction for this amount. On the other hand the Company, provided they satisfied their obligations under company law, would be entitled to a deduction if it simply purchased shares for employees on market via a broker or alternatively remunerated employees directly via an alternative method such as cash bonuses.

Thus the Company does obtain a tax benefit, as defined, in the form of a deduction for contributions made to the EST which it otherwise would not be entitled to if it were to issue shares directly to employees.

Dominant Purpose

Subsection 177D(2) 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:

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

(b) the form and substance of the scheme

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

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

(e) 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

(f) 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

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out

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

Subsection 177A(5) of the ITAA 1936 requires the purpose to be the dominant purpose. Therefore in considering whether Part IVA applies or not, the necessary comparison to be made in relation to the factors listed in subsection 177D(2) is between the scheme as proposed and the relevant counterfactual in order to determine the dominant purpose.

(a) The manner in which the scheme was entered into or carried out

The inclusion of the EST in the scheme does give rise to a tax benefit, but the Company contends that the presence of the EST provides commercial benefits, in particular:

a) Capital management flexibility as it provides a streamlined approach to using contributions received from the Company and employees to either acquire shares in the Company on market (in a more convenient manner than if no trust was used) or alternatively to subscribe for new shares in the Company. This provides flexibility as circumstances change in how shares are sourced for provision to employees.

b) Administrative efficiency as it provides a single arm's length vehicle to facilitate the provision of shares to employees under The Plan.

c) Assisting the Company to meet Corporations Act 2001 requirements in relation to dealing in its own shares and insider trading. The Corporations Act 2001 generally prohibits a company from acquiring its own shares. The use of the EST will assist the Company to meet these requirements as it provides a mechanism for the acquisition of Company shares through the EST. The EST is not prohibited from doing this because the Company has no beneficial interest in either shares held by the EST or the EST itself.

The EST also helps the Company manage any insider trading prohibitions in the Corporations Act 2001 as The Trustee, an independent party, is acquiring shares in accordance with a set policy for the sole benefit of employees.

Unlike in Pridecraft, it is noted that the arrangement is not deliberately and intentionally established close to the end of the Company's income year nor with a large up-front payment intended to provide for the EST operations for several years into the future. Rather the Company states that:

…The Company will fund the EST on a recurring basis as the need arises.

It is accepted that the EST provide benefits to the operation of the scheme that would not be available if the Company bought shares for employees (subject to company law requirements) on market via a broker.

(b) 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 Plan. It takes the form of payments by The Company to The Trustee of the EST who acquires shares and transfers them to participants.

While the existence of the EST confers a tax benefit, it cannot be concluded that it is the only benefit provided as outlined above. The Company state that the form of the arrangement with the EST provides a number of non-tax benefits and this is accepted.

(c) 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 EST for several years. There is nothing in this factor to suggest that a dominant purpose of entering into the scheme was to obtain a tax benefit.

(d) The Result of the Scheme

The result of the scheme is to provide the 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 Company to achieve a business outcome. It is to be expected that a deduction would normally be allowable in these circumstances.

(e) Any Change in the Financial Position of the Company

As noted above, the Company makes irretrievable contributions to the EST and those contributions constitute a real expense with the result that the Company's financial position is changed to that extent. While it is arguable that the quantum of the deductions is higher with the EST as part of the scheme, than would be the case if the Company provided shares to participants by acquiring them on market via a broker (subject to company law requirements), there is nothing artificial, contrived or notional about the expenditure incurred by the Company.

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

The contributions by the Company to the EST will form part of the corpus of the EST and must be dealt with by The Trustee in accordance with the terms of the relevant trust deed (i.e. exclusively for the acquisition of shares to provide to participants in the employee share scheme). The Company is not a beneficiary of the EST and its contributions cannot be returned to it in any form except where The Trustee acquires shares from the Company by subscribing for new issues at market value.

Therefore, the contributions made by the 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.

(g) Any Other Consequence

Not relevant to this scheme.

(h) The Nature of any Connection between the Company and any Other Persons

The relationship between the Company and the participants in the scheme is one of employer and employee. The Trustee of the ESP is independent to the Company and is under a fiduciary obligation to act in the interests of the employees who participate in The Plan. The contributions made by the Company to The Trustee are commensurate with the Company's stated aim of encouraging employees to share in the ownership and the long-term success of the Company. There is nothing to suggest that the parties to The Plan 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

Objective consideration of all eight matters contained in paragraph 177D(2) of the ITAA 1936 supports a conclusion that the dominant purpose of the Company and of the other persons who entered into the scheme was not to obtain a tax benefit.

The Commissioner will not make a determination under section 177F of the ITAA 1936 in respect of the Company, to deny, in part or full, any deduction claimed by them in respect of the irretrievable cash contributions made by them to The Trustee of the EST to fund the subscription for or acquisition on-market of Company shares.

Question 6

Summary

The options granted under The Plan are a benefit constituted by the acquisition of an ESS interest under an employee share scheme, ESS interests are excluded from the definition of fringe benefit. As such the provision of these options will not be a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

When an employee accepts to participate in The Plan, they obtain a right to acquire a beneficial interest in a Company share and this right constitutes an ESS interest. When this right is subsequently exercised, any benefit received would be in respect of the exercise of the right, and not in respect of employment. Therefore, the subsequent provision of a Company share will not give rise to a fringe benefit as a benefit has not been provided in respect of the employment of the employee.

Detailed reasoning

Provision of options under The Plan

An employer's liability to fringe benefits tax (FBT) arises under section 66 of the FBTAA 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 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 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) to (s) of the fringe benefit definition.

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

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 83AB or 83AC of that Act applies.

Subsection 83A-10(1) of the ITAA 1997 defines an ESS interest in a company as:

…. a beneficial interest in:

(a) a share in the company; or

(b) a right to acquire a beneficial interest in a share in the company.

Subsection 83A-10(2) of the ITAA 1997 defines an employee share scheme as:

…. 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; or

(b) subsidiaries of the company;

in relation to the employees' employment.

The options granted under The Plan are a beneficial interest in a right to acquire a beneficial interest in a Company share, which is in connection with employment by the Company, making the options an ESS interest. As such the discount obtained as part of the issue of these options is a benefit constituted by the acquisition of an ESS interest under an employee share scheme, which is excluded from the definition of fringe benefit in subsection 136(1) of the FBTAA. As such the provision of these options to employees under The Plan will not be a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

The provision of shares upon exercise of the options

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

The meaning of the phrase 'in respect of' was considered by the Full Federal Court in J & G Knowles & Associates Pty Ltd v Federal Commissioner of Taxation (2000) 96 FCR 402. The court at page 410 said:

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, casual connection or relationship between the benefit and the employment.

The situation is similar to that which existed in Federal Commissioner of Taxation v McArdle (1988) 19 ATR 1901 where an employee was granted valuable rights in respect of his employment which he subsequently surrendered in return for a lump sum payment. The full Federal Court noted that what had occurred under the surrender agreement was not the granting of a valuable benefit, but the exploitation of rights received from the employer in previous years.

When an employee accepts to participate in The Plan, they obtain a right to acquire a beneficial interest in a Company share and this right constitutes an ESS interest. When this right is subsequently exercised, any benefit received would be in respect of the exercise of the right, and not in respect of employment.

Therefore, the benefit that arises to an employee upon the exercise of a right under The Plan (that is, the provision of a Company share) will not give rise to a fringe benefit as a benefit has not been provided in respect of the employment of the employee.

Question 7

Summary

The EST is an employee share trust, as defined in subsection 130-85(4) of the ITAA 1997. As the FBTAA excludes contributions to an employee share trust from being a fringe benefit, The 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 Company shares in accordance with The Plan.

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:

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);

Employee share trust

The definition of employee share trust is found in subsection 130-85(4) of the ITAA 1997, which states:

An employee share trust, for an employee share scheme, 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

An employee share scheme is defined in subsection 83A-10(2) of the ITAA 1997 as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment. The option to acquire a The Company share and the beneficial interest in a The Company share (that is acquired pursuant to the exercise of the option granted under The Plan) are ESS interests within the meaning of subsection 83A-10(1) of the ITAA 1997.

Thus The Plan is an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which options (being rights to acquire shares in the Company) and ultimately shares are provided to employees in relation to the employee's employment.

Under The Plan, the employer has established the EST to acquire shares in the Company and to allocate those shares to employees to satisfy the ESS interest acquired under The Plan. The beneficial interest in the shares is also provided under an employee share scheme because they are provided as part of the same scheme under which the options are provided to the employee in relation to their employment.

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

n the EST acquires shares in the Company; and

n the EST ensures that ESS interests (as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in the shares of the Company), are provided under an ESS (as defined in subsection 83A-10(2) of the ITAA 1997) by allocating those shares to the employees in accordance with the governing documents of The Plan.

Paragraph 130-85(4)(c) of the ITAA 1997

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 employee share plan and administering the EST.

ATO Interpretative Decision ATO ID 2010/108 Income Tax Employee share trust that acquires shares to satisfy rights provided under an employee share scheme and engages in other incidental activities, explains that the Commissioner considers activities which are merely incidental in accordance with paragraph 130-85(4)(c) of the ITAA 1997, include:

• the opening and operating of a bank account to facilitate the receipt and payment of money;

• the receipt of dividends in respect of shares held by the trust on behalf of an employee, and their distribution to an 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 purpose 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.

The provisions of The Plan collectively make it clear that The Trustee can only use the contributions received exclusively for the acquisition of shares for eligible employees in accordance with The Plan. The Trust Deed states that:

…. the Company and the Trustee agree that the Trust will be managed and administered so that it satisfies the definition of employee share trust in section 130-85(4) of the ITAA 1997.

It is accepted that all other duties/general powers listed in the provisions of the EST trust deed are considered to be merely incidental to the functions of The Trustee in relation to its dealing with the shares for the sole benefit of participants in accordance with The Plan.

Conclusion

The Trust is an employee share trust, as defined in subsection 130-85(4) of the ITAA 1997, as the activities of The Trustee in acquiring and providing ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 and its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997.

As paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes contributions to The Trustee of the EST from being a fringe benefit, the Company will not be required to pay FBT in respect of the irretrievable cash contributions it makes to The Trustee to fund the acquisition of Company shares in accordance with The Plan.

Question 8

Summary

The general anti-avoidance provision in the FBTAA contains comparable elements to Part IVA of the ITAA 1936 in that it:

n requires identification of an arrangement,

n requires a tax benefit to be obtained by the employer which is the sole or dominant purpose of entering into the arrangement, and

n is activated by the making of a determination by the Commissioner.

Benefits provided to The Trustee by way of irretrievable cash contributions to the EST will not be subject to FBT as they are not a fringe benefit as explained in question 7. As such no amount could reasonably be expected to be included in the aggregate fringe benefits amount attributable to The Plan, the amount of FBT 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 applies to The Plan.

Detailed reasoning

The general anti-avoidance provision for fringe benefits tax is in section 67 of the FBTAA, which contains comparable elements to Part IVA of the ITAA 1936. This is summarised in PS LA 2005/24 which provides guidance on the application of section 67 of the FBTAA in paragraphs 145-148:

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 and or could reasonably be expected to be 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 if the arrangement resulted in the payment of less FBT than would be payable but for entering into the arrangement.

The answer to question 18 of the appendix to Miscellaneous Taxation Ruling MT 2021 Fringe benefits tax: response to questions by major rural organisation, regarding the application of section 67 FBTAA, states that:

.… 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 .…

Paragraph 151 of PS LA 2005/24 provides guidance on the application of section 67 of the FBTAA as it relates to Part IVA of the ITAA 1936:

The approach outlined in this practice statement (refer to paragraph 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.

Under The Plan amounts provided to The Trustee by way of irretrievable cash contributions to the EST to purchase The Company shares, will not be subject to FBT, as they are not fringe benefits as explained in 7. Consequently, no amount could reasonably be expected to be included in the aggregate fringe benefits amount, attributable to The Plan if the arrangement had not been entered into. It follows therefore that the amount of FBT 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 applies to include an amount in the aggregate fringe benefits amount of the Company in relation to a tax benefit obtained under The Plan.

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