Edited version of your written advice

Authorisation Number: 1013069822785

Date of advice: 29 August 2016

Ruling

Subject: Employee Share Scheme

Question 1

Will Company A as head entity of the Company A tax consolidated group obtain an income tax deduction, pursuant to section 8-1 of the ITAA 1997 in respect of the irretrievable cash contributions made by Company A or any subsidiary member of the Company A tax consolidated group to the Trustee to fund the subscription for or acquisition on-market of Company A shares by the Trust?

Answer

Yes

Question 2

Will Company A as head entity of the Company A tax consolidated group obtain an income tax deduction, pursuant to section 8-1 of the ITAA 1997, in respect of cost incurred by Company A or any subsidiary member of the Company A tax consolidated group in relation to the implementation and on-going administration of the Trust?

Answer

Yes

Question 3

Will irretrievable cash contribution made by Company A or any subsidiary member of the Company A tax consolidated group to the Trustee, to fund the subscription for or acquisition on-market of Company A shares by the Trust, be deductible by Company A at a time determined by section 83A-210 of the ITAA 1997?

Answer

Yes

Question 4

If the Trust satisfies its obligation under the Performance Rights Plan (PRP) by subscribing for new shares in Company A, will the subscription proceeds be included in the assessable income of Company A under section 6-5 or 20-20 of the ITAA 1997 or trigger a capital gain tax (CGT) event under Division 104 of the ITAA 1997?

Answer

No

Question 5

Will the Commissioner seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part of full, any deduction claimed by Company A as head entity of the tax consolidated group in respect of the irretrievable cash contribution made by Company A or any subsidiary member of the Company A tax consolidated group to the Trustee to fund the subscription for or acquisition on-market of Company A shares by the Trust?

Answer

No

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

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Question 6

Will the provision of Performance Rights by Company A to employees of Company A under the Performance Rights Plan be a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No

Question 7

Will the irretrievable cash contribution made by Company A or any subsidiary of Company A to the Trustee, to fund the subscription for or acquisition on-market of Company A shares, be treated as a fringe benefit within the meaning of section 136(1) of the FBTAA?

Answer

No

Question 8

Will the Commissioner seek to make a determination that section 67 of the FBTAA applies to increase the fringe benefits taxable amount to Company A or any subsidiary of Company A by the amount of tax benefit gained from irretrievable cash contribution made by Company A to the Trustee, to fund the subscription for or acquisition on-market of Company A shares?

Answer

No

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

Year ending 31 March 2017

Year ending 31 March 2018

Year ending 31 March 2019

Year ending 31 March 2020

Year ending 31 March 2021

Year ending 31 March 2022

Year ending 31 March 2023

Relevant facts and circumstances

Company A is an Australian company.

Company A's stated purpose in establishing and funding its PRP is to maintain a productive and motivated work environment including:

• to act as a key retention tool, and

• to focus attention on future Shareholder value generation.

Company A's overall remuneration strategy adopts the use of fixed remuneration, short term incentives (such as cash bonuses) and long term incentives such as the PRP.

Performance Rights Plans

The PRP is governed by Company A's Performance Rights Plans Rules (PRPR).

Company A PRP under the PRPR

The PRP is governed by the PRPR, they operate as follows:

• Eligible Participants are issued Invitations by the Board to apply for up to a specified number of Performance Rights, which vest according to performance criteria (also referred to as "Vesting Conditions"). The Performance Rights will be issued to Participants for nil consideration.

• Amongst other things, the Invitation will outline the maximum number of Performance Rights offered that the Eligible Participant may apply for, the maximum number of Shares that the Participant is entitled to be issued on the exercise of each Performance Right, whether the exercise on Vesting is automatic or manual and the applicable Vesting Conditions.

• Once the Eligible Participant has received the Invitation, the Eligible Participant or a Nominee may apply for Performance Rights described in that Invitation, in accordance with the instructions accompanying the Invitation. The Board may accept or reject any application in its absolute discretion.

• Once the Board has received and accepted a duly signed application form for Performance Rights, the Company must promptly grant Performance Rights to the applicant.

• The satisfaction of the Vesting Conditions shall determine the proportion of Performance Rights which vest and become exercisable to the Participant.

• Once exercised, Company A must issue to the Participant or instruct the Trustee to subscribe for, acquire and/or allocate for the benefit of the Participant the number of shares.

• The Trustee will hold the shares that were subscribed for and/or acquired on-market in accordance with the terms of the Trust Deed.

• The Performance Rights will vest at the end of the performance period, subject to the satisfaction of all or some of the PRPR.

• Once allotted, the Shares will be held in the Trust on behalf of the Participant subject to conditions as specified in the Plan Rules.

Company A's PRP

The PRP is a key part of Company A's remuneration framework for key management personnel.

As set out in the PRPR the purpose of the PRP is to:

(a) assist in the reward, retention and motivation of Eligible Participants

(b) link the reward of Eligible Participants to performance and the creation of Shareholder value

(c) align the interests of Eligible Participants more closely with the interests of Shareholders by providing an opportunity for Eligible Participants to receive Shares

(d) provide Eligible Participants with the opportunity to share in any future growth in value of the Company, and

(e) provide greater incentive for Eligible Participants to focus on the Company's longer term goals.

Participants in the PRP are Directors and key management personnel of the Company A Employer Entities.

The grant of Performance Rights does not automatically entitle a Participant to a Share. The actual number of Shares to which the Participant may become entitled will depend on:

• the degree to which the PRP performance measures are satisfied over the PRP performance period

• the satisfaction of one or more of the Vesting Conditions (as determined by the Board), during the relevant performance period, and

• the operation of the PRPR.

Company A Employee Share Trust

The Trust will be set up for the sole purpose of obtaining shares for the benefit of employees of Company A.

The Trust operates as follows:

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

• The Trust will be funded by contributions from Company A's Employer Entities

• These funds will be used by the Trustee of the Trust to acquire the shares in Company A either on-market or via a subscription for new shares in Company A.

The Trustee is an external trustee acting in an independent capacity on behalf of the beneficiaries of the Trust.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 section 67

Fringe Benefits Tax Assessment Act 1986 subsection 67(1)

Fringe Benefits Tax Assessment Act 1986 subsection 67(2)

Fringe Benefits Tax Assessment Act 1986 section 66

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(h)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(ha)

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1997 section 6-5

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 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 section 20-20

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

Income Tax Assessment Act 1997 section 83A-10

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

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

Income Tax Assessment Act 1997 section 83A-210

Income Tax Assessment Act 1997 subparagraph 83A-210(a)(i).

Income Tax Assessment Act 1997 section 83A-340

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 paragraph 104-35(5)(c)

Income Tax Assessment Act 1997 paragraph 104-155(5)(c)

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

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

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

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

Income Tax Assessment Act 1997 subsection 995-1

Income Tax assessment Act 1997 section 974-75

Reasons for decision

Note: All subsequent legislative references are to the ITAA 1997 unless specified otherwise.

Question 1

Summary

The irretrievable Contributions Company A makes to the employee share trust (EST), to acquire Shares, whether by on-market purchase or subscription, are allowable deductions under section

8-1.

Detailed reasoning

Section 8-1 states:

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your *exempt income or your *non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

(3) A loss or outgoing that you can deduct under this section is called a general deduction.

Loss or Outgoing Incurred

To qualify for a deduction under section 8-1 a contribution to the trustee of an employee share trust (EST) must be incurred.

As a broad guide, 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 EST is incurred only when the ownership of that contribution passes from an employer to the trustee of the EST and there is no circumstance in which the employer can retrieve any of the contribution - Pridecraft Pty Ltd v. Federal Commissioner of Taxation [2004] FCAFC 339; 2005 ATC 4001 (Pridecraft); Spotlight Stores Pty Ltd v. Commissioner of Taxation [2004] FCA 650 2004 ATC 4674; 55 ATR 745 (Spotlight).

Application to the facts

The Trust Deed provides that:

(a) subject to clause A the Company must provide the Trustee, or cause the provision to the Trustee, of any funds required by the Trustee (after application by the Trustee of any capital as provided by B in order to comply with its obligations under clause C.

(b) all funds provided to the Trustee under clause A:

(i) will constitute accretions to the corpus of the Trust and will not be repayable by the Trustee; and

(ii) may be paid to the Company as consideration for the subscription for Shares provided such Shares are held under the terms of this Deed.

(c) if the Trustee acting reasonably and in good faith considers the terms of any funding under this clause A would materially prejudice the ability of the Trustee (in its capacity as trustee of the Trust) to meet its debts as and when they fall due, the Trustee is entitled to refuse such funding and the relevant Dealing Notice will be invalid to the extent that the requisite dealings in Shares cannot be satisfactorily funded.

The terms of the Trust Deed provide clear evidence of the irretrievable and non-refundable nature of the employer contributions to the Trust in that they must be provided by Company A to the Trust which must use them exclusively to purchase shares in Company A for participants and, pending such an acquisition, form part of the assets of the Trust. On this basis, the contributions will be incurred at the time that they are made to the Trust in accordance with the Trust Deed and the PRPR.

Therefore, under the terms of the Trust Deed contributions made to the Trustee of the EST by Company A will be irretrievable and will therefore be considered a loss or outgoing incurred by Company A for the purpose of subsection 8-1(1).

Necessarily incurred in carrying on a business

In order to satisfy the second limb of section 8-1 there must be a relevant 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' (Ronpibon Tin NL and Tongkah Compound NL v. FC of T (1949) 78 CLR 47 at 55-58; [1949] HCA 15 at [9]-[15] (Ronpibon); Magna Alloys & Research Pty Ltd v. Federal Commission of Taxation [1980] FCA 150; 80 ATC 4542 at 4559-4561; (1980) 11 ATR 276 at 294-297 (Magna Alloys)).

Draft Taxation Ruling TR 2014/D1 Income tax: employee remuneration trust arrangements (TR 2014/D1) 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 (ERT).

The way in which the EST has been established and operates is in line with the elements of an ERT to which TR 2014/D1 applies.

Paragraph 14 of TR 2014/D1 provides 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 EST

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

then, such a contribution would ordinarily 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 rights to acquire shares) in the employer or in its subsidiaries to which Subdivision 83A-C applies, the statutory scheme is such that 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.

Application to the facts

It is considered that Company A is carrying on a business and when the Company or a member of the Group makes a contribution to the Trustee of the EST, its primary purpose is to enable Company A to meet its obligations arising from the grant of Performance Rights under PRP.

Therefore, the contributions made by Company A or a member of the Group to the Trustee of the EST are part of the overall employee remuneration costs of Company A. The benefits provided to employees under the PRP are designed to reward, retain and motivate employees and to provide them with the opportunity to share in any future growth in value of the Company.

Consequently, we consider that contributions made to Trustee of the EST by Company A or a member of the Company A Group for the purpose of remunerating its employees in the form of Shares under the PRP is an outgoing incurred in carrying on the Company's business for the purpose of gaining or producing assessable income.

Capital or revenue

Where a contribution satisfies either limb of subsection 8-1(1), it may still be capital or of a capital nature. Pursuant to subsection 8-1(2), the contributions will not be deductible under section 8-1 to the extent to which it is capital or of a capital nature.

In ATO Interpretative Decision ATO ID 2002/1074 Income Tax - deductibility - irretrievable employer contributions paid to the Trustee of its employee share scheme to acquire a share or right under the employee share scheme the view is expressed that a company will be entitled to a deduction for irretrievable contributions made to the trustee of its employee share scheme under section 8-1.

Whether an outgoing is capital or revenue in nature can generally be determined by reference to the test articulated by Dixon J in Sun Newspapers Ltd and Associated Newspapers Ltd. v. Federal Commissioner of Taxation(1938) 61 CLR 337:

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...

More recently in GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 21 ATR 1; 90 ATC 4413 the High Court pointed out that the character of expenditure is ordinarily determined by reference to the nature of the asset acquired and that the character of the advantage sought by the making of the expenditure is a critical factor in determining the character of what is paid.

In Spotlight Stores Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 745 and Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 58 ATR 210 it was determined that payments by an employer company to an employee share trust established for the purpose of providing incentive payments to employees were on revenue account and were not capital or of a capital nature.

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

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

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

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

In this regard, the draft taxation ruling TR 2014/D1 at paragraph 202 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.

For these purposes, the Commissioner considers that a relatively short period of time is up to 5 years, increased to 7 years where the benefit in question relates to an ESS (paragraph 178 of TR 2014/D1).

Where the primary purpose of the employer in making the contribution is to remunerate employees with a relatively short period 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 it is intended that:

• any direct interest in the employer acquired by the trustee of the employee share trust (for examples shares) will be transferred to employees within that relatively short period, and

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

Application to the facts

On weighing up the facts in this case we consider the capital structure advantage will only be small or trifling as:

• the operation of the EST and the PRPR of the schemes are such that Shares allocated to each employee will generally be transferred into the name of the relevant employee subject to any sale restriction that applies to such Shares

• Shares acquired by the Trustee on behalf of employees will be immediately allocated to employees who will become absolutely entitled to them at that point in time

• Shares are subject to Vesting Conditions

• Company A's PRP provides employee equity incentive plans to further align the interests of staff and shareholders, by employees earning significant rewards from the acquisition of equity in the company.

Therefore, apportionment for the capital structure advantage will not be required.

Conclusion

Accordingly, where irretrievable cash contributions are made by Company A or by a subsidiary member of the Company A Group to the Trustee of the EST to acquire Shares, whether by on-market purchase or subscription, are allowable deductions under section 8-1.

Question 2

Summary

Company A will obtain an income tax deduction, pursuant to section 8-1, in respect of the costs incurred by Company A or any subsidiary member of the Company A Group in relation to the implementation and on-going administration of the Trust.

Detailed reasoning

Company A will incur various costs in relation to the implementation and on-going administration of the Trust. For example, Company A will incur costs associated with the services provided by the Trustee of the EST, including but not limited to:

• employee plan record keeping

• production and dispatch of holding statements to employees

• provision of annual income tax return information for employees

• acquisition of shares and allocation to participants, and

• management of employee termination.

In addition to the services to be provided by the Trustee, Company A has incurred and will incur various costs, including the services provided by the company's accounting and legal advisors.

In accordance with the Trust Deed, the Trustee is not entitled to receive from the Trust any fees, commission or remuneration for operating or administering the Trust. Company A may pay to the Trustee fees, commission or remuneration and reimburse any expenses incurred and agreed upon from time to time. The Trustee is entitled to retain for its own benefit any such remuneration or reimbursement. Such costs are likely to include brokerage costs incurred by the Trustee of the EST (for example, where the Trustee is directed by Company A to acquire Shares on-market), as well as other Trustee expenses such and the annual audit of the financial statements of the EST.

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

• incurred in gaining or producing the assessable income of Company A, or

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

The costs incurred by Company A are deductible under section 8-1 consistent with ATO Interpretative Decision ATO ID 2014/42 Employer costs for the purpose of administering its employee share scheme are deductible in which it was decided that such costs are part of the ordinary employee remuneration costs of a taxpayer.

Consistent with the analysis in Question 1 (above), the costs are revenue and not capital in nature, on the basis that they are regular and recurrent employment expenses. The costs are therefore not excluded from being deductible under paragraph 8-1(2)(a). Accordingly Company A is entitled to an income tax deduction, pursuant to section 8-1, in respect of costs incurred in relation to the implementation and on-going administration of the Company A EST.

Question 3

Summary

A deduction for the irretrievable contribution under section 8-1 will generally be allowable in the income year in which Company A incurred the outgoing, the timing of which is pursuant to section 83A-210.

Detailed reasoning

The provision of money to the trustee of an EST by the employer for the purpose of remunerating its employees under an employee share scheme is an outgoing in carrying on the employer's business and is deductible under section 8-1.

The deduction under section 8-1 would generally be allowable in the income year in which the employer incurred the outgoing but under certain circumstances, the timing of the deduction is specifically determined under section 83A-210.

Section 83A-210 provides that if:

(a) at a particular time, you provide another entity with money or other property:

(i) under an arrangement; and

(ii) for the purpose 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 purpose of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time.

Section 83A-210 will only apply if there is a relevant connection between the irretrievable cash contribution (the money) provided to the trustee for the purpose of enabling an employee to acquire (directly or indirectly) an ESS interest under an ESS and the contributions are made before the income year in which the employee acquires the ESS interest.

Arrangement

The implementation of PRP, the establishment of the EST under the Trust Deed and the provision of money by Company A or the Group to the Trustee of the EST to acquire and hold Shares on behalf of Participants, are considered as constituting an arrangement for the purpose of subparagraph 83A-210(a)(i).

ESS interest

An ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

ESS

An ESS is a scheme under which ESS interest in a company (or subsidiaries of the company) are provided to employees of a company, or their associates, in relation to their employment (subsection 83A-10(2)).

Subsection 995-1(1) defines the term 'scheme' to include any arrangement, or any scheme, plan, proposal, action, course or action of course to conduct, whether unilateral or otherwise.

Under the PRP, the Shares granted to a Participant are an ESS interest as it is a right to acquire a beneficial interest in a share in Company A.

Relevant connection

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

If the irretrievable contributions are provided by the Group to the Trustee before the income year in which the relevant ESS interests are acquired by a Participant, then section 83A-210 will apply to determine the timing of a deduction for the irretrievable contributions under section 8-1. In this instance, the irretrievable contributions will only be deductible in the income year in which the relevant ESS interests (performance rights) are acquired by the Participants.

If the irretrievable contributions are provided in or after the income year in which the ESS interest is acquired by the Participant, section 83A-210 will not apply and the irretrievable contributions will be deductible under section 8-1 in the income year in which the expenses are incurred.

Question 4

Summary

The contributions by Company A to the EST will not result in Company A deriving income assessable under section 6-5 or 20-20 or trigger a CGT event under Division 104 at the time the contributions are made or at the time the shares are provided.

Detailed reasoning

Ordinary income

Section 6-5 provides that assessable income includes income according to ordinary concepts which is called ordinary income.

The definition of 'income' was considered by Jordan CJ in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 where his Honour said:

The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

A leading case on ordinary income is Eisner v Macomber 252 US 189 (1919). It was said in that case that:

The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being "derived" that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; …that is income derived from property. Nothing else answers the description.

In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. They further stated at page 138 that:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

Periodicity, recurrence and regularity are regarded the most visible indicators of ordinary income. As a more general rule, amounts received as a result of carrying on a business should also represent ordinary income. Importantly, however, receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

The decision in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (Sun Newspapers) is a leading authority on the distinction between revenue and capital expenditure, where his Honour said at 363:

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 to cover its use or enjoyment for periods commensurate  with the payment or by making a final provision or payment so as to secure future use or enjoyment. 

Application to the facts

In accordance with the Trust Deed, the irretrievable cash contributions will be used by the Trustee of the Trust to acquire the shares in Company A either on-market or via a subscription for new shares in Company A, based on the written instructions from Company A.

The character of the contributions for share subscription to the Trustee of the EST can be determined by the character of the right or thing or thing disposed of in exchange for the receipt. Here the Company is issuing the Trustee with new Shares in itself. The character of the newly issued Shares is one of capital. Therefore, it can be concluded that the receipt, being the subscription proceeds, take the character of share capital, and accordingly, is also of a capital nature.

Accordingly, when Company A receives subscription proceeds from the Trustee of the EST for new Shares in Company A to satisfy obligations to the Participants under the PRP, the subscription proceeds received are a capital receipt and therefore not ordinary income under section 6-5.

Section 20-20 Assessable recoupments

Under Subdivision 20-A, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

Specifically, under subsection 20-20(2), an amount you have received as recoupment of a loss or outgoing is an assessable recoupment if:

(a) you received the amount by way of insurance or indemnity; and

(b) you can deduct an amount for the loss or outgoing for the *current year, or you have deducted or can deduct an amount for the loss or outgoing for an earlier income year under any provision of this Act.

Application to the facts

The subscription proceeds received by Company A from the Trustee of the EST are for the issuing of new Shares in accordance with the PRP. The character of the subscriptions paid to Company A for Shares is not one of insurance, indemnity or other recoupment of a previously deducted loss or outgoing.

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

Capital gains tax

Section 102-20 states that you make a capital gain or loss if, and only if, a CGT event happens. The relevant CGT events that may be applicable when the subscription proceeds are received by Company A are CGT events D1 (creating a contractual or other rights) and H2 (receipt for event relating to a CGT asset).

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

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

Application to the facts

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

Therefore, when the Trustee of the EST satisfies the obligations under the Performance Rights Plan by subscribing for new Shares in Company A, the subscription proceeds will not constitute the assessable income of Company A under section 6-5 or section 20-20, nor trigger a CGT event under Division 104.

Question 5

Summary

The Commissioner will not seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Company A as head entity of the tax consolidated group in respect of the irretrievable cash contribution made by Company A or any subsidiary member of the Company A tax consolidated group to the Trustee to fund the subscription for or acquisition on-market of Company A shares by the Trust.

Detailed reasoning

Law Administration Practice Statement (draft) Application of General Anti-Avoidance Rules (PS LA 2005/24 (draft)) deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936. Before the Commissioner can exercise his discretion to make a determination in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met:

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

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

3. having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose).

On the basis of an analysis of these three requirements, the Commissioner will not seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or in full, any deduction claimed by Company A for the irretrievable contributions made by Company A or any subsidiary member of the Company A tax consolidated group to the Trustee to fund the subscription for, or acquisition on-market of, Company A shares by the EST.

Question 6

Summary

The provision of Performance Rights by Company A to employees of Company A under the PRP will not be treated as a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA).

Detailed reasoning

An employer's liability to fringe benefit tax (FBT) arises under section 66 of the FBTAA which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer for the relevant year of tax. The fringe benefits taxable amount is calculated under the FBTAA by reference to the taxable value of each fringe benefit provided.

No amount will be subject to FBT unless a fringe benefit is provided.

In general terms, 'fringe benefit' is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee by the employer or an associate of the employer in respect of the employment of the employee.

However, certain benefits are excluded from being a fringe benefit by virtue of paragraphs (f) to (s) of the 'fringe benefit' definition.

The provision of Performance Rights

Paragraph (h) of the definition of 'fringe benefit' states that a fringe benefit does not include:

(a) 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 83AB or 83AC of that Act applies.

Subsection 83A-10(1) defines an ESS interest as:

(a) a share in the company

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

Subsection 83A - 10(2) defines an ESS as:

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.

Company A has stated that it will grant ESS interest to participants under the PRP. These ESS interests offered to participants are offered at discount (as there is no consideration paid for them) and in connection with the participants employment.

It is therefore accepted that the PRP described in this private ruling comprise employee share schemes and incorporates the use of trust that is employee share trust within the meaning of subsection 130-85(4).

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

The provision of shares upon exercise of Performance Rights

As stated above, in general terms, 'fringe benefit' is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee 'in respect of' the employment of the employee.

The meaning of the phrase 'in respect of' was considered by the Full Federal Court in J & G Knowles & Associates Pty Ltd v Federal Commissioner of Taxation (2000) 96 FCR 402. The court at page 410 said:

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, casual connection or relationship between the benefit and the employment.

The situation is similar to that which existed in Federal Commissioner of Taxation v McArdle (1988) 19 ATR 1901 where an employee was granted valuable rights in respect of his employment which he subsequently surrendered in return for a lump sum payment. The full Federal 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.

When an employee is granted a Performance Right under the PRP, they obtain a right to acquire a beneficial interest in a share in Company A. It is this right that constitutes an ESS interest. When this right is subsequently exercised, any benefit received, that is, the beneficial interest is shares, would be in respect of the exercise of the right, and not in respect of employment.

Therefore, the benefit that arises to an employee after the exercise of Performance Rights, being the beneficial interest in a share, does not give rise to a fringe benefit as no benefit has been provided in respect of the employment of the employee.

Question 7

Summary

The irretrievable cash contributions made by Company A Group to The Trustee of the EST Trust to fund the subscription for or acquisition on-market of Company A shares will not constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

Detailed reasoning

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

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);

Employee Share Trust

An employee share trust is defined in subsection 995-1(1) as having the meaning given by subsection 130-85(4). Subsection 130-85(4) states:

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

(iii) other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b).

An ESS is defined in subsection 83A-10(2) as a scheme to 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.

Once the Board of Company A resolves to convert the performance rights to shares, section 83A-340 applies and the rights are treated as having been ESS interests from the time the performance rights were granted to the employees.

Thus the PRP is an employee share scheme within the meaning of subsection 83A-10(2) because it is a scheme under which performance rights and ultimately shares are provided to eligible employees in relation to the employee's employment.

Under the PRP, Company A has established the Trust for the sole purpose of the Trustee acquiring shares in Company A and allocating those shares to employees. Therefore, paragraphs 130-85(4)(a) and (b) are satisfied because:

• the Trust acquires shares in Company A, and

• the Trust ensures that the ESS interest, being beneficial interest in Company A shares is provided under an ESS by allocating those shares to the employees in accordance with the Trust Deed and relevant PRR.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and (b) will also require that the Trustee undertake incidental activities that are a function of managing the employee share plan and administering the Trust.

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 explains that the activities which are considered to be merely incidental (in accordance with paragraph 130-85(4)(c)) include:

• the opening and operating 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 an 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 purpose of the employee share scheme

• the transfer of shares to employee beneficiaries or the sale of shares on behalf of an employee beneficiaries 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.

The provision of the PRP Rules and Trust Deed collectively make it clear that the Trustee can only use the contributions for the acquisition of shares for eligible employees in accordance with the PRPR. In addition, the Trust Deed states that the Trust will be managed and administered to that it satisfies the definition of "employee share trust' for the purposes of subsection 130-85(4).

Therefore, the Trust is an employee share trust as the activities of the trust involve acquiring shares and allocating beneficial interest in those shares to employees. Its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c). As such, paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes the contributions to the Trustee to fund the acquisition of Company A shares from being a fringe benefit.

Question 8

Summary

The benefits provided to the trustee by way of irretrievable contributions to the EST and to eligible employees by way of the provision of share rights and shares under the company's ESS are excluded from the definition of a fringe benefit.

Detailed Reasoning

Section 67 of the FBTAA is the general anti-avoidance provision in the FBTAA. The operation of section 67 of the FBTAA is comparable to Part IVA of the ITAA 1936 as it requires identification of an arrangement, a tax benefit obtained by the employer that was the sole or dominant purpose for a person entering into the arrangement and it is activated by the making of a determination by the Commissioner.

PS LA 2005/24 (draft) provides guidance on the application of section 67 of the FBTAA. Paragraphs 174 to 177 state:

174. Section 67 is the general anti-avoidance provision in the FBTAA. The operation of section 67 is comparable to Part IVA, in that the section requires the identification of an arrangement and a tax benefit, includes a sole or dominant purpose test and is activated by the making of a determination by the Commissioner. The definition of 'arrangement' in subsection 136(1) of the FBTAA is virtually identical to the definition of 'scheme' in section 177A of Part IVA.

175. Subsection 67(1) of the FBTAA is satisfied where a person or one of the persons who entered into or carried out an arrangement or part of an arrangement under which a benefit is or was provided to a person, did so for the sole or dominant purpose of enabling an eligible employer or the eligible employer and another employer(s) to obtain a tax benefit.

176. An objective review of the transaction and the surrounding circumstances should be undertaken in determining a person's sole or dominant purpose in carrying out the arrangement or part of the arrangement. Section 67 of the FBTAA differs from subsection 177D(2) in Part IVA in that it does not explicitly list the factors that should be taken into account in determining a person's sole or dominant purpose.

177. Subsection 67(2) of the FBTAA provides that a tax benefit arises in respect of a year of tax in connection with an arrangement if under the arrangement:

(i) a benefit is provided to a person;

(ii) an amount is not included in the aggregate fringe benefits amount of the employer; and

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

The Commissioner will only make a determination under section 67 of the FBTAA if the arrangement resulted in the payments of less fringe benefit tax than would be payable but for entering into the arrangement.

PS LA 2005/24 (draft) provides instructions and practical guidance to tax officers on the application of Part IVA and other General Anti Avoidance rules. Paragraph 180 of PS LA 2005/24 (draft) states:

180. The approach outlined in this practice statement (refer to paragraphs 67 to 139) to the counterfactual and the sole or dominant purpose test in Part IVA is relevant (except that amendments corresponding to the 2013 amendments of Part IVA have not been made to section 67) and should be taken into account by Tax officers who are considering the application of section 67 of the FBTAA.

In the present case, the benefits provided to the Trustee by way of irretrievable contributions to the EST, and to Participants by way of the provision of Share Rights (and the Company A shares received on their vesting) under the Company A Performance Plan are excluded from the definition of a fringe benefit for the reasons give above in questions 6 and 7. As the benefits have been excluded from the definition of a fringe benefit tax liability is not any less than it would have been but for the arrangement.

Accordingly, the Commissioner will not make a determination that section 67 of the FBTAA to increase the aggregate fringe benefits amount of Company A by the mount of the tax benefit gained from the irretrievable cash contributions made by Company A to the Trustee of the EST to fund the subscription for, or acquisition on-market of shares in Company A.

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