Edited version of your written advice

Authorisation Number: 1012704426308

Ruling

Subject: employee share scheme (ESS) interests

Question

Are you required to include the discount you received on your employee share scheme (ESS) interests in your assessable income in the 2009-10 financial year?

Answer:

Yes

This ruling applies for the following period(s)

Year ended 30 June 2010

The scheme commences on

1 July 2009

Relevant facts and circumstances

Initially, when you were a resident of the foreign country you were employed by a company, which was a subsidiary of an Australian company.

While employed by the subsidiary, you participated in the Australian company's employee share scheme (ESS) program, based in Australia.

Under this scheme, you were granted some performance rights for nil consideration. The exercising of the right 'exchanges' it for one Australian company share. Each share delivered on exercise will be a fully paid ordinary share in the capital of the Australian company and will carry the same rights as all other shares in the same class then on issue.

According to your program;

• your option shall be exercisable only if it has vested, the specified exercise date has been reached, you have paid the exercise price and the option has not lapsed

• if you cease to be an employee of the company group for any other reason (except termination for a cause) unexercised options, whether vested or unvested may only be exercised if permitted by the Board (which includes such circumstances as retirement, redundancy, death)

• if you seek tax deferral (no election has been made) you will be assessed on the options at the 'cessation time' being the earliest of;

- when you dispose of the options

- when you are no longer employed by an member of the company group

- when you exercise your options

Later, you arrived in Australia from the foreign country on a temporary work visa and worked for the Australian company until the options vested.

The rights matured on in the 2009-10 financial year, and you exercised them.

You included an amount, representing the assessable discount on the shares in your 2010 income tax return.

You were subsequently granted permanent residence in Australia.

You have not made any election for the ESS interest you received.

You do not hold a legal or beneficial interest in more than 5% of the shares in the Australian company.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 13A

Income Tax Assessment Act 1936 Section 139B

Income Tax Assessment Act 1936 Section 139CB

Income Tax Assessment Act 1936 Section 139CD

Income Tax Assessment Act 1936 Section 139CDA

Income Tax Assessment Act 1936 Section 139GC

Income Tax Assessment Act 1936 Section 139GCA

Income Tax Assessment Act 1936 Section 139E

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Division 83A-C

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-110

Income Tax Assessment Act 1997 Section 83A-120

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

Income Tax Assessment Act 1997 Section 6-10

Reasons for decision

Detailed reasoning

Employee share scheme (ESS) interests

Former Division 13A of the Income Tax Assessment Act 1936 (ITAA 1936) provided for the taxation treatment of shares or rights (called ESS interests) acquired under an employee share scheme (ESS).

The ESS rules contained in Division 13A of the ITAA 1936 that applied to shares or rights acquired before 1 July 2009 have been repealed effective from 14 December 2009. A new Division 83A in the Income Tax Assessment Act 1997 (ITAA 1997) contains employee share scheme rules that apply to shares or rights acquired on or after 1 July 2009.

The new rules in Division 83A of the ITAA 1997 will apply to some shares or rights that were acquired before 1 July 2009 under transitional rules. These shares and rights are known as transitioned interests. However, the previous rules in Division 13A of the ITAA 1936 will continue to apply (despite its repeal) to shares or rights that do not transition to the new rules.

Transitioned interests

Subsection 83A-5(2) of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997) prescribes that subdivision 83A-C of the ITAA 1997 and the rest of Division 83A of the ITAA 1997 that relates to that subdivision will apply to an ESS interest if:

a) all of the following subparagraphs apply:

i. at the pre-Division 83A time, 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 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;

Former subsection 139B(3) of the ITAA 1936 explains that if the share or right is a qualifying share or right and the taxpayer has not made an election under section 139E covering the share or right, the discount is included in the taxpayer's assessable income of the year of income in which the cessation time occurs.

Former subsection 139CB(1) of the ITAA 1936 provides that the cessation time for a right is the earliest of the following:

a) the time when the taxpayer disposes of the right (other than by exercising it);

b) the time when the employment in respect of which the right was acquired ceases;

c) subject to subsection (3) (about takeovers and restructures), if the right is exercised and there is a restriction preventing the taxpayer from disposing of the share acquired as a result of the exercise of the right or a condition that could result in the taxpayer forfeiting ownership of the share - the time when the last such restriction or condition ceases to have effect;

d) subject to subsection (3), if the right is exercised and there is no such restriction or condition - the time when the right is exercised;

e) if subsection (3) applies - the time when the taxpayer disposes of the share referred to in paragraph (3)(b);

f) the end of the 10 year period starting when the taxpayer acquired the right.

Qualifying rights

Former subsection 139CD(1) of the ITAA 1936 provides the definition of a qualifying right as a right to acquire a share in a company is a qualifying right if:

i. the first, second, third, fifth and sixth of the 6 conditions below are satisfied; and

ii. in the case of a right that a taxpayer has acquired while engaged in foreign service - section 139CDA (about being engaged in foreign service) applies to the right.

• The first condition is that the share or right is acquired by a taxpayer under an employee share scheme (ESS).

• The second condition is that the company is the employer of the taxpayer or a holding company of the employer of the taxpayer

• The third condition is that all the shares available for acquisition under the scheme are ordinary shares and all the rights available for acquisition under the scheme are rights to acquire ordinary shares.

• The fifth condition is that, immediately after the acquisition of the share or right, the taxpayer does not hold a legal or beneficial interest in more than 5% of the shares in the company.

• The sixth condition is that, immediately after the acquisition of the share or right, the taxpayer is not in a position to cast, or control the casting of, more than 5% of the maximum number of votes that might be cast at a general meeting of the company.

Section 139GC of the ITAA 1936 defined the meaning of 'holding company' to have the same meaning as in the Corporations Act 2001 (CA), likewise section 139GCA explained that a 'subsidiary' has the same meaning as in the CA.

Section 9 of the CA provides that a 'holding company' in relation to a body corporate, means a body corporate of which the first body corporate is a 'subsidiary'.

You have stated that your employer, was a subsidiary of an Australian company.

Therefore, the rights you acquired will be qualifying rights as;

• The right was acquired under an ESS

• The rights relate to the Australian company and the Australian company is the holding company of your employer

• The rights relate to ordinary shares

• You do not, immediately after acquisition, hold more than 5% of legal or beneficial interest in the company, and

• You do not, immediately after acquisition, hold more than 5% of the maximum number of votes that might be cast a general meeting of the company.

Accordingly, as the rights are qualifying rights that were acquired prior to 1 July 2009 and there is no indication that you have made an election under section 139E of the ITAA 1936 and the cessation time for the interest did not occur before 1 July 2009, the rights will be transitioned interests and the new rules in Division 83A of the ITAA 1997 will apply to the interests.

When is the gain assessable?

Subsection 83A-5(4) of the ITTPA 1997 explains that if Subdivision 83A-C of the ITAA 1997 applies in relation to an ESS interest because of subsection (2):

a) do not include an amount in your assessable income under subsection 83A-110(1) of that Act in relation to the ESS interest to the extent that the amount relates to your employment outside Australia; and

b) subject to subsection 83A-115(3) (about shares) or 83A-120(3) (about rights) of that Act, whichever is applicable, treat the ESS deferred taxing point for the interest as being:

i. if paragraph (2)(a) of this section applies - the cessation time mentioned in subparagraph (2)(a)(iii);

Subsection 83A-120(3) of the ITAA 1997 explains that the ESS deferred taxing point if you exercise the right is the time you dispose of the beneficial interest in the share, if that disposal occurs within 30 days after the determined taxing point.

You have exercised your rights, there is no indication that you disposed of the shares received in 'exchange' for the options within 30 days of this date. Therefore, the ESS deferred taxing point is determined using the cessation time from subsection 139B(3) of the ITAA 1936 being, for a right, the time when the right is exercised, provided there is no restriction or condition that could result in the taxpayer forfeiting ownership of the share (section 139CB).

Accordingly, the amount, representing the assessable discount on the ESS interests is assessable in the 2009-10 financial year.

Amount to include in assessable income

Subsection 83A-110(1) of the ITAA 1997 provides that your assessable income for the year that the deferred taxing point occurs includes the market value of the ESS interest (calculated at the deferred taxing point) reduced by the cost base of the interest. Subsection 83A-110(2) prescribes that you treat an amount included in your assessable income under subsection (1) as being from a source other than an Australian source to the extent that it relates to your employment outside Australia.

Subsection 83A-110(2) of the ITAA 1997 attributes a source to a gain that is (or would be) assessable income under subsection 83A-110(1). Whether the gain is ultimately included in the taxpayer's assessable income is then determined by the core residence and source rules relating to statutory income in section 6-10.

The assessability of statutory income is affected by the residency status of the person who derives it. The assessable income of an Australian resident will include statutory income from all sources, whether in or out of Australia (subsection 6-10(4) of the ITAA 1997). On the other hand, for a foreign resident, the assessable income includes statutory income from all Australian sources (paragraph 6-10(5)(a)).

A gain on an ESS interest that relates to employment in Australia is treated as income from sources in Australia. The gain will be assessable income under the core residence and source rules, whatever the residency status of the taxpayer.

A gain on an ESS interest that relates to employment outside Australia is treated as income from sources outside Australia. This has several important consequences, as set out below, which flow from the core residence and source rules and specific provisions regarding foreign employment income.

There are no provisions in Division 83A of the ITAA 1997 that specify whether a gain on an ESS interest relates to employment inside or outside Australia. The Explanatory Memorandum to Act No 133 of 2009 makes the following comments regarding the matter:

1.351 ... In the case of an ESS interest that is subject to a deferred taxing point, it is the amount included in your assessable income that is attributed a source (that is, both the discount and subsequent gains are attributed with a source). The attribution is done in a manner consistent with the rule applying to discounts.

1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005.

1.354 Whether the discount on the ESS interest acquired under an employee share scheme relates to employment in Australia or outside Australia is a question of fact that needs to be determined on a case-by-case basis.

Generally, if the ESS interest may be forfeited unless the individual undertakes further employment or services at the time employment commences in Australia, a portion of the discount will generally be assessable in Australia.

Consequently, apportionment of amounts that relate to employment both in and out of Australia may be required.

In your case, you were granted the performance rights on before moving to Australia.

You then moved to Australia on a temporary work visa and worked for the Australian company until the options vested.

As there are forfeiture conditions that apply to your ESS interests if you did not continue to work for the company group up until the vesting date of the ESS interest, your interests are earned over the vesting period. Accordingly, the amount of the gain calculated on the vesting of the interests will need to be apportioned between the period where you were considered to be a foreign resident earning foreign income and, where you were a temporary resident earning Australian source income.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).