Edited version of your written advice

Authorisation Number: 1012727942014

Ruling

Subject: Employee Share Scheme

Issue 1

Timing and availability of deductions for irretrievable contributions made to the trustee of an employee share trust under an employee share scheme

Question 1

Will Company A obtain a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for irretrievable contributions it makes to the Trustee of the Employee Share Trust (EST) to fund the subscription for, or acquisition on-market of, Company A shares in respect of employees based in Australia (Participants)?

Answer

Yes

Question 2(a)

Are irretrievable 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 EST, deductible to Company A at a time determined by section 83A-210 of the ITAA 1997, in respect to those Employee Share Scheme (ESS) interests which are subject to Division 83A of the ITAA 1997, where contributions are made before the acquisition of the relevant ESS interests?

Answer

Yes

Question 2(b)

Are irretrievable 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 EST to satisfy ESS interests in respect of Participants, deductible to Company A under section 8-1 of the ITAA 1997 in the income year when the contributions are made, where the contribution is made after the acquisition of the relevant ESS interests?

Answer

Yes

This ruling applies for the following periods:

Income tax years ending:

30 September 2014

30 September 2015

30 September 2016

30 September 2017

30 September 2018

The scheme commences on:

1 July 2014

Issue 2

Application of Part IVA of the ITAA 1936 (Part IVA) to employee share schemes

Question 1

Will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the arrangement where irretrievable contributions are made to the Trustee of the EST to fund the subscription for, or acquisition on-market of, Company A shares in respect of Participants, where a share is a fully paid ordinary share in the capital of Company A?

Answer

No

This ruling applies for the following periods:

Income tax years ending:

30 September 2014

30 September 2015

30 September 2016

30 September 2017

30 September 2018

The scheme commences on:

1 July 2014

Issue 3

Application of Fringe Benefits Tax to an employee share scheme

Question 1

Is the provision of ESS interests and shares by Company A to employees of the company (or subsidiary member employees) a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefit Tax Assessment Act 1986?

Answer

No

Question 2

Will the irretrievable contributions made by Company A and/or Company X to the Trustee of the EST to fund the subscription for, or acquisition on-market of, Company A shares in respect of Participants, be a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986?

Answer

No

This ruling applies for the following periods:

Fringe benefits tax years ending:

31 March 2014

31 March 2015

31 March 2016

31 March 2017

31 March 2018

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Background

• Company A is the head company of an income tax consolidated group ('the Group'). Company X is one of a number of subsidiaries of Company A.

• Company A has established a number of employee share plans (collectively, the 'employee share plans') that operate in accordance with Subdivision 83A-C of the ITAA 1997 including:

• A number of employee share plans under which performance share rights (PSRs) may be issued to employees of the Group ('the PSR Plans').

• An employee share plan under which employees may be allocated shares in Company A subject to certain trading restrictions ('the general share plan').

• Under the employee share plans, Company A grants shares or rights to shares to employees of the Group, which may be subject to the meeting of certain performance and/or service conditions.

• The shares and rights constitute part of Company A's remuneration and reward program for employees of the Group.

• Employees of the Group become Participants in the relevant employee share plans by accepting an invitation to join.

The PSR Plans

• Pursuant to the relevant Plan Rules, eligible employees of the Group may be offered Performance Share Rights (PSRs) at the discretion of the Board of Company A.

• Under the relevant Plan Rules the Board may issue PSRs on the terms and conditions it determines including prescribing performance criteria that must be satisfied before shares are allocated to Participants and the performance period during which the performance criteria must be satisfied.

• Before shares are allocated under the PSRs, employees must satisfy certain vesting conditions for the duration of the vesting period. Where a Participant satisfies the vesting conditions for the relevant vesting period they will be allocated shares in Company A at the end of the vesting period. If a Participant fails to satisfy the vesting conditions, the PSRs will lapse and no shares in Company A will be allocated to them.

• Under the PSR Plans, the maximum time that may elapse between the granting of PSRs and their vesting if conditions are met (the vesting period) is 5 years.

• Shares may also be allocated to Participants (at the discretion of the Board) if a Change of Control Event as defined in the relevant Plan Rules occurs. A Change of Control Event is defined in the Plan Rules as where a person acquires a relevant (within the meaning of section 608 of the Corporations Act 2001) in more than fifty per cent (50%) of the shares in Company A as a result of a takeover bid or a scheme or arrangement, or any other similar event (including a merger of Company A with another company) which the Board determines to be a Change of Control Event.

The general Share Plan ('GSP')

• Under the GSP, eligible employees receive shares in Company A up to a particular dollar value. There are no vesting conditions, but shares issued under the GSP cannot be traded by the relevant employee for 3 years, whilst they remain an employee of the Group. If the employee leaves the Group within this 3 year period the shares are transferred from the plan to the employee and the trading restriction is removed.

The Employee Share Trust

• The employee share plans are carried out through an employee share trust ('the EST').

• The EST was established under a Trust Deed ('the Trust Deed'). Company A intends for the EST to remain in place for the foreseeable future whilst it continues to use employee equity plans to remunerate its employees.

• The EST is an independent legal entity. Under the Trust Deed, Company A and its subsidiaries may not have any interest in Company A shares held by the EST.

• Under the Trust Deed Recitals the sole purpose of the EST is to obtain shares to satisfy the requirements under the employee share plans operated by Company A.

• Under the Trust Deed, the Trustee of the EST has all the powers of a natural person to carry out (or incidental to the carrying out of) its duties under the Trust Deed, including acquiring and disposing of Company A shares; operation of a bank account; opening accounts with share brokers and engaging advisers.

• Company A and/or Company X provide irretrievable contributions to the trustee of the EST to allow the EST to acquire Company A shares on-market or subscribe for new shares in Company A in order to satisfy requirements for the allocation of shares under the employee share plans. For PSR plans, contributions are only made after the relevant PSRs have been granted.

• Under the Trust Deed, Company A may cause the Trustee of the EST to acquire Company A shares for the purposes of satisfying obligations under the employee share plans.

• The commercial reasons for and benefits of the EST are stated to include the following:

• A company is unable to hold its own shares. The EST is a vehicle that enables Company A to effectively acquire and hold its own shares for the purposes of fulfilling its obligations resulting from new and existing grants under the employee share plans.

• The EST facilitates the acquisition of shares either on-market or by a new issue of shares by Company A.

• The EST allows Company A to place a disposal restriction on shares, requiring that shares allocated to a Participant on the vesting of PSRs are held by the EST for a specified period after the vesting date (no such restrictions are currently incorporated in the terms of the PSRs, but may be considered by Company A to be appropriate for future PSRs). As the EST will be the legal owner of the shares, the participant will not be able to deal with the shares until they are transferred out of the EST into the participant's name.

• The EST provides an arm's length vehicle for acquiring and holding shares in Company A, either by way of new issue or acquiring on-market, i.e. providing flexibility relating to capital management.

• Contributing to the EST may enable Company A to hedge against share price growth where shares are to be purchased on-market (i.e. by acquiring shares before they are required to be allocated to Participants). Making a contribution to the EST, regardless of whether shares are to be acquired on-market or via a subscription for new shares ensures a consistent process whether Company A, or Company X, is required to fund the EST to meet the related cost of providing the shares.

• The EST provides the flexibility to acquire and hold shares that will be allocated to employees under the employee share plans. When vesting conditions are not met, PSRs are forfeited and the EST enables Shares held for such forfeited PSRs to be 'recycled' to satisfy other grants of Rights.

• The EST establishes independent records and accounts for participating employees.

• Sufficient shares may not be available on market should a vesting occur in accordance with the Change of Control rule. Therefore the EST allows Company A to prepare for this potential vesting event by issuing shares to the Trust before the Change of Control occurs. The Trustee of the EST may then allocate Shares to Participants in a timely manner, and in accordance with any transaction timeline which may be imposed by Company A and the Acquirer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 section 8-1

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

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

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 subsection 83A-20(2)

Income Tax Assessment Act 1997 paragraph 83A-105(1)(a)

Income Tax Assessment Act 1997 section 83A-210

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

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177A(5)

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 subsection 177C(1)

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 paragraph 177D(2)(a)

Income Tax Assessment Act 1936 paragraph 177D(2)(b)

Income Tax Assessment Act 1936 paragraph 177D(2)(c)

Income Tax Assessment Act 1936 paragraph 177D(2)(d)

Income Tax Assessment Act 1936 paragraph 177D(2)(e)

Income Tax Assessment Act 1936 paragraph 177D(2)(f)

Income Tax Assessment Act 1936 paragraph 177D(2)(g)

Income Tax Assessment Act 1936 paragraph 177D(2)(h)

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177EB

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 subsection 177F(1)

Fringe Benefits Tax Assessment Act 1986 section 66

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Reasons for decision

Issue 1

Timing and availability of deductions for irretrievable contributions made to the trustee of an employee share trust under an employee share scheme

Question 1

Summary

Company A will be entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for irretrievable contributions made by it to the Trustee of the Employee Share Trust (EST).

Detailed reasoning

An employer is entitled to a deduction under section 8-1 of the ITAA 1997 for a contribution paid to the trustee of an employee share trust that is either:

• incurred in gaining or producing the employer's assessable income ('first limb'), or

• necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income ('second limb')

to the extent that the contribution is not capital, or of a capital nature, is not private or domestic in nature, does not relate to the earning of exempt income or non-assessable non-exempt income, and deductibility is not precluded by another provision of the ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936).

Therefore, in order to satisfy deductibility under section 8-1 of the ITAA:

(i) there must be a loss or an outgoing

(ii) the loss or outgoing must be incurred

(iii) there must be the required connection between the outgoing and the gaining or producing of assessable income or the carrying on of a business for the purpose of gaining or producing assessable income, and

(iv) the loss or outgoing must not be:

a. capital, or of a capital nature

b. of a private or domestic nature

c. related to the earning of exempt income or non-assessable, non-exempt income, or

d. precluded from deductibility by another provision of the ITAA 1997 or ITAA 1936.

(i) loss or outgoing

The irretrievable contributions made by Company A to the Trustee of the EST constitute an outgoing of Company A.

(ii) the loss or outgoing must be incurred

Broadly, a taxpayer incurs an outgoing at the time the taxpayer owes a present money debt that they cannot escape. This must be read subject to the propositions developed by the Courts, which are discussed in more detail in Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions and Taxation Ruling TR 94/26 Income tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance.

A contribution made to the trustee of an employee share trust is incurred only when the ownership of that contribution passes from an employer to the trustee and there is no circumstance in which the employer can retrieve that contribution - Pridecraft Pty Ltd v Federal Commissioner of Taxation [2004] FCAFC 339 (Pridecraft); Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCAFC 339 (Spotlight).

In the present case, Company A has established the EST for the purposes of facilitating the acquisition, holding and allocation of shares to meet its obligations under the employee share plans. Company A has a legal obligation to provide the shares to Participants in accordance with the relevant plan rules and to fund the EST to acquire, hold and allocate the shares for that purpose. Therefore, Company A will incur an outgoing when they make irretrievable contributions to the trustee of the EST.

(iii) required connection with gaining of assessable income or the carrying on of a business for the purposes of gaining or producing assessable income

To satisfy the second limb of section 8-1 of the ITAA 1997, there must be the required connection between the outgoing and the business. An expense will have the relevant connection to the business when it is 'desirable or appropriate in the pursuit of the business ends of the business' (Ronbipon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56).

Draft Taxation Ruling TR 2014/D1 Income tax: employee remuneration trust arrangements provides the Commissioner's current view on a broad scope of taxation consequences for employers, trustees and employees who participate in an employee remuneration trust arrangement.

Paragraph 14 of TR 2014/D1 makes clear that where an employer:

• carries on a business for the purpose of gaining or producing assessable income and engages employees in the ordinary course of carrying on that business;

• makes a contribution to the trustee of an employee remuneration trust (ERT); and

• at the time the contribution is made, the primary purpose of the contribution is for it to be applied, within a relatively short period, to the direct provision of remuneration of employees (who are employed in that business),

then such a contribution will satisfy the nexus of being necessarily incurred in carrying on that business.

Paragraph 178 of TR 2014/D1 provides that the Commissioner will generally accept a relatively short period of time for the trustee of an ERT to diminish a contribution for the direct provision of remuneration to employees to be up to five years from the date the contribution was made by an employer to the trustee of an ERT. However, where the contribution has been made to facilitate an employee having an interest in the ERT corresponding to a particular number of shares (or right to acquire shares) in the employer or in its subsidiaries to which Subdivision 83A-C of the ITAA 1997 applies, a relatively short period of time for these arrangements will generally be accepted as being up to seven years from the date the contribution is made.

Under the GSP, the maximum time between the allocation of shares subject to trading restrictions until the removal of trading restrictions is 3 years. Under the various employee share PSR Plans, the maximum time between the granting of PSRs subject vesting conditions and the vesting of those PSRs where the vesting conditions are met is 5 years.

The irretrievable contributions made by Company A to the trustee of the EST are in the nature of an employee remuneration cost incurred in carrying on a business for the purposes of deriving assessable income. Consistent with the guidance at paragraph 178 of TR 2014/D1, the contribution will be applied with a relatively short period to the direct provision of remuneration of employees (through the allocation of shares).

Accordingly, it is considered that the irretrievable contributions made by Company A to the trustee of the EST will be an outgoing incurred in carrying on a business and will satisfy the nexus of being necessarily incurred in carrying on that business, for the purposes of gaining or producing assessable income.

(iv) nature of the outgoing

The Commissioner does not consider the contributions to be a loss or outgoing:

• of a private or domestic nature

• related to the earning of exempt income or non-assessable, non-exempt income, or

• for which deductibility is precluded by another provision of the ITAA 1997 or ITAA 1936.

Whether the contribution could be capital or of a capital nature

Pursuant to subsection 8-1(2) of the ITAA 1997, a loss or outgoing will not be deductible if it is of capital or of a capital nature despite satisfying either limb of subsection 8-1(1) of the ITAA 1997.

The leading case on the capital/revenue distinction is Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337. In that case Dixon J stated that:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay…

Draft Taxation Ruling TR2014/D1 Income tax: employee remuneration trust arrangements, discusses when a contribution made to the trustee of an employee share trust may be of a capital nature. Relevantly, paragraphs 186 and 187 of TR 2014/D1 state:

186. A contribution to the trustee of an ERT is of capital or of a capital nature, when the contribution secures for an 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.

187. A contribution by an employer to the trustee of an ERT is considered to be capital or of a capital nature, in whole or in part, where the contribution…

• is ultimately and in substance, applied by the trustee to acquire a direct interest in the employer (for example shares).

In the present case, irretrievable contributions are provided by Company A, as an employer to the trustee of an ERT (the EST). The contributions may ultimately and in substance be applied by the trustee of the EST to subscribe for equity interests in the employer (Company A shares). In this way Company A could be considered as having acquired an asset or advantage of an enduring nature which is capital or of a capital nature, in whole or in part.

In cases where a contribution is made for the purpose of securing advantages for the employer of both a capital and revenue nature, section 8-1 of the ITAA 1997 may require the contribution to be apportioned into deductible and non-deductible components. However, paragraph 198 of TR 2014/D1 states that where the advantages of a capital nature are only expected to be very small or trifling in comparison, apportionment may not be required.

Relevantly, paragraph 202 of TR 2014/D1 states:

…where the primary purpose of the employer in making the contribution is to remunerate employees within a relatively short period (as discussed in paragraph 178 of this draft Ruling) of the contribution being made, it is considered that any amount of the contribution attributable to securing a capital structure advantage will only be very small or trifling where the employer:

• intends that any direct interest in the employer acquired by the trustee of the ERT (for example shares) will be transferred to employees within that relatively short period, and

• does not anticipate that such shares will be on-sold to third parties at that time or shortly thereafter.

As noted above, under the employee share plans, the time between the making of the contribution and the remuneration of the employee by the allocation of shares to the employee does not exceed 5 years and this is considered to be a 'relatively short period' as discussed in paragraph 178 of TR 2014/D1.

Therefore, the Commissioner accepts that any advantages of a capital nature that may arise from the irretrievable contributions made by Company A to the Trustee of the EST are expected to be very small or trifling and that apportionment of the deductible amount under section 8-1 of the ITAA 1997 is not required.

Conclusion

Irretrievable contributions made by Company A to the Trustee of the EST are deductible under section 8-1 of the ITAA 1997. To the extent that any part of the contribution is of capital or of a capital nature, the Commissioner accepts that such amounts will be very small or trifling, such that apportionment to account for any capital component of the contribution would not be required.

Question 2(a)

Summary

Irretrievable contributions made by Company A to the Trustee of the EST before the acquisition of the relevant ESS interests are deductible to Company A at a time determined by section 83A-210 of the ITAA 1997.

Detailed reasoning

Irretrievable contributions that are deductible under section 8-1 of the ITAA 1997 would generally be an allowable deduction in the income year in which the outgoing was made. However, under certain circumstances, the timing of the deduction is instead determined under section 83A-210 of the ITAA 1997.

Section 83A-210 of the ITAA 1997 provides that:

83A-210 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.

'Employee share scheme' (ESS) and 'ESS interest' are defined in subsection 83A-10 of the ITAA 1997 which provides:

83A-10(1) An ESS interest, in a company, is a beneficial interest in

(a) a *share of the company; or

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

83A-10(2) An employee share scheme is a *scheme under which *ESS interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:

(a) the company; or

(b) *subsidiaries of the company

in relation to the employees' employment.

Therefore, broadly, section 83A-210 of the ITAA 1997 will only apply if there is a relevant connection between the irretrievable contributions provided to the trustee of the EST, and the acquisition of ESS interests (directly or indirectly) by an individual under an employee share scheme in relation to their employment.

The provision of PSRs or allocation of shares with trading restrictions in the case of the GSP, constitute ESS interests as either a beneficial interest in a share of Company A or a beneficial interest in a right to acquire a beneficial interest in a share in Company A.

The Company A employee share plans each constitute an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997.

Under both the PSR Plans and the GSP, the granting of the ESS interests, the provision of money to the Trustee of the EST under the arrangement, the acquisition and holding of shares by the Trustee and the allocation of shares to Participants of the plans are all interrelated components of the employee share schemes. As one of the components, the provision of money to the Trustee of the EST necessarily allows the scheme to proceed.

Consequently, the provision of money by Company A to the Trustee of the EST is considered to be for the purpose of enabling participating employees, indirectly under the employee share scheme to acquire the ESS interests. In circumstances where irretrievable contributions are made to the EST before the acquisition of the relevant ESS interests, section 83A-210 will apply and the contributions will be deductible to Company A at a time determined by that section.

Question 2(b)

Summary

Irretrievable contributions made by Company A to the Trustee of the EST to satisfy ESS interests in respect of Participants are deductible to Company A under section 8-1 of the ITAA 1997 in the income year in which the contributions are made, if the contributions are made after the acquisition of the relevant ESS interests.

Detailed reasoning

As concluded under question 1 above, the irretrievable contributions made by Company A to the Trustee of the EST will be deductible to Company A under section 8-1 of the ITAA 1997.

Further, as explained above in the reasoning for question 2(a), section 83A-210 of the ITAA 1997 will operate to determine the timing of the deduction, where the contributions are made to the EST before the acquisition of the relevant ESS interests.

If the irretrievable contributions are made to the EST after the acquisition of the relevant ESS interests, section 83A-210 of the ITAA 1997 will not apply. In such a case the contribution will be deductible under section 8-1 of the ITAA 1997 in the income year in which Company A makes the contribution.

Issue 2

Application of Part IVA of the ITAA 1936 (Part IVA) to Employee Share Scheme

Question 1

Summary

Part IVA will not apply to the arrangement where irretrievable contributions are made to the Trustee of the EST to fund the subscription for, or acquisition on-market of, Company A shares in respect of Participants, where a share is a fully paid ordinary share in the capital of the company.

Detailed reasoning

Part IVA of the ITAA 1936 contains a number of anti-avoidance provisions. On the facts, the anti-avoidance rules in sections 177E, 177EA or 177EB of the ITAA 1936 are not relevant. The following reasoning therefore considers the general anti-avoidance rule against schemes for the dominant purpose of obtaining a tax benefit under section 177D of the ITAA 1936.

Under subsection 177F(1) of the ITAA 1936, the Commissioner may cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

The following requirements must be met before the Commissioner can exercise the discretion under subsection 177F(1) of the ITAA 1936:

(i) a 'tax benefit' as identified in section 177C was, or would but for subsection 177F(1), have been obtained;

(ii) the tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A; and

(iii) having regard to section 177D, the scheme is one to which Part IVA applies.

The scheme

Subsection 177A(1) of the ITAA 1936 provides that 'scheme' means:

(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.

This definition is sufficiently wide to cover the present arrangement, which consists of the creation of the EST, the payment of the irretrievable contributions by Company A to the Trustee of the EST, the acquisition of shares in Company A and the allocation of those shares to employees.

Tax Benefit

'Tax benefit' is defined in subsection 177C(1) of the ITAA 1936. As far as is relevant here, a tax benefit is:

(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 the present case, a potential tax benefit arises when Company A receives an income tax deduction under section 8-1 of the ITAA 1997 arising from the irretrievable contributions it makes to the Trustee of the EST.

To determine whether a tax benefit has been obtained in connection with the scheme, it is necessary to examine the alternative hypotheses or counterfactuals. That is, what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out and what other schemes Company A might reasonably have been expected to enter into to achieve its aims in relation to employee remuneration.

Three alternatives have been provided:

(Alternative 1) Company A could fund the purchase of shares on-market in the name of Participants upon vesting of the PSRs. Under this alternative, a tax deduction would be available to Company A for the purchase price of the shares.

(Alternative 2) Company A could remunerate Participants via payments of salary, bonuses or superannuation contributions (i.e. cash equivalent amounts based on the value of shares) rather than the grant of PSRs and/or delivery of shares. Under this alternative, payments of the additional cash amounts would be deductible to Company A.

(Alternative 3) Company A could issue new shares directly to Participants when rights vest. Under this alternative, Company A would be entitled to a tax deduction for costs incurred in issuing and transferring the shares, but is unlikely to receive a deduction for the cost / value of the shares issued.

As noted above in issue 1, question 1 above, Company A can deduct amounts under section 8-1 of the ITAA 1997 for irretrievable contributions made to the Trustee of the EST.

A comparison between alternatives 1 and 2 and the current scheme would likely reveal no tax benefit because the deductible amounts under both would be the same or similar to a tax deduction for irretrievable contributions made to the Trustee of the EST.

A comparison of the scheme with alternative 3 reveals a potential tax benefit. The deduction under that alternative would be limited to the costs incurred in issuing and transferring the shares to Participants. This amount is likely to be lower than the deduction that would be available under the scheme and therefore a tax benefit might be considered to have been obtained.

Company A have submitted that alternative 3 does not represent a reasonable alternative and therefore no tax benefit arises in respect of the scheme for the purpose of section 177C of the ITA 1936. Notwithstanding, the factors in subsection 177D(2) of the ITAA 1936 are considered below, in the event that a tax benefit exists.

Sole or Dominant Purpose

Under subsection 177A(5) and section 177D of the ITAA 1936, the Commissioner may seek to disallow a tax benefit obtained in connection with a scheme if the dominant purpose of one of the persons who entered into the scheme was to enable a taxpayer to obtain a tax benefit.

In deciding whether Part IVA of the ITAA 1936 applies to a scheme, it is necessary to consider whether, having regard to each of the factors set out in subsection 177D(2) of the ITAA 1936, it would be concluded that the person, or one of the persons who entered into the scheme or any part of it, did so for the purpose of enabling a relevant taxpayer to obtain a tax benefit in connection with the scheme.

Paragraph 177D(2) of the ITAA 1936

Paragraph 177D(2) of the ITAA 1936 sets out the factors to be considered in deciding whether a scheme was entered into for the dominant 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 paragraph (f).

The consideration of the eight factors involves comparison of the scheme with the 'alternative hypothesis', or counterfactual. That is the conclusion about the dominant purpose of a person entering into or carrying out the scheme, or any part of it, necessarily requires consideration of what may otherwise have occurred.

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

The first factor enables contrivance and artificiality to be identified by comparing the manner in which the scheme was entered into or carried out with the manner in which the counterfactual would have been implemented, for example, by the presence of a step or steps in a relevant transaction or arrangement that would not be expected to be present in a more straightforward or ordinary method of achieving the outcome of the transaction or arrangement.

Company A contends that the operation of the EST provides a number of commercial benefits that are not available if shares were provided directly by the Company A to Participants under alternative 3. In particular, Company A identifies the following benefits from the use of the EST:

• A company is unable to hold its own shares. The EST is a vehicle that enables the Company A to effectively acquire and hold its own shares for the purposes of fulfilling its obligations resulting from new and existing grants under the employee share plans.

• The EST facilitates the acquisition of shares either on-market or by a new issue of shares Company A.

• The EST allows Company A to place a disposal restriction on Shares, requiring that shares allocated to a participant on the vesting of PSRs are held by the EST for a specified period after the vesting date (no such restrictions are currently incorporated in the terms of the PSRs, but may be considered by Company A to be appropriate for future PSRs). As the EST will be the legal owner of the Shares, the Participant will not be able to deal with the shares until they are transferred out of the EST into the Participant's name.

• The EST provides an arm's length vehicle for acquiring and holding shares in Company A, either by way of new issue or acquiring on-market, i.e. providing flexibility relating to capital management.

• Contributing to the EST may enable Company A to hedge against share price growth where shares are to be purchased on-market (i.e. by acquiring shares before they are required to be allocated to Participants). Making a contribution to the EST, regardless of whether shares are to be acquired on-market or via a subscription for new shares ensures a consistent process whether Company A, or appropriate employing Entity, is required to fund the EST to meet the related cost of providing the shares.

• The EST provides the flexibility to acquire and hold shares that will be allocated to employees under the employee share plans. When vesting conditions are not met, PSRs are forfeited and the EST enables shares held for such forfeited PSRs to be 'recycled' to satisfy other grants of Rights.

• The EST establishes independent records and accounts for participating employees.

• Sufficient shares may not be available on market should a vesting occur in accordance with a Change of Control Event. Therefore, the EST allows Company A to prepare for this potential vesting event by issuing shares to the EST before the Change of Control occurs. The Trustee of the EST may then allocate shares to Participants in a timely manner and in accordance with any transaction timeline which may be imposed by Company A and the Acquirer.

It is accepted that the EST provides benefits to the operation of the scheme (other than tax benefits) that would not be available if the shares were provided directly by Company A in accordance with alternative 3. The use of the EST is explicable by reference to these benefits and no contrivance or artificiality is evident in the manner in which the scheme has been operated with respect to the EST. Accordingly, this factor does not incline toward the requisite purpose.

(b) The form and substance of the scheme

This factor directs attention to whether there is a discrepancy between the form of the scheme and its substance, meaning its commercial and economic substance. A discrepancy between the business and practical effect of a scheme on one hand and its legal form on the other, may well indicate the scheme has been implemented in a particular form as the means to obtain a tax benefit if the substance of the scheme may be achieved or available by some other more straightforward or commercial transaction or dealing.

The substance of the scheme is the provision of remuneration in the form of shares to Participants under Company A's employee share plans. It takes the form of irretrievable contributions made by Company A to the Trustee of the EST for the acquisition of shares for Participants, either on-market or by way of new issue and the allocation of shares.

There is no apparent discrepancy between the effect of the scheme and its form. Accordingly, this factor does not incline toward the requisite purpose.

(c) Time at which the scheme was entered into

This factor considers the time the scheme, or any part of it, was entered into or carried out, and the length of the period during which it was carried out. It enables consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements.

The scheme was entered into at a particular past time and Company A intends to keep the scheme in place for the foreseeable future whilst the company continues to use employee share plans to remunerate its employees.

The scheme has been operated for a considerable period. The facts do not suggest that the scheme has been established to provide a substantial year-end deduction to the company or with a contribution sufficiently large to fund the trust for several years. The facts suggest that the scheme will be funded by recurring contributions to the EST. Accordingly this factor does not incline toward the requisite purpose.

(d) The result of the scheme

This factor expressly focuses on the tax benefit and any other tax consequences resulting from the scheme.

In the present case, the result of the scheme is to provide Company A with allowable deductions for the contributions it makes to the EST. However, it is noted that the contributions reflect a genuine outgoing on the part of Company A to provide remuneration to participating employees. The EST assists Company A in achieving this business outcome.

(e) Any change in the financial position of Company A

As noted above, Company A makes irretrievable contributions to the Trustee of the EST and those contributions constitute a real outgoing with the result that Company A's financial position is changed to that extent.

The quantum of the deductions is also likely to be higher with an EST as part of the scheme, in contrast to Company A providing shares to Participants directly (under alternative 3).

(f) Any change in the financial position of other entities or persons

The irretrievable contributions made by Company A to the Trustee of the EST will form part of the corpus of the trust and must be dealt with by the Trustee in accordance with the terms of the Trust Deed. The Trustee is an independent third party. Company A and its subsidiaries cannot be beneficiaries of the EST and its contributions cannot be returned except where the Trustee acquires shares from Company A by subscribing for new shares at market value. Therefore, the contributions made by Company A will result in a change in financial position for the Trustee.

The financial position of participants in the Plans will also change, but it is noted that this change would occur regardless of whether the relevant shares are acquired through the EST or provided directly by Company A.

Whilst the scheme results in a change in the financial position of the EST and Participants of the employee share plans, there is nothing artificial, contrived or notional about these changes. The purpose of the scheme is to change the financial position of the participants by providing ESS interests as part of their remuneration, and the EST is an independent third party which receives contributions only for the purpose of acquiring, holding and allocating shares to satisfy Company A's obligations under the employee share plans.

(g) Any other consequences

No other consequence is identified as relevant to the scheme.

(h) The nature of any connection between Company A and any other persons

The relationship between Company A and the Participants is that of employer/employee. The Trustee of the EST is an unrelated independent party, but Company A does provide instructions to the Trustee as to whether the Trustee should acquire the shares on market or subscribe for new shares. However, there is nothing to suggest that the parties to the employee share plans are not acting at arm's length with one another. Accordingly, this factor does not incline toward the requisite purpose.

Conclusion

Having regard to the factors set out in subsection 177D(2) of the ITAA 1936, the Commissioner does not consider that the requisite purpose exists. In this case, the scheme does not contain the elements of artificiality or unnecessary complexity and the commercial drivers sufficiently explain the entry into and use of the EST arrangement. Therefore, the scheme is not one to which Part IVA of the ITAA 1936 applies.

Further, as noted above, on the facts provided, sections 177E, 177EA and 177EB have no application to the scheme.

Issue 3

Application of Fringe Benefits Tax to an employee share scheme

Question 1

Summary

The provision of ESS benefits and shares by Company A to employees of the Group is not a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986).

Detailed reasoning

A liability to fringe benefits tax (FBT) arises under section 66 of the FBTAA 1986 which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer of a year of tax. The fringe benefits taxable amount is calculated under the FBTAA 1986 by reference to the taxable value of each fringe benefit provided. No amount will be subject to FBT unless a fringe benefit is provided.

The term 'fringe benefit' is defined in subsection 136(1) of the FBTAA 1986 to mean benefits provided by an employer, an associate of the employer or an arranger with the employer, to employees, in respect of the employment of the employee.

The relevant rights to shares (PSRs) or shares (in the case of the GSP) will be provided to Participants who are Company A employees when they are granted. Paragraph (h) of the definition of fringe benefit in subsection 136(1) of the FBTAA 1986, 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

Subsection 83A-10(1) of the ITAA 1997 provides that an ESS interest in a company is 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. An employee share scheme is a scheme under which ESS interests in the company are provided to employees (or associates of employees) of the company or subsidiaries of the company, in relation to the employee's employment (subsection 83A-10(2) of the ITAA 1997).

Under the Company A employee share plans, employees of Company A (or its subsidiary members) may receive PSRs or shares in respect of their employment upon acceptance of an invitation to the relevant employee share plan. These are ESS interests.

The Company A employee share plans the subject of this Ruling are each an employee share scheme or schemes under which relevant ESS interests are acquired by employees (or associates of those employees), and the acquisition of those ESS interests are in relation to the employment of those employees. Therefore, the provision of the PSRs and shares will not be subject to FBT because they are specifically excluded from the definition of fringe benefit.

The shares acquired by the Trustee of the EST under the employee share plan to satisfy the PSRs are also provided to employees under the employee share plans. However, these shares are not ESS interests acquired under an employee share scheme to which Subdivision 83A-B or 83A-C of the ITAA 1997 apply (see subsection 83A-20(2) of the ITAA 1997 and paragraph 83A-105(1)(a) of the ITAA 1997). Therefore, the provision of these shares will not be specifically excluded from the definition of fringe benefits under paragraph (h) of the definition in subsection 136(1) of the FBTAA 1986.

As stated above, a fringe benefit will only arise under subsection 136(1) of the FBTAA 1986 where the benefit is provided by an employer to an employee or associate of the employee in respect of the employment of the employee.

Under the Company A employee share plans, the benefit that may arise (i.e. beneficial interest in shares) upon the vesting of PSRs at the end of the vesting period is considered to be provided as a result of the vesting of rights (previously obtained upon acceptance to participate in the relevant employee share plan) as opposed to being provided to an employee in the employment of the employee.

The situation mentioned above is considered analogous to that addressed in ATO Interpretative Decision 2003/316 Fringe benefit: benefit arising upon discharge of a limited recourse loan which refers to the case of Federal Commissioner of Taxation v McArdle 19 ATR 1901. In that case, an employee was granted valuable rights in respect of his employment which he subsequently surrendered in return for a lump sum payment. The 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.

In the present circumstances, when an employee accepts to an invitation to participate, he or she obtains a right to acquire a beneficial interest in a share and this right constitutes an ESS interest. When this right is subsequently exercised, any benefit received, that is, beneficial interest in shares, would be in respect of the exercise of the right, and not in respect of employment.

Therefore, the benefit received does not give rise to a fringe benefit as no benefit has been provided to the employee in respect of the employment relationship

Question 2

Summary

Irretrievable contributions made by Company A and/or Company X to the Trustee of the EST to fund the subscription for, or acquisition on-market of, Company A shares in respect of Participants are not a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986.

Detailed Reasoning

Pursuant to subsection 136(1) of the FBTAA, a fringe benefit is defined to exclude:

…(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' (EST) is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by subsection 130-85(4) of the ITAA 1997. Subsection 130-85(4) of the ITAA 1997 provides that:

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).

As noted above, the employee share plans each constitute an employee share scheme.

Under the Deed Recitals of the Trust Deed, the sole purpose of the EST is to obtain shares to satisfy the requirements under the employee share plans operated by Company A. Under the Trust Deed, the Trustee is stated to have the power to carry out (or incidental to carry out of) its duties under the Deed, including:

(a) acquire and dispose of shares (in Company A)

(b) to operate a bank account

(c) to open accounts with share brokers, and

(d) to engage advisers.

It is considered that the EST is an employee share trust as defined in subsection 130-85(4) of the ITAA 1997. The Deed Recitals indicate that the sole activities of the EST are obtaining shares (or rights to acquire shares) in Company A and providing them to employees of the company (or its subsidiaries) under employee share plans. The powers of the Trustee listed as provided under the Trust Deed can reasonably be considered as incidental to those activities.

Therefore, irretrievable contributions made by Company A and/or Company X to the Trustee of the EST to fund the subscription for, or on market acquisition of, Company A shares are not a fringe benefit within the meaning of subsection 136(1) of the FBTAA 1986.

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