Edited version of your written advice

Authorisation Number: 1012760691467

Ruling

Subject: Employee share trust

Question 1

Will the irretrievable cash contributions made to the Trustee to fund the acquisition of Company A shares by the Company A Equity Plan Employee Share Trust (EST) be assessable income of the EST under section 6-5 or 6-10 of the ITAA 1997?

Answer

No.

Question 2

Will a capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to Company A shares be disregarded under section 130-90 of ITAA 1997?

Answer

Yes.

Relevant facts and circumstances

Background

1. Company A is a listed Australian company.

2. Company A prides itself on its ongoing efforts to maintain a productive and motivated work environment. A clear factor in its successes to date can be linked to the opportunities and rewards which it provides to staff and senior employees. The design of remuneration packages is an aspect of Company A's strategy to retain and attract high-quality staff. In addition to wages and salaries, Company A offer its employees cash bonuses to acknowledge and encourage exceptional short-term performance. Long-term equity based incentives are also offered to encourage loyalty and prolonged employee excellence.

3. The Company A Equity Plan was established as part of its remuneration and incentive programmes. Pursuant to the specific rules of the Company A Equity Plan, eligible senior employees identified by the Board of Directors (Board) may be granted performance rights. Each performance right results in an entitlement to one share in Company A, subject to the satisfaction of certain pre-determined exercise conditions set by the Board.

Company A Equity Plan

4. The Company A Equity Plan was established and implemented to assist in the reward, retention and motivation of employees of Company A.

5. The Company A Equity Plan broadly operates as follows:

• It is at the absolute discretion of the Board to extend an invitation to grant performance rights to eligible employees selected by the Board (Participants).

• Exercise of a performance right constitutes an acceptance by the Participant of an irrevocable offer by Company A that entitles the Participant to one fully paid ordinary share in Company A. Shares allotted upon exercise of the performance rights will rank equally with all other ordinary shares of Company A.

• Unless otherwise determined by the Board, the total exercise price payable on the exercise of one or more performance rights on a particular day is AUDX.00, irrespective of the number of performance rights exercised on said day.

• Accordingly once all vesting conditions on the performance rights, as determined by the Board, have been satisfied the Participant will be entitled to exercise the performance rights.

• The performance right is exercised by the Participant lodging a notice of exercise and application for the corresponding parcel of shares, together with the nominal exercise price payable, to the Company Secretary or other such person as the Board designates.

• A performance right will lapse on the first to occur of: the expiry date of the performance right; 30 days after a Participant ceases to be employed by Company A, unless the Board otherwise determines; and notice from the Participant that he/she wishes for the performance right to lapse.

• Performance rights are not transferrable without the consent of the Board.

Operation of the Employee Share Trust (EST)

6. Company A established an EST as a sole purpose trust to subscribe for, or acquire, allocate, hold and deliver shares for employees of Company A pursuant to the Company A Equity Plan and other future employee equity plans for the benefit of Participants.

7. Company A appointed an independent third party, Company T as trustee for the EST (the Trustee).

8. 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. The Trustee is not permitted to carry out activities which result in the Participants being provided with additional benefits other than the benefits that arise from the Company A Equity Plan rules (plan rules).

9. 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. Company A may pay the Trustee from its own resources any fees, commission or remuneration and reimburse any expenses incurred by the Trustee as Company A and the Trustee may agree from time to time. The Trustee is entitled to retain for its own benefit any such remuneration or reimbursement.

10. The EST will be managed and administered so that it satisfies the definition of 'employee share trust' in section 130-85(4) of the ITAA 1997.

11. The EST operates as follows:

• The EST is funded by contributions from Company A for the purchase of shares in accordance with the Trust Deed and the Company A Equity Plan. Generally, Company A makes a contribution to the Trust to acquire shares at or around the time of vesting of the performance rights.

• These contributions will be used by the Trustee to acquire shares in Company A either on-market or via a subscription for new shares in Company A, based on written instructions from Company A. The Trustee acquires shares from Company A by subscribing for newly issued shares at market value.

• Shares acquired by the Trustee will be allocated to the Participant following exercise of the performance rights. The Participant will become absolutely entitled to such shares from that point in time.

• The structure of the EST and the plan 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 can sell shares on behalf of an employee where permitted to do so by the employee.

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

• The Trustee will establish and maintain a separate Trust Share Account or record in respect of each Participant.

• 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 plan rules or the relevant Terms of Participation; or deposit the funds into any account opened and operated by the Trustee.

Contributions made by the EST to Company A

12. Company A makes cash contributions to the EST on an ongoing basis. The EST must use these cash contributions exclusively to purchase shares in Company A for employees under the Company A Equity Plan and, pending such an acquisition, form part of the EST's assets.

13. Funds received by the Trustee from Company A may be paid to Company A where the Trustee subscribes for Shares in accordance with the Trust Deed, the plan rules or Terms of Participation.

14. Shortly after vesting, the Trustee will then allocate shares to the relevant Participants, having subscribed for or acquired on-market sufficient shares to fulfil the obligation as necessary.

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

Use of the EST to facilitate the Plan

16. An EST has a range of commercial uses in addition to being a vehicle for the delivery of Shares to employees. In the present case, 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, and provides Company A with a convenient and efficient way to undertake on-market acquisitions as compared to if no trust was used;

• assists Company A with meeting its Corporations Law requirements in relation to dealing in its own shares. The Corporations Act generally prohibits a company from acquiring its own shares. The use of the EST provides a mechanism to allow for the acquisition of Company A's shares through the EST and the EST is not prohibited from doing so as a result of Company A having no beneficial interest in any shares held by the EST or the EST itself;

• assists Company A with managing any insider trading issues as the Trustee, an independent party, is acquiring shares in accordance with a set policy. This is in part because the Corporations Regulations specifically exempt certain activities from some of the insider trading prohibitions in the Corporations Act. In particular, the regulations provide an exemption where there is an acquisition of the financial products of a company by, or by a trustee for, employees of that company or its related companies, under a scheme established solely or primarily for the benefit of employees. In addition, the ability of the EST to acquire shares in advance may allow the EST to hold those shares on behalf of employees at a time when Company A would be otherwise prevented from issuing shares to its employees in order to satisfy obligations under the Company A Equity Plan;

• provides Company A with capital management flexibility, i.e. by allowing for on-market purchases of shares using cash or a new issue of shares by Company A where cash is retained. The EST forms part of Company A's wider capital management policy which takes into account matters such as the need for funding and its dividend policy;

• allows for Company A to give effect to disposal restrictions after vesting. As the Trustee is the legal owner of the shares, employees as beneficial owner have no ability to deal in the shares;

• provides Company A with an efficient mechanism for the administration and operation of any new employee equity plans which it introduces in the future.

Costs incurred by Company A to administer the EST

17. Company A incurs various costs in relation to the implementation and on-going administration of the EST. Company A will incur costs associated with the services provided by the Trustee of the EST.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 subsection 6-10

Income Tax Assessment Act 1997 subsection 6-10(1)

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Division 83A

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

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

Income Tax Assessment Act 1997 subsection 83A-20(1)

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 subsection 104-75(1)

Income Tax Assessment Act 1997 subsection 104-75(3)

Income Tax Assessment Act 1997 subsection 104-85(1)

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 subsection 106-50(1)

Income Tax Assessment Act 1997 subsection 106-50(2)

Income Tax Assessment Act 1997 Subdivision 130-D

Income Tax Assessment Act 1997 subsection 130-85(1)

Income Tax Assessment Act 1997 subsection 130-85(2)

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

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

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

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

Income Tax Assessment Act 1997 section 130-90

Income Tax Assessment Act 1997 subsection 130-90(1)

Income Tax Assessment Act 1997 paragraph 130-90(1)(a)

Income Tax Assessment Act 1997 paragraph 130-90(1)(b)

Income Tax Assessment Act 1997 paragraph 130-90(1)(c)

Income Tax Assessment Act 1997 subsection 130-90(1)(d)

Income Tax Assessment Act 1997 subsection 130-90(2)

Income Tax Assessment Act 1997 section 995-1

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

Reasons for decision

All subsequent legislative references are to the ITAA 1997 unless otherwise indicated.

Question 1

Summary

The irretrievable cash contributions made to the Trustee to fund the acquisition of Company A shares by the Company A Equity Plan will not be assessable income of the EST under section 6-5 or 6-10.

Detailed reasoning

Section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) defines net income in relation to a trust as follows, insofar as it is relevant:

net income , in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions …

Subsection 6-5(1) states:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Subsection 6-10(1) states:

Your assessable income also includes some amounts that are not ordinary income.

Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.

The irretrievable contributions made by Company A to the EST are unlike those provisions listed in section 10-5 of the ITAA 1997. Therefore irretrievable contributions made by Company A to the EST will not be assessable income under section 6-10. They will only be included in the calculation of the net income of the trust under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6-5.

Under the terms of the Trust Deed, all contributions by Company A to the EST for the purposes of acquiring Company A shares constitute accretions to the corpus of the EST. Furthermore, pursuant to the Trust Deed, the Trustee must, when directed by the Board, acquire Company A shares on behalf of participating employees and use the contributions made by Company A (and the employees, as the case may be) to do so.

The Trust Deed grants the trustee certain powers but these powers are subject to the general limitation that they may only be exercised for the sole purpose of discharging its obligations under the Trust Deed and plan rules. To this end, the contributions received from Company A and Participants must, therefore, be used to acquire Company A shares in accordance with the terms of the Trust Deed and the plan rules.

Accordingly, the irretrievable contributions made by Company A to the Trustee to acquire Company A shares will not be assessable income under section 6-5 but constitute capital receipts of the Trustee.

Therefore, the irretrievable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition of Company A shares by the EST in accordance with Trust Deed of the EST will not be assessable income of the EST pursuant to sections 6-5 or 6-10. This accords with the view expressed in ATO Interpretative Decision ATO ID 2002/965 Trustee not assessable on employer contributions made to it under the employer's employee share scheme. Note also that income derived by the employment of the property that is the fund of the corpus of the trust and which the Trustee holds on trust will be income according to ordinary concepts. (See Federal Commissioner of Taxation v Everett (1980) 143 CLR; 440; (1980) 10 ATR 608; 80 ATC 4076 for a discussion of the distinction between the trust income and corpus).

Question 2

Summary

A capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to the Company A shares will be disregarded under section 130-90.

Detailed reasoning

Section 130-90

Section 130-90 operates to disregard any capital gain or capital loss where the specified conditions are satisfied.

Section 130-90 states:

130-90(1)

Disregard any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, to the extent that it results from a CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

(b) the CGT event happens in relation to a share; and

(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d) the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

130-90(2)

Subsection (1) does not apply if the beneficiary acquired the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time the CGT event happens.

Employee share trust

The term 'employee share trust' referred to in subsection 130-90(1) is defined in subsection 995-1 as having the meaning given by subsection 130-85(4).

Subsection 130-85(4) provides that an employee share trust for an employee share scheme (having the meaning given by subsection 83A-10(2)) 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).

The right to acquire a share and the beneficial interest in the share that is acquired pursuant to the exercise of the Performance Right are both ESS interests within the meaning of subsection 83A-10(1).

An employee share scheme is defined in subsection 83A-10(2) as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

The Company A Equity Plan is an employee share scheme within the meaning of subsection 83A-10(2) because it is a scheme under which rights to acquire shares in Company A are provided to employees in relation to their employment.

Company A established the EST to facilitate the Company A Equity Plan by acquiring Company A shares and allocating those shares to Participants, in order to satisfy the Performance Rights acquired under the employee share scheme. The beneficial interest in the Company A share is itself provided under an employee share scheme because it is provided under the same scheme under which the Performance Rights to acquire the Company A shares are provided to the Participant in relation to the Participant's employment, being an employee share scheme as defined in subsection 83A-10(2).

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

• the Trustee acquires Company A shares, and

• the Trustee 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 shares to the Participants in accordance with the governing documents of the scheme.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) will require a trustee to undertake incidental activities that are a function of managing the employee share scheme and administering the trust.

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 includes a clause titled 'Sole activities test' and provides that Company A and the Trustee:

…agree that the Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the ITAA 1997.

The Trust Deed makes it clear that the Trustee can only use the contributions received from Company A for the acquisition of Company A shares for Participants in accordance with the Company A Equity Plan. To this end, all other duties/general powers listed in the Trust Deed are considered to be merely incidental to the functions of the Trustee in relation to its dealing with the Company A shares to be acquired for Participants of the Company A Equity Plan.

Accordingly, paragraph 130-85(4)(c) is also satisfied because the EST satisfies the definition of an employee share trust in subsection 130-85(4), as 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.

Therefore, the EST is an employee share trust, as defined in subsection 995-1(1), as the activities of the EST in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) and its other activities (general powers) are merely incidental to those activities in accordance with paragraph 130-85(4)(c).

Paragraph 130-90(1)(a)

CGT event E5

Subsection 104-75(1) provides that CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies), as against the trustee. Subsection 104-75(3) provides that the trustee will make a capital gain if the market value of the asset (at the time of the event) is more than its cost base, but will make a capital loss if that market value is less than the asset's reduced cost base.

Subdivision 130-D treats an employee who acquires an ESS interest through an ESS to be 'absolutely entitled' to the share or right to which the ESS interest relates, from the time that they acquire the ESS interest (subsections 130-85(1) and 130-85(2)).

Under the Company A Equity Plan, where a Participant becomes absolutely entitled to Company A shares as against the Trustee, CGT event E5 will occur, and pursuant to subsection 104-75(3), the Trustee will make a capital gain or loss.

CGT event E5 will happen under the terms of the Company A Equity Plan at the time when the Participant becomes absolutely entitled to the shares in Company A as against the Trustee of the EST.

CGT event E7

Subsection 104-85(1) provides that CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital.

However, subsection 106-50(1) provides:

For the purposes of this Part and Part 3-3 (about capital gains and losses) and Subdivision 328-C (What is a small business entity), from just after the time you become absolutely entitled to a *CGT asset as against the trustee of a trust (disregarding any legal disability), the asset is treated as being your asset (instead of being an asset of the trust).

and section 106-50 (2) provides:

This Part, Part 3-3 and Subdivision 328-C apply, from just after the time you become absolutely entitled to a *CGT asset as against the trustee of a trust (disregarding any legal disability), to an act done in relation to the asset by the trustee as if the act had been done by you (instead of by the trustee).

Example:

An individual becomes absolutely entitled to a CGT asset of a trust. The trustee later sells the asset. Any capital gain or loss from the sale is made by the individual, not the trustee.

The Participant, on allocation of the Company A shares by the Trustee, becomes absolutely entitled to those shares. Once the Participants are absolutely entitled to the Company A shares held on their behalf by the EST, section 106-50 will deem the disposal of them by the Trustee to be done by the Participants.

Section 106-50 will apply, such that if the Trustee disposes of the Company A shares under the Company A Equity Plan (by way of transfer to Participants), the Trustee will not make a capital gain or capital loss under CGT Event E7.

Conclusion

CGT event E5 will happen, therefore paragraph 130-90(1)(a) will be satisfied.

Paragraph 130-90(1)(b)

Section 995 defines a share to mean a share in the capital of a company. An ordinary share in Company A held by the Trustee of the EST and to which a Participant is entitled to upon the exercising of a Performance Right is a share in the capital of Company A. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a share in Company A by the exercising of a Performance Right granted under the Company A Equity Plan.

Paragraph 130-90(1)(d)

Subsection 83A-20(1) of Subdivision 83A-B states:

This Subdivision applies to an *ESS interest if you acquire the interest under an *employee share scheme at a discount.

The term 'employee share scheme' is defined in subsection 83A-10(2). Subsection 83A-10(2) states:

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;….

in relation to the employees' employment.

For the purposes of subsection 83A-10(2), section 995 defines the term 'scheme' as follows:

scheme means:

(a) any *arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The Company A Equity Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest (i.e. a beneficial interest in a right to acquire a beneficial interest in a share of Company A), is provided to eligible employees in relation to their employment in Company A in accordance with the Trust Deed. The Performance Rights are issued under the Company A Equity Plan upon the payment of an exercise price. The exercise price will not exceed the share price paid by the EST to acquire those shares. Shares will be acquired by the EST under the Company A Equity Plan on behalf of employees, using contributions from Company A.

Accordingly, prima facie ,Subdivision 83A-B will apply to shares acquired under the Company A Equity Plan as pursuant to subsection 83A-20(1), the Company A shares will be acquired under an employee share scheme at a discount. It should be noted however that whether a Participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

Section 130-90(2)

As the Participant does not acquire the beneficial interest in a Company A share for more than its cost base in the hands of the EST at the time that CGT event E5 happens, subsection 130-90(2) will also have been satisfied.

Conclusion

Accordingly, section 130-90 operates to disregard any capital gain or loss made by the Trustee on any Company A share when a Participant becomes absolutely entitled to that share.

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