Edited version of your written advice

Authorisation Number: 1012706102398

Ruling

Subject: Company A Equity Plans

Question 1

Will Company A obtain a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for irretrievable cash contributions made by Company A to Company B as trustee (the Trustee) for the Company A Employee Share Trust (the EST) to fund the subscription for, or acquisition on-market of, Company A shares, to satisfy Options issued pursuant to the Company A Employee Option Plan (AESOP)?

Answer

Yes.

Question 2

Will Company A obtain an income tax deduction, pursuant to section 8-1 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 Company A to the Trustee of the EST, to fund the subscription for or acquisition on-market of Company A shares by the Trustee of the EST to satisfy Options issued pursuant to the AESOP, deductible to Company A at a time determined by section 83A-210 of the ITAA 1997, where the contributions are made before the acquisition of the relevant Options?

Answer

Yes.

Question 4

If the EST satisfies its obligation under the AESOP by subscribing for new shares in Company A, will the subscription proceeds be included in the assessable income of Company A 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) applies to deny, in part or full, any deduction claimed by Company A in respect of the irretrievable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition on-market of Company A shares by the Trustee of the EST?

Answer

No.

The rulings for questions 1 to 5 inclusive each apply for the following periods:

Year ending 30 June 2013 - year ending 30 June 2017

Question 6

Is the provision by Company A of Options or Company A shares to Eligible Employees under the AESOP 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 Company A to the Trustee of the EST, to fund the subscription for or acquisition on-market of Company A 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 Company A, by the amount of the tax benefit gained from the irretrievable cash contributions made by Company A to the Trustee of the EST, to fund the subscription for or acquisition on-market of Company A shares?

Answer

No.

The rulings for questions 6 to 8 inclusive each apply for the following periods:

FBT year ending 31 March 2013 - year ending 31March 2017

Relevant facts and circumstances

Overview

One aspect of Company A's success has been its ability to attract and retain high quality employees. Developing suitable remuneration packages to recruit and retain personnel is an ongoing problem for Company A. The remuneration policy of Company A is designed to be competitive and equitable with the aim of aligning the economic interest of employees with those of its shareholders, by providing an opportunity for employees to earn significant rewards by acquiring an equity interest in the company based on creating shareholder value. Accordingly, as part of its remuneration package, Company A has implemented and operates the Company A Employee Option Plan (AESOP).

The purpose of Company A operating the AESOP is too primarily recognise and reward the ability and efforts of employees who have contributed to the success of Company A by providing an incentive to employees to achieve the long term objectives of Company A and to improve its overall performance.

To support the operation of the AESOP, Company A established the Company A Employee Share Trust (EST) pursuant to the Trust Deed for Company A Employee Share Trust entered into between Company A and Company C (Trust Deed) to facilitate the provision of shares in Company A to Eligible Employees (defined below) under the AESOP.

By way of Deed of Appointment and Removal of Trustee Company C was removed, and Company B was appointed, the trustee of the EST.

The applicant has stated that this scheme utilising the EST and to which this ruling relates is intended to provide greater flexibility to accommodate the long term incentive arrangement of Company A by:

• streamlining its approach to the administration of its plans by providing greater flexibility for Company A to accommodate the long term incentive arrangements both now and into the future as Company A continues to expand operations and therefore employee numbers

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

• providing an arm's-length vehicle through which shares in Company A can be acquired and held on behalf of the relevant employee - this assists Company A to satisfy Corporate Law requirements relating to a company owning its own shares

Operation of the AESOP

The AESOP is governed by the Rules of the Company A Employee Option Plan (AESOP Rules).

Pursuant to the AESOP Rules an Eligible Employee may be granted options (Options) at the discretion of the Board of Directors, being the Board of Directors of Company A so comprised from time to time (the Board).

Pursuant to the Trust Deed, one Option represents one right to acquire a share in Company A (Company A share)

An Eligible Employee is defined in the AESOP Rules to mean a full-time or permanent part-time employee of any Group company listed in the AESOP and includes executive Directors.

An Invitation to Apply for Options given to an Eligible Employee will be extended on such terms and conditions as the Board decides, from time to time, including:

• the number of Options

• the Exercise Price (if any)

• the Exercise Period

• Vesting Conditions

• Performance Conditions (if any)

• the Restriction Period

• and any right or restriction attaching to the Options or Company A shares in respect of which the Options are exercisable being offered to the Eligible Employee

An Eligible Employee will be able to take up all (or a portion) of their entitlement. The number of Options not taken up will be forfeited irrevocably.

Options are not listed for Official Quotation on the Australian Securities Exchange (ASX) and are granted for nil consideration.

Where an Eligible Employee ceases to be an Eligible Employee by reason of the cessation of his or her employment with Company A for whatever reason, including redundancy, resignation or retirement (unless otherwise determined by the Board in its absolute discretion) all unexercised Options held will immediately lapse.

Where the Trustee holds shares on behalf of an Eligible Employee as a Shareholder (as defined in the AESOP Rules) pursuant to the AESOP:

• the dividends payable on those shares will be paid by Company A to the Trustee, and the Trustee will then pay any such dividend to the Shareholder as soon as practically reasonable after those dividends are paid by Company A to the Trustee

• each Shareholder may direct the Trustee by notice in writing as to how to exercise the voting rights attaching to Company A shares held on their behalf by the Trustee, either generally or in respect of a particular resolution, by way of proxy

Options may be exercised during pre-defined Window Periods in accordance with the AESOP Rules provided that, if applicable, certain pre-determined vesting hurdles and or/conditions have been satisfied.

An Eligible Employee to whom Options have been granted is referred to as a Participant in the singular, or as Participants in the plural.

Employee Share Trust

The EST was established for the sole purpose of acquiring shares for Australian employees of Company A pursuant to any employee equity plan established on behalf of Company A. It is operated in accordance with the Trust Deed.

The EST is funded by cash contributions from Company A for the acquisition of Company A shares in accordance with the Trust Deed and the AESOP Rules.

The structure of the EST and the AESOP Rules are such that Company A shares allocated to each employee will generally be transferred into the name of the relevant employee following receipt by the Trustee of a Notice of Withdrawal.

The Trustee is able to sell Company A shares on behalf of an employee where permitted to do so.

Pursuant to the Trust Deed the Trustee is not permitted to carry out activities that are not matters or things which are necessary or expedient to administer and maintain the EST. In addition, it is not permitted to carry out activities which result in the Participants in the AESOP being provided with additional benefits other than the benefits that arise from any relevant plan rules.

Pursuant to the Trust Deed the Trustee of the EST is empowered to acquire Company A shares either on-market or via subscription for new shares in Company A.

Pursuant to the Trust Deed the Board, on behalf of a Participant, will instruct the Trustee, by way of notice in writing, to subscribe for, purchase and/or allocate the requisite number of Company A shares specified in the notice.

Pursuant to the Trust Deed, Company A must provide the necessary funds to the Trustee for the purpose of enabling it to acquire Company A shares as specified in the notice in accordance with the Trust Deed.

Company A shares acquired by the Trustee are allocated to the relevant employees upon exercise of Options and the employees will become absolutely entitled to such shares from that point in time.

The Trustee will, in accordance with instructions received pursuant to the AESOP Rules, acquire, deliver and allocate Company A shares for the benefit of Participants provided that the Trustee receives, when required and necessary, sufficient payment from a Participant to subscribe for or purchase such shares and/or has sufficient unallocated trust shares available.

The Trustee (or any other party which the Trustee considers appropriate) will establish and maintain a separate Trust Share Account or record in respect of each Participant in accordance with the Trust Deed.

While Company A shares are held in trust, the Participant will be entitled to dividend and voting rights. These shares may be subject to a sale restriction under an ASX administered holding lock. By written notice, Participants can apply for legal title to the appropriate Company A shares held in the EST to be transferred to them.

All funds received by the Trustee from Company A will constitute accretions to the corpus of the trust and no Participant will be entitled to receive such funds. The contributions will not be repaid to Company A unless they are used to subscribe for Company A shares.

Where an amount paid by Company A to the Trustee in respect of the acquisition of Company A shares for the benefit of a Participant is in excess of the amount required by the Trustee to acquire those shares, Company A may require the Trustee to apply such amount to acquire, deliver or allocate the shares in accordance with the Trust Deed, the relevant plan rules or the relevant Terms of Participation (as defined in the Trust Deed) or deposit the funds into any account opened and operated by the Trustee.

The Trustee of the EST holds all Company A shares pursuant to the AESOP on capital account.

The total period from the date the funds are contributed by Company A to the EST to the date that Company A shares are allocated to the employees by the Trustee upon vesting and exercise of the Options held under the AESOP will be less than 7 years.

The Trustee of the EST is an independent party and a member of the Computershare group of companies.

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 83A-10

Income Tax Assessment Act 1997 Section 83A-35

Income Tax Assessment Act 1997 Section 83A-205

Income Tax Assessment Act 1997 Section 83A-210

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-25

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 995-1

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 67

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Reasons for decision

These reasons for decision accompany the Notice of private ruling for Company A. While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated

Question 1

Subsection 8-1(1) is a general deduction provision. Broadly, the provision provides an entitlement to a deduction from assessable income for 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.

However, subsection 8-1(2) prevents such a deduction to the extent that it is a loss or outgoing of capital, or of a capital nature, is a loss or outgoing of a private or a domestic nature, is incurred in gaining or producing exempt income, or is prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936.

Losses or outgoings

Pursuant to the Trust Deed, Company A must provide the Trustee with all the funds (contributions) required to enable it to subscribe for, or acquire Company A shares in accordance with the Trust Deed. The Trustee will, in accordance with instructions received pursuant to the AESOP, acquire, allocate and deliver Company A shares for the benefit of Participants provided that the Trustee receives sufficient payment to subscribe for or purchase such shares and / or has sufficient unallocated trust shares available. These contributions made to the Trustee by Company A will be irretrievable and non-refundable (the Trust Deed provides that funds provided to the Trustee will not be repaid to Company A and no Participant shall be entitled to receive the funds). On this basis, it is concluded that the irretrievable contributions made by Company A are considered to be a loss or outgoing for the purpose of subsection 8-1(1).

Relevant nexus

The purpose of Company A in establishing and making irretrievable contributions to the Trustee of the EST is to provide benefits to certain eligible employees in the form of Company A shares.

All the documentation provided indicates that the contributions are made to the Trustee of the EST solely to enable the Trustee to acquire Company A shares for eligible employees of the business. As stated by the applicant in its private ruling application:

In our view, the contributions should be deductible……Contributions to the EST are incurred for the purposes set out in the Plan Rules which are designed, through the alignment of employee and shareholder interest, to improve Company A's operating performance and to attract and retain valued employees…

Accordingly, there is a sufficient nexus between the outgoings (contributions made by Company A) and the derivation of Company A 's assessable income (The Herald and Weekly Times Limited v The Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169), Amalgamated Zinc (De Bavay's) Limited v The Federal Commissioner of Taxation (1935) 54 CLR 295;(1935) 3 ATD 288, W. Nevill And Company Limited v The Federal Commissioner of Taxation (1937) 56 CLR 290;4 ATD 187;(1937) 1 AITR 67, Ronpibon Tin No Liability v The Federal Commissioner of Taxation(1949) 78 CLR 47; 4 AITR 236; (1949) 8 ATD 431, Charles Moore & Co (W.A.) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344;(1956) 6 AITR 379; (1956) 11 ATD 147).

Capital or Revenue

Contributions will be recurring and be made from time to time as and when Company A shares are to be subscribed for or acquired pursuant to the Trust Deed. Therefore, to this end, the contributions are not capital in nature, but rather outgoings incurred by the company in carrying on its business. In support of this conclusion, the Court held in Pridecraft Pty Ltd v Federal Commissioner of Taxation [2004] FCAFC 339; 2005 ATC 4001; 58 ATR 210; Spotlight Stores Pty Ltd v Federal Commissioner of Taxation [2004] FCA 650; 2004 ATC 4674; 55 ATR 745 that payments by an employer company to a trust established for the purpose of providing incentive payments to employees were on revenue account and not capital or of a capital nature.¹ This confirms the view expressed in ATO ID 2002/1074 that a company will be entitled to a deduction under section 8-1 for irretrievable contributions made to the trustee of its employee share scheme.

Apportionment

The combined operation of subsections 8-1(1) and 8-1(2) may require apportionment of a loss or outgoing into deductible and non-deductible components, where a single loss or outgoing is incurred for more than one purpose or on items of a different nature.

A contribution to the trustee of an employee share trust is capital or of a capital nature where the contribution secures for the employer an asset or advantage of an enduring or lasting nature that is independent of year to year benefits that the employer derives from a loyal and contented workforce.

Where a contribution is, ultimately and in substance, applied to the trustee of an employee share trust to subscribe for equity interests in the employer (for example shares), the employer has also acquired an asset or advantage of an enduring nature.

Where a contribution is made for the purpose of securing for the employer advantages of both a revenue and capital nature, but the advantages of a capital nature are only expected to be very small or trifling by comparison, apportionment may not be required.

In this case, the outgoings incurred by Company A by way of contributions to the EST in order to carry on its business are either not capital in nature or any capital component is sufficiently small or trifling such that the Commissioner would not seek to apportion the deduction.

Finally, nothing in the facts suggests that the contributions 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 1997 or the ITAA 1936.

Therefore, when Company A makes irretrievable contributions to the Trustee to fund the acquisition of Company A shares in accordance with the Trust Deed, those contributions will be an allowable deduction to Company A under section 8-1.

Question 2

Company A will incur various costs in relation to the on-going administration of the EST. For example, Company A will incur costs associated with the services provided by the Trustee of the EST. These costs are likely to include:

• employee plan record keeping;

• production and dispatch of holding statements to employees;

• provision of annual income tax return information;

• acquisition of shares and allocation to Participants; and

• management of employee termination.

In addition to the services to be provided by the Trustee of the EST, Company A has incurred costs associated with applying for this private ruling.

In accordance with the Trust Deed the Trustee is not entitled to receive from the Trust any fees, commission or remuneration in respect of its performance of its obligations as trustee of the Trust. The Company (Company A) may pay to the Trustee from the Company's own resources any fees, commission or remuneration and reimburse any expenses incurred by the Trustee as the Company and the Trustee may agree from time to time. The Trustee is entitled to retain for its own benefit any such remuneration or reimbursement.

Such costs are likely to include brokering costs incurred by the Trustee of the EST (for example, where the Trustee is directed to acquire Company A shares on-market), as well as other Trustee expenses such as the annual audit of the financial statements of the EST.

The costs incurred by Company A in relation to the implementation and on-going administration of the EST are deductible under section 8-1 as either:

• costs incurred in gaining or producing the assessable income of Company A; or alternatively

• costs necessarily incurred in carrying on Company A's business for the purpose of gaining or producing the assessable income of Company A.

The view that the costs incurred by Company A are deductible under section 8-1 is consistent with ATO ID 2002/961 in which it was decided that such costs are part of the ordinary employee remuneration costs of a taxpayer.

Consistent with the analysis above in Question 1, the costs are revenue and not capital in nature on the basis that they are regular and recurrent employment expenses, and are deductible under section 8-1.

Question 3

Section 83A-210 states:

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 will only apply if there is an arrangement under which there is a relevant connection between the money provided to another entity and the acquisition of ESS interests (directly or indirectly) by the employee under an employee share scheme in relation to the employee's employment.

Arrangement

Company A's adoption of the AESOP, the establishment of the EST, and Company A's provision of money to the Trustee, is considered as constituting an arrangement for the purpose of subparagraph 83A-210(a)(i).

ESS interest

An ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in a company or a beneficial interest in a right to acquire a beneficial interest in a share in a company. Under the AESOP, Options issued to Eligible Employees represent rights to acquire beneficial interests in shares in Company A, and are accordingly 'ESS interests'.

Employee share scheme

An employee share scheme is a scheme under which ESS interests in a company are provided to employees of a company, or their associates, in relation to their employment (subsection 83A-10(2)). The AESOP is a scheme under which Options in Company A are provided to Eligible Employees of Company A in relation to their employment, and is accordingly an employee share scheme. A Company A share acquired by the Trustee to satisfy an Option to acquire a share under the ESS, provided to an employee in relation their employment, is itself provided under the same ESS.

Relevant connection

The granting of the Options, the provision of the money to the Trustee under the arrangement, the acquisition and holding of the Company A shares by the Trustee, and the allocation of those Company A shares to the Participants are all interrelated components of the ESS. All the components of the arrangement must be carried out so that the ESS can operate as intended. As one of those components, the provision of money to the Trustee necessarily allows the scheme to proceed. Accordingly, the provision of money to the Trustee to acquire Company A shares is considered to be for the purpose of enabling Participants, indirectly as part of the AESOP, to acquire Options (that is ESS interests).

Contribution made prior to the acquisition of ESS interests

Section 83A-210 will only apply in situations where a contribution is made to another entity prior to the time when the ultimate beneficiary acquires the ESS interests. When it does apply, it operates by deferring the timing of the deduction to the income year in which the ultimate beneficiary acquires the ESS interests.

For the purposes of paragraph 83A-210(b), a Participant acquires the ESS interests when the Options are issued to them.

Accordingly, when Company A makes a cash contribution to the Trustee before the acquisition time for the Options occurs, the timing of the deduction allowable under section 8-1 will be determined by section 83A-210 as being the income year in which the relevant Options issued under the AESOP are acquired.

Question 4

Ordinary Income

Section 6-5 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 G.P. International Pipecoaters Proprietary Limited v The Commissioner of Taxation of the Commonwealth of Australia (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. Brennan, Dawson, Toohey, Gaudron and McHugh JJ 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 Company A 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, Company A is issuing the Trustee with a new share 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. This view is supported by the reasoning in ATO ID 2010/155.

Accordingly, when Company A receives subscription proceeds from the Trustee of the EST where the EST has subscribed for new shares in Company A to satisfy obligations to Participants, that subscription price received by Company A is a capital receipt. That is, it will not be on revenue account, and not ordinary income under section 6-5.

Section 20-20

Subsection 20-20(2) provides that if you receive an amount as a recoupment of a loss or outgoing, it will be assessable income if you received it by way of insurance or indemnity and that amount can be deducted as a loss or outgoing in the current year or earlier income year.

Recoupment is defined in section 20-25(1) to include any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described and a grant in respect of a loss or outgoing.

Company A will receive an amount for the subscription of shares by the Trustee of the EST. There is no insurance contract in this case, so the amount is not received by way of insurance.

Further, 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.

However, subsection 20-20(3) also 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 in section 20-30. For current purposes, the only relevant provision in section 20-30 is section 8-1, but the deduction under that section must be in respect of expenses for bad debts or rates or taxes.

In satisfying its obligations under the AESOP, the EST is acquiring new shares in Company A and the subscription amount cannot be said to be a recoupment by Company A under subsection 20-25(1).

In any event, the receipt by Company A made in return for issuing the shares to the EST would not be a recoupment of previously deducted expenditure under section 8-1 regarding bad debts or rates and taxes.

Therefore, the subscription proceeds will not be an assessable recoupment under section 20-20.

Capital Gains Tax (CGT)

Section 102-20 states that you make a capital gain or loss, if and only if a CGT event happens. No CGT events occur when the EST satisfies its obligations under the AESOP by subscribing for new shares in Company A.

The relevant CGT events that may be applicable when the subscription proceeds are received by Company A are CGT events D1 (creating a contractual or other rights) and H2 (receipt for event relating to a CGT asset).

However, paragraph 104-35(5)(c) states that CGT event D1 does not happen if a company issues or allots equity interests or non-equity shares in the company. In this case, Company A is issuing shares, being equity interests as defined in section 974-75, to the Trustee and therefore CGT event D1 does not happen.

In relation to CGT event H2, paragraph 104-155(5)(c) states that CGT event H2 does not happen if a company issues or allots equity interests or non-equity shares in the company. Therefore, CGT event H2 does not occur.

Since no CGT event occurs, there is no amount that will be assessable as a capital gain to Company A.

Therefore, when the EST satisfies its obligations under the AESOP by subscribing for new shares in Company A, the subscription proceeds will not be included in the assessable income of Company A under section 6-5 or section 20-20, nor trigger a CGT event under Division 104.

Question 5

Law Administration Practice Statement PS LA 2005/24 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. These are:

• there must be a scheme within the meaning of section 177A of the ITAA 1936

• a tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, and

• 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

A scheme is defined in subsection 177A(1) of the ITAA 1936 which states:

(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

It is considered that this definition is sufficiently wide to cover the proposed employee arrangement under the AESOP, which consists of the creation of the EST, including the Trust Deed, and the payment of the irretrievable cash contributions to the Trustee.

Tax Benefit

'Tax benefit' is defined in subsection 177C(1) of the ITAA 1936 of which the relevant paragraph is:

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 whether a tax benefit would be derived by Company A from this scheme, subsections 177CB(2) and (3) of the ITAA 1936 provide that there are two alternate bases on which the existence of a tax effect can be demonstrated, referred to as the annihilation and reconstruction approaches respectively. These approaches are:

177CB(2) A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme).

177CB(3) A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme.

A decision that a tax effect 'would have' occurred if the scheme had not been entered into or carried out, must be made solely on the basis of a postulate comprising all of the events or circumstances that actually happened or existed, other than those that form part of the scheme (subsection 177CB(2) of the ITAA 1936). When postulating what would have occurred in the absence of the scheme, the scheme must be assumed not to have happened, that is it must be 'annihilated' or extinguished. However, the alternative postulate must incorporate all the events or circumstances that actually happened or existed.

A decision that a deduction 'might reasonably be expected not to have been allowable' if the scheme had not been entered into or carried out, must be made on the basis of a postulate that is a reasonable alternative to the scheme (subsection 177CB(3) of the ITAA 1936). Whether a postulate is a reasonable alternative to a scheme must be worked out having particular regard to the substance of the scheme and its results and consequences for the taxpayer, and disregarding any potential tax results and consequences (see subsection 177CB(4)). This approach (reconstruction) is a way to identify a tax benefit in relation to a scheme that also achieves substantive non-tax results and consequences. In these cases, simply annihilating the scheme would be inconsistent with the non-tax results and consequences sought by the participants in the scheme.

Within the above statutory parameters, the Applicant examined predictions of events for the purpose of concluding upon a postulate that is a reasonable alternative to the entering into or carrying out of the Scheme.² It stated:

If the scheme were not entered into (i.e. the EST was not used) and Company A simply chose to issue new shares, Company A may not receive a tax deduction for this amount. However, Company A would still be entitled to a deduction if it simply bought shares for employees on market via a broker (subject to company law requirements) or alternatively remunerated the employees via an entirely different method such as cash bonuses.

Accordingly, if Company A issued new shares directly to Eligible Employees it would not receive a deduction for the same amount as under section 8-1 in respect of issuing the shares; any deduction received would be limited to that allowable under section 83A-205. Therefore by using an EST, a tax benefit is created through the greater deduction Company A will receive under section 8-1 for the irretrievable cash contributions it makes to the Trustee.

Dominant purpose

Subsection 177D(2) of the ITAA 1936 sets out certain factors that must be considered in deciding whether a scheme was entered into for the purpose of obtaining a tax benefit. For Part IVA to apply, subsection 177A(5) of the ITAA 1936 requires the purpose of obtaining a tax benefit to be the 'dominant purpose' for undertaking the scheme.

In considering whether Part IVA applies, it is necessary to compare the following factors from paragraph 177D(2)(b) between the scheme as proposed and the relevant alternate action:

i. the manner in which the scheme was entered into or carried out

ii. the form and substance of the scheme

iii. the time at which the scheme was entered into and the length of the period during which the scheme was carried out

iv. the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

v. 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

vi. 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

vii. any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

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

(i) The Manner of the Scheme

The inclusion of the EST in the scheme does give rise to a tax benefit, but the Applicant contends that the presence of the EST provides other commercial benefits. In particular, in the application, it states:

The establishment of the EST provides Company A with many commercial benefits, including:

• Capital management flexibility as it provides a streamlined approach to using contributions received from Company A and employees to either acquire shares in Company A on market (in a more convenient manner than if a trust was not used) or alternatively to subscribe for new shares in Company A. This provides flexibility as circumstances change as to how shares are sourced for provision to employees.

• Administrative efficiency as it provides a single arm's length vehicle to facilitate the provision of shares to employees under the Plan. This is increasingly important as Company A continues to expand operations and employee numbers in future years.

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

The EST also helps Company A 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.

Further, it is noted that the arrangement is not deliberately and intentionally established close to the end of the Company A income year nor is it intended that Company A will provide large up-front payments to provide for the EST's operations for several years into the future (as happened in Pridecraft Pty Ltd v FC of T [2004] FCAFC 339; 2005 ATC 4001; 58 ATR 210.) Rather, Company A will fund the EST on a recurring basis as the need arises.

It is accepted that the use of the EST provides some benefits to the operation of the scheme that would not be available if the shares were provided directly by Company A as in the relevant counterfactual.

(ii) The Form and Substance

The substance of the scheme is the provision of remuneration in the form of Company A shares to Eligible Employees who participate in the AESOP. It takes the form of payments by Company A to the Trustee who acquires the Company A shares and transfers them to Participants.

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

(iii) 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 Company A nor with a contribution sufficiently large to fund the EST for several years, but by recurring (periodic) contributions. There is nothing in this factor to suggest a dominant purpose of seeking to obtain a tax benefit in relation to the scheme.

(iv) The Result of the Scheme

The result of the scheme is to provide Company A with allowable deductions for the contributions they make to the Trustee. However, it is noted that the contributions are irretrievable and reflect a genuine non-capital outgoing on the part of Company A to achieve a business outcome. The Applicant has argued that the EST and the AESOP are an integral part of the overall remuneration strategy of Company A which are likely to result in improved employee performance and ultimately will improve Company A' operating performance. This is the intended outcome and it is to be expected that a deduction would normally be allowable in these circumstances.

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

As noted above, Company A makes irretrievable contributions to the Trustee and those contributions constitute a real expense with the result that Company A' financial position is changed to that extent. While it is arguable that the quantum of the deductions is higher with an EST as part of the scheme than would be the case if Company A provided shares to Participants directly, there is nothing artificial, contrived or notional about the expenditure.

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

The contributions by Company A to the Trustee will form part of the corpus of the EST and must be dealt with by the Trustee in accordance with the terms of the Trust Deed i.e. for the acquisition of Company A shares to provide to Participants under the AESOP. Company A is not a beneficiary of the EST and its contributions cannot be returned to it in any form except where the Trustee acquires Company A shares from Company A by subscribing for new issues at market value, or where for example, the Trustee is directed to pay some proceeds of the sale of shares to the Company (Company A) to extinguish a Participant's obligation to pay the exercise price (see the Trust Deed)

Therefore, the contributions made by Company A 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.

(vii) Any Other Consequence

Not relevant to this scheme.

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

The relationship between Company A and the Participants of the AESOP is one of employer/employee. The Trustee is independent of Company A and is under a fiduciary obligation to act in the interests of the employees who participate in employee share schemes and in particular, in this case, the AESOP. The contributions made by Company A to the Trustee are commensurate with Company A's stated aim of recognising the ongoing ability of employees and their contribution to the long term performance and success of Company A. There is nothing to suggest that the parties to the employee share scheme are not acting at arm's length to one another. There is nothing in relation to this factor to indicate a dominant purpose of obtaining a tax benefit.

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

Question 6

The provision of Options

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 83A-B or 83A-C of that Act applies.

The Commissioner accepts that the AESOP comprises an employee share scheme, that the Options are ESS interests (see question 3 above) and that Subdivision 83A-B or 83A-C applies to those ESS interests.

Accordingly, the acquisition of ESS interests (being the Options) pursuant to the AESOP will not be subject to fringe benefits tax on the basis that they are acquired under an employee share scheme (to which Subdivision 83A-B or 83A-C will apply) and are thereby excluded from being a fringe benefit by virtue of paragraph (h) of the definition of fringe benefit in subsection 136(1) of the FBTAA.

The provision of Company A shares upon exercise of 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; 2000 ATC 4151; (2000) 44 ATR 22. Heerey, Merkel and Finkelstein JJ at page 410 stated:

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, causal connection or relationship between the benefit and the employment.

The situation is similar to that which existed in Federal Commissioner of Taxation v. McArdle 89 ATC 4051; (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. Davies, Gummow and Lee JJ 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 of Company A accepts an offer to participate in the AESOP, they obtain an Option (being a right to acquire a beneficial interest in a share in Company A) and this Option constitutes an ESS interest. When this Option is subsequently exercised, any benefit received would be in respect of the exercise of the Option, and not in respect of employment (refer ATO Interpretative Decision ATO ID 2010/219 Fringe Benefits Tax Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme).

Therefore, the benefit that arises to an employee upon the exercise of a vested Option (being the provision of a Company A 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

Paragraph (ha) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA states that a fringe benefit does not include:

(ha) 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);

An 'employee share trust' for an employee share scheme is defined in subsection 130-85(4) as 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).

For the purposes of paragraph 130-85(4)(c), activities which are merely incidental, as set out in 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, include:

• the opening and operation 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 the 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 purposes 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.

Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered merely incidental.

The Trust Deed states that Company A and the Trustee agree that the Trust will be managed and administered so that it satisfies the sole activities test for the purposes of subsection 139C(5) of the ITAA 1936 and be an 'employee share trust' as defined in subsection 995-1(1) of the ITAA 1997, as interpreted in ATO ID 2007/179.

For the avoidance of doubt, this statement is supported by the Recitals of the Trust Deed which provide that the EST was established by Company A to facilitate the AESOP and future employee equity plans and for the purposes of holding shares for the benefit of Participants who are, or will become, the beneficial owners of shares pursuant to a Company Plan. It is further supported by the Trust Deed which outlines 'How the Trust Works', and expressly provides for the Trustee to apply funds it acquires from Company A to obtaining shares in Company A , and to ensuring that those shares are allocated or transferred to relevant Participants.

Therefore, the EST satisfies the definition of an employee share trust in subsection 130-85(4) as:

• the EST acquires shares in a company (being Company A); and

• the EST ensures that ESS interests as defined in subsection 83A-10(1), being beneficial interests in those shares, are provided under an ESS, as defined in subsection 83A-10(2), by allocating those Company A shares to the Participants in accordance with the AESOP; and

• the Trust Deed does not provide for the Trustee to participate in any activities which are not considered merely incidental to a function of managing the employee share scheme and administering the trust.

As paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes the contributions to the Trustee of the EST from being a fringe benefit, Company A will not be required to pay FBT in respect of irretrievable contributions made to the Trustee of the Trust to fund the acquisition of Company A shares.

Question 8

As mentioned in the answer to Question 5, PS LA 2005/24 has been written to assist those who are contemplating the application of Part IVA or other general anti-avoidance rules to an arrangement. It succinctly explains how section 67 of the FBTAA operates. Most notably, paragraphs 145-148 of PS LA 2005/24 provide as follows:

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 or could reasonably be expected to have been included in the aggregate fringe benefits amount, if the arrangement had not been entered into.

It is clear, therefore, that the Commissioner would only seek to make a determination under section 67 of the FBTAA if the arrangement resulted in the payment of less fringe benefits tax than would be payable but for entering into the arrangement. The point is made effectively in Miscellaneous Taxation Ruling MT 2021 under the heading 'Appendix, Question 18' where, on the application of section 67 of the FBTAA , the Commissioner states:

…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...

Further, paragraph 151 of PS LA 2005/24 provides:

151. The approach outlined in this practice statement (refer to paragraphs 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 AESOP, if an EST was not used, no fringe benefits tax would be payable and nor is it likely that benefits provided to employees under alternative remuneration plans would result in fringe benefits tax being payable.

In addition, under the AESOP arrangement (with an EST), the benefits provided by way of irretrievable contributions to the EST and the provision of Options (and the Company A shares received on their exercise) to Eligible Employees are excluded from the definition of a fringe benefit for the reasons given in the responses to questions 6 and 7 above. Therefore, as these benefits have been excluded from the definition of a fringe benefit, no fringe benefit arises and no fringe benefits tax will be payable by using an EST. As there would be no fringe benefits tax payable under the AESOP without the use of an EST (and nor likely would fringe benefits tax be payable under alternative remuneration plans), the fringe benefits tax liability 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 Company A, in relation to a tax benefit obtained from the irretrievable cash contributions made by Company A to the Trustee, to fund the subscription for or acquisition on-market of shares in Company A.

¹ It should be noted that although the Court held that the payments were deductible under subsection 51(1) of the ITAA 1936, it found that subsection 177F(1) of Part IVA of the ITAA 1936 applied to cancel the tax benefit arising from the deduction.

² Page 27 of the Application

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