Edited version of your written advice

Authorisation Number: 1012807835598

Ruling

Subject: Employee share scheme

Question 1

Will the irretrievable cash contributions made by the Employer or any member of the Employer's Australian income tax consolidated group (the Group) to the Trustee to fund the acquisition of Employer shares by the Trust be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (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 the Employer shares (capital gains tax (CGT) event E5), or when the Trustee disposes of the shares to the employees (CGT event E7), be disregarded under section 130-90 of ITAA 1997 if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee?

Answer

Yes

This ruling applies for the following period(s)

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

The scheme commences on

30 June 2014

Relevant facts and circumstances

Background

The Employer is a listed Australian company.

The Employer has put in place a long term incentive plan (the Plan) for key employees of the business. This plan is governed by the Plan Rules.

Participants in the Plan are employees of the Employer.

This aspect of employee remuneration is considered to be crucial to rewarding and retaining key management personnel who are important to the Employer's long term success. It is a key part of the Employer's executive remuneration framework which aims to increase alignment of employee interests to shareholders' interests, drive improved business performance and attract, reward, retain and motivate key talent.

The Plan enables eligible executives to share in the growth of the Employer through a grant of Performance Rights. The Performance Rights are capable of being exercised into the Employer's ordinary shares following the satisfaction of certain vesting conditions over a three year period. Under the current offer, the Performance Rights will be subject to time-based vesting conditions and performance-based conditions or requirements.

The 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;

• subject to the terms attaching to the Performance Rights as determined by the Board and specified in an Invitation Letter, each Performance Right entitles the Participant to one fully paid ordinary share in the capital of the Employer (Share). If any of the terms specified in the Invitation Letter are inconsistent with the Plan Rules, then the Plan Rules will prevail;

• to participate in the Plan, the Eligible Employee must deliver an Application to the Employer in response to the Invitation Letter. If the Application is accepted, then the Eligible Employee becomes a Participant. No amount is payable by the Participant to participate in the Plan;

• once all conditions on the Performance Rights as determined by the Board and specified in the Invitation Letter have been satisfied, the Performance Rights vest and the Employer issues a Notification to the Participants, upon which the Performance Rights are automatically exercised. A Performance Right has a nil exercise price;

• a Performance Right will be automatically forfeited if a Participant becomes a Bad Leaver.

The Employee Incentive Trust

The Employer has established the Employee Incentive Trust (the Trust), a sole purpose trust to acquire Shares for Australian employees of the Employer and the Group entities pursuant to the Plan and the appointment of a trustee operate the Trust as Trustee (the Trustee). The establishment of the Trust for such a purpose is specifically allowable under the Plan Rules.

The Trustee is an independent third party specialising in the provision of trustee services to listed Australian groups for the operation of employee incentive plans through trusts.

The Trust will operate in accordance with 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 Trust. 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 Trust Deed and the Plan Rules.

The Trustee is not entitled to receive from the Trust any fees, commission or remuneration for operating or administering the Trust. The Employer must pay the Trustee from its own resources such fees, commission or other remuneration and may reimburse expenses incurred by the Trustee as the Employer and the Trustee agree from time to time. The Trustee is entitled to retain for its own benefit any such remuneration or reimbursement.

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

The Trust will operate as follows:

• the Trust will be funded by contributions from the Employer for the purchase of Shares in accordance with the Plan;

• these contributions will be used by the Trustee to acquire Shares either on-market or via a subscription for new Shares, based on written instructions from the Employer;

• 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 Trustee can sell Shares on behalf of a Participant where permitted to do so by the Participant;

• the Trustee will, in accordance with instructions received pursuant to the Plan Rules, subscribe for, purchase or allocate Shares for the benefit of Participants provided that the Trustee receives sufficient funds from the Employer to subscribe for or purchase such Shares and/or has sufficient unallocated Trust Shares available;

• the Trustee must establish and maintain a separate Trust Share Account or record in respect of each Participant;

• while Shares are held in trust, the Participant will be entitled to dividend and voting rights;

• all funds provided to the Trustee from the Employer will constitute accretions to the corpus of the trust and will not be repayable by the Trustee. The contributions will not be repaid to the Employer unless they are used to subscribe for Shares.

Contributions made by the Employer to the Trust

The Employer will make cash contributions equal to the fair market value of Shares that will be acquired for Participants. The Trust has and will use the cash contributions exclusively to purchase Shares for Participants under the Plan and, pending such an acquisition, form part of the Trust's Assets.

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.

The Trustee holds all Shares pursuant to the Plan on capital account.

Use of the Trust to facilitate the Plan

Offering equity to employees creates another administrative task for the Employer and involves a range of skills that the Employer staff do not have. The use of a trust by the Employer and in particular the outsourcing of these services to the Trustee is designed to solve these problems by outsourcing the operation of the Trust to those with the necessary skills.

The issuing of equity can also be dilutive to existing shareholders, meaning the Group would need flexibility to acquire Shares on market or issue new Shares to meet its obligations to employees under the Plan. The use of a trust by the Employer would address this challenge and assist the Employer in retaining flexibility. The use of a trust by the Employer also has the advantage of creating flexibility in terms of needing to seek shareholder, ASX and Australian Securities and Investment Commission approval, which are required when new Shares above a certain threshold are issued to the market.

Further, the ability for the Employer to acquire shares in itself on market is difficult given the general prohibition of companies holding shares in themselves. The Trust will allow Shares to be acquired at or before Performance Rights vest and be held without breaching the rules relating to a company holding shares in itself.

Finally, the existence of a third party trustee, together with the Employer's share trading restriction policy assists the Employer to show shareholders and the market that share trades by employees do not occur with insider or inappropriate knowledge.

In conclusion, the use of a trust to operate the necessary employee incentive plan achieves a number of commercial objectives and addresses the challenges previously identified.

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 section 6-10

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

Income Tax Assessment Act 1997 Section 10-5

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

Income Tax Assessment Act 1997 paragraph130-85(4)(b)

Income Tax Assessment Act 1997 paragraph130-85(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 paragraph 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 stated.

Question 1

Summary

The irretrievable cash contributions made by the Employer or any member of the Group to fund the acquisition of Shares by the Trust will not be assessable income of the Trust 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 cash contributions made by the Employer to the Trust are unlike those provisions listed in section 10-5. Therefore irretrievable cash contributions made by the Employer to the Trust 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.

Pursuant to the Trust Deed, all contributions by the Employer to the Trust for the purposes of acquiring Shares constitute accretions to the corpus of the Trust. Furthermore, the Trust Deed also provides that the Trustee must, when directed by the Board, acquire Shares on behalf of the Participants and use the contributions made by the Employer to do so.

The general powers granted to the Trustee under the Trust Deed require that these powers must be exercised only for the purposes of the Trust and only to give effect to the Plan which the Trust supports. To this end, the contributions received from the Employer must, therefore, be used for the sole purpose of enabling the Trustee to acquire Shares in accordance with the terms of the Trust Deed and the Plan Rules.

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

Therefore, the irretrievable cash contributions made by the Employer to the Trustee to fund the subscription for or acquisition of Shares by the Trust in accordance with the Trust Deed will not be assessable income of the Trust 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 that the Trust Deed provides that the Employer may pay from its own resources any fees, commission or remuneration and reimburse any expenses incurred by the Trustee as the Employer and the Trustee may agree from time to time. The Trust Deed provides further that the Trustee is entitled to retain for its own benefit any such remuneration or reimbursement. Such receipts will be assessable income of the Trustee in contrast to the irretrievable cash contributions to acquire Shares.

Question 2

Summary

A capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to Shares (CGT event E5) or when the Trustee disposes of the Shares to the employees (CGT event E7) will be disregarded under section 130-90 if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee.

Detailed reasoning

Section 130-90

Section 130-90 operates to disregard any capital gain or capital loss made by an employee share trust or a beneficiary of the trust where the specified conditions in subsection 130-90(1) are satisfied.

The conditions in subsection 130-90(1) are that CGT event E5 or E7 happens in relation to a beneficial interest in a share and it was acquired by the beneficiary by exercising a right and 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.

However subsection 130-90(2) provides that subsection 130-90(1) will 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 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 are provided to employees in relation to their employment.

The Employer will establish the Trust to facilitate the Plan by acquiring 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 Shares is itself provided under an employee share scheme because it is provided under the same scheme under which the Performance Rights to acquire the 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 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 (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 provides 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).

The Trust Deed makes it clear that the Trustee can only use the contributions received from the Employer for the acquisition of Shares for Participants in accordance with the 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 Shares to be acquired for Participants of the Plan.

Accordingly, paragraph 130-85(4)(c) is also satisfied because the Trust 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 Trust is an employee share trust, as defined in subsection 995-1(1), as the activities of the Trust 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 Plan, where a Participant becomes absolutely entitled to 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 Plan at the time when the Participant becomes absolutely entitled to the Shares 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:

If you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), this Part and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

The Participant, on allocation of the Shares by the Trustee, becomes absolutely entitled to those Shares. In accordance with the Trust Deed each Participant is absolutely entitled to any Allocated Shares held by the Trustee on their behalf, and is entitled to the same rights in those shares as if he or she was the legal owner of the shares.

Once the Participants are absolutely entitled to the Shares held on their behalf by the Trust, section 106-50 will deem the disposal of them by the Trustee to be done by the Participants.

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

Paragraph 130-90(1)(b)

Subsection 995-1(1) defines a share to mean a share in the capital of a company. A Share held by the Trustee of the Trust and to which a Participant is entitled to upon the exercising of a Performance Right is a share in the capital of the Employer. 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 by the exercising of a Performance Right granted under the 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 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), is provided to Participants in relation to their employment in the Employer or any member of the Group in accordance with the Trust Deed. The Performance Rights are issued under the Plan at no exercise price. The exercise price will not exceed the share price paid by the Trust to acquire those Shares. Shares will be acquired by the Trust under the Plan on behalf of employees, using contributions from the Employer.

Accordingly, prima facie, Subdivision 83A-B will apply to Performance Rights acquired under the Plan as pursuant to subsection 83A-20(1), the ESS interest (i.e. Performance Rights issued under the Plan) 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 Share for more than its cost base in the hands of the Trust 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 the Shares.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

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