Edited version of your written advice

Authorisation Number: 1051190876740

Date of Advice: 22 February 2017

Ruling

Subject: Employee share scheme

Question 1

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the irrevocable cash contributions made to the Trustee of the Employee Share Trust (Trust) to fund the subscription for, or acquisition of, shares in the taxpayer under the Employee Option Plan (Plan)?

Answer

Yes.

Question 2

Will the irrevocable contributions made by the taxpayer to the Trustee of the Trust to fund the subscription for, or acquisition of, shares in the taxpayer under the Plan be deductible at a time determined by section 83A-210 of the ITAA 1997 if the contributions are made before the acquisition of the ESS interests?

Answer

Yes. The timing of the deduction will only be established once the taxpayer has determined that the Options will be satisfied with Shares. At that time, contributions can be matched to ESS interests that have been issued to employees or their nominees and where necessary the relevant earlier income year assessments can be amended to allow the deduction.

Question 3

Is the taxpayer entitled to a deduction under section 8-1 of the ITAA 1997 for the costs incurred, other than those which are capital in nature, in relation to the implementation and on-going administration of the Trust?

Answer

Yes.

Question 4

Will the irrevocable cash contributions made by the taxpayer to fund the subscription for, or acquisition of their shares by the Trustee of the Trust constitute a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No.

Question 5

Will the provision of ESS interests to the taxpayer's employees under the Plan constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

Question 6

Will the Commissioner of Taxation make a determination that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to deny, in part or in full, a deduction claimed by the taxpayer for the irrevocable cash contribution it makes to fund the subscription for, or acquisition of, its shares by the Trustee of the Trust?

Answer

No.

Question 7

Is the Trust an employee share trust as defined in subsection 130-85(4) of the (ITAA 1997)?

Answer

Yes.

Question 8

Does Division 7A of Part III of the (ITAA 1936) apply to deem as a dividend the irrevocable cash contributions made by the taxpayer to the Trustee to fund the subscription for, or acquisition of, its shares to enable the Trustee to provide those shares to employees under the terms of the Plan?

Answer

No

This ruling applies for the following periods:

In relation to income tax related issues:

Year ended 30 June 2017;

Year ended 30 June 2018 and

Year ended 30 June 2019

In relation to Fringe benefits tax related issues:

Year ended 31 March 2017,

Year ended 31 March 2018,

Year ended 31 March 2019 and

Year ended 31 March 2020

The scheme commences on:

01 July 2016

Relevant Facts and Circumstances

The taxpayer is an Australian private company. It has one class of shares on issue, namely ordinary shares.

The taxpayer is not involved predominantly in the business of acquiring, selling or holding shares, securities or other investments.

The taxpayer has established an Employee Option Plan (Plan) for eligible employees (the Participants) who permanently work and live in Australia. The stated purpose of the Plan is to attract, retain, motivate and reward high performing employees and to align the interests of those employees.

The Employee Share Option Plan

The Plan provides long term incentive awards to the Participants in the form of an option (Option) to subscribe for a fully paid ordinary share in the taxpayer (Share) under the terms of the Plan Rules and Invitation.

The vesting of Options is subject to performance hurdles and a performance period. Where the vesting conditions are satisfied, the awards will vest. Currently, the performance periods during which the vesting conditions must be satisfied range from 1 to 3 years.

The definitions in the Plan Rules include the following:

Exercise Condition means in respect of an Option, any condition set out in the Invitation which must be satisfied before that Option can be exercised or any other restriction on exercise of that Option specified in the Invitation or in these Rules.

Expiry Date means, in respect of an Option, the date outlined in the Invitation letter to each Eligible Participant.

Participant means an Eligible Participant to whom Options have been granted under the Plan.

Nominee means:

a corporation (as defined in the Corporations Act) which is nominated by an Eligible Participant to hold an Option or a Share which may be issued pursuant to the exercise of the Option, in place of the Eligible Participant pursuant to the terms of the Plan provided however, that the Eligible Participant:

controls, either alone or jointly, the composition of the board and exercises and continues to exercise all management powers, of the nominee corporation, and is at all times able to cast sufficient votes to enable the board to pass an ordinary or special resolution in all board meetings of the nominee corporation;

alone holds more than 50% of the total issued share capital of the nominee corporation, and is at all times able to cast sufficient votes to enable them to pass an ordinary or special resolution in all general meetings of the nominee corporation,

or

a trustee of a trust which is nominated by an Eligible Participant to hold an Option, or a Share which may be issued pursuant to the exercise of the Option, either by the Eligible Participant as trustee or in place of the Eligible Participant pursuant to the terms of the Plan provided however, that:

the Eligible Participant is a beneficiary of the trust either alone or jointly with members of the Eligible Participant's immediate family, or in the case of a trust other than a discretionary trust, the Eligible Participant is a beneficiary who holds more than 50% of the value of the interest in the trust; and

the Eligible Participant has the capacity to exercise control (as defined in the Corporations Act) over the trust, whether through their capacity as trustee, appointor, principal or guardian, or otherwise having the power or ability to exercise control over the trustee or the trust in another manner or having the power or ability to amend or vary the terms of the trust deed.

Pursuant to the Plan Rules, the Board of the taxpayer may extend an Invitation for participation in the Plan to employees or officers or directors of the taxpayer to participate in the Plan (Invitation). The Invitation may impose conditions on the right of a Participant to exercise any Option granted. Options issued under the Plan will be issued for no consideration.

The Plan Rules provides that the Board may determine the price at which the option can be exercised in respect of any proposed Invitation, including nil and at a premium.

The Plan Rules provides that a Participant will be entitled to exercise Options in respect of which all Exercise Conditions are satisfied and which are otherwise capable of exercise in accordance with the terms of the relevant Invitation and Plan Rules. Options may be exercised at any time up to close of business on the last Business Day before the Expiry Date. Participant's options will lapse where the Exercise Conditions are unable to be met. Where the Exercise Conditions are met Options will lapse when the Expiry Date has passed.

The Plan Rules states that an Eligible Participant may, subject to the Rules, nominate a Nominee to hold options and Shares issued pursuant to the exercise of such Options, on the Participants' behalf.

For Bad Leavers, all vested and unvested Options held at the date they cease employment will automatically lapse. For Good Leavers, Participants may exercise vested Options prior to the Expiry Date. The Board has discretion to allow Good Leavers to exercise unvested Options.

The grant of Options does not confer a right to vote or an entitlement to dividends until the option vests and has been exercised and the Share issued to the Participant. Vested Options may be transferred by the Participant to a third party at the discretion of the Board.

Options may be exercised by delivery of an Option Exercise Notice and the certificate for the Options to the taxpayer.

The taxpayer's default position is to settle its obligation with Shares. Where Participants are current employees, the board of directors considers that the objective of aligning the Participants' interest with the interests of the taxpayer so as to enhance the Participants' commitment to taxpayer's long term goals is best met by allocating Shares to Participants.

The taxpayer has established the Employee Share Trust (Trust) by the Employee Share Trust Deed (Deed) to facilitate the allocation of Shares to Participants. Under the terms of the Deed, the taxpayer will direct the Trustee of the Trust to subscribe for, or purchase, Shares to be allocated to Participants on exercise of the Options in accordance with the Plan Rules.

The taxpayer will make irrevocable cash contributions to the Trust for the purpose of acquiring shares in order to satisfy its obligations under the Plan when Options are exercised. The irrevocable contributions will be made at the time the taxpayer directs the Trustee to purchase the Shares, which may be in advance of the time that the Participant exercises the Options. The amount of the contribution will correspond closely with the amounts needed to fund the acquisition of Shares to satisfy the Options and is likely to be applied within 3 years from the vesting date.

If the Options are settled in cash, the cash payment will be made by the taxpayer, not via the Trust.

Where the Participant chooses to exercise their Options by way of the Cashless Exercise Facility as permitted under the Plan Rules, the Cashless Exercise Facility will not be managed by the Trustee on behalf of the taxpayer. The taxpayer will direct the Trustee to provide the reduced number of Shares to the relevant Participant in these circumstances.

The taxpayer's stated reasons for implementing and administering the Plan via a trust include:

Employee share trusts are common commercial vehicles, which have been used by taxpayers for many years to provide remuneration benefits to employees. Their usage is wide spread among both public and private companies in Australia and overseas, and they provide significant commercial benefit to taxpayers.

From a commercial and governance perspective, an employee share trust provides the board of directors of the taxpayer with flexibility to satisfy its obligations under the Plan by purchasing shares from existing shareholders or alternatively, through the fresh issue of shares;

Using a single vehicle assists with consolidation of administration and reduces administration costs as the employee share trust structure can be employed for all of the employee long-term incentive arrangements.

Using an employee share trust with an independent trustee acquiring shares in accordance with a settled trust deed allows a company to meet its obligations under the Corporations Act 2001(Cth) regarding not dealing in its own shares and to manage its obligations in respect of Australian financial service and licensing requirements;

An employee share trust provides a useful means of enforcing time-related vesting and performance conditions or disposal restrictions which may be attached to the securities granted under the Plan;

An employee share trust can enable a trustee to recycles shares without increasing the percentage of ownership of other shareholders.

An employee share trust provides the taxpayer with capital management flexibility by allowing the taxpayer to decide whether the Trustee should purchase shares from another shareholder or subscribe for shares to satisfy the exercise of options by employees.

The Employee Share Trust Deed

The stated object of the Trust in the Deed is to facilitate the allocation of Shares to Participants upon the exercise of Options under the Plan for the benefit of the Participants as beneficiaries of the Trust.

The Trustee has agreed to act as the first trustee of the Trust and to receive funds from the taxpayer and apply the funds in accordance with the Trust Deed and to deal with any Shares held in the Trust as set out in the Deed.

Pursuant to clause 2 of the Deed, the Trustee declares that it will allocate the beneficial interest in Shares (Allocate Shares) to Participants as directed by the taxpayer and agrees to be bound by the Plan Rules to the extent that they are relevant to the Trustee.

The taxpayer agrees to pay all expenses, costs, fees and charges incurred in establishing and operating the Trust.

The Trust Deed provides that the taxpayer may issue Shares to the Trustee for the purposes of Allocating Shares to Participants under the Plan

The Trust Property consists of the amount of $10 paid by The taxpayer to the Trustee to establish the Trust and any Unallocated Shares, Shares acquired to be Allocated and any Entitlements relating thereto or money properly received in relation to the Shares. 'Entitlements' is defined as any rights accruing to, or in connection with, Shares.

The taxpayer has no proprietary right or interest, charge or lien in the Shares acquired by the Trustee in accordance with the Deed.

Subject to the Deed and terms of the Plan, the Trustee has the power to do all things a natural person is permitted to do by law in respect of the Trust Property.

The Trustee has the power to do anything necessary or convenient to carry out its functions under the Deed including:

To comply with directions of the taxpayer unless in conflict with Plan Rules or Invitation;

To acquire any Shares and sell any Shares the Trustee is authorised to sell under the Plan Rules, Invitation or Deed;

Operate bank accounts, make contracts, give receipts, and follow advice.

The Trust Deed provides for the Trustee's discretion in exercising its powers under the Deed subject to the Plan Rules and specific provisions of the Deed.

The limitations of the Trustee are outlined in the Trust Deed.

The Trustee is not entitled to receive any fees or charges in respect of its office (clause 6).

The Trust Deed provides for the Trustee to keep records and maintain accounts for Participants.

The taxpayer indemnifies the Trustee for liabilities incurred by the Trustee and claims made against the Trustee in connection with the performance of its functions under the Deed.

If the Trust terminates the Trustee must transfer any Unallocated Shares to Participants and make any other arrangements regarding the Shares that the taxpayer directs. Any residual amounts, property or Shares not dealt with must be applied to a provident, benefit or superannuation or retirement fund established or maintained by the taxpayer or in any other manner that would not result in the Trust ceasing to be an “Employee Share Trust” within the meaning of section 995-1 of the ITAA 1997.

This scheme description incorporates, and should be read with, the following documents:

The Plan Rules

The Invitation

The Deed.

Question 1

Are you entitled to a deduction under section 8-1 of the ITAA 1997 for the irrevocable cash contribution made to the Trust to fund the subscription for, or acquisition of, shares in you under the Plan?

Detailed reasoning

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

incurred in gaining or producing assessable income ('first limb') or

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

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

Contribution to the trustee of an employee share trust

To qualify for a deduction under section 8-1 of the ITAA 1997 a contribution to the trustee of an employee share trust 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 (TR 97/7) and Taxation Ruling TR 94/26 Income tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance (TR 94/26).

A contribution made to the trustee of an employee share trust is incurred only when the ownership of that contribution passes from an employer to the trustee of the employee share trust 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 (Pridecraft); Spotlight Stores Pty Ltd v. Commissioner of Taxation [2004] FCA 650 (Spotlight).

The taxpayer will establish the Trust under the terms of the Deed. The Trust's purpose is to acquire Shares for the benefit of employees and otherwise facilitating the operation and implementation of the Plan.

The taxpayer will make Irrevocable Contributions to the Trust to allow the Trustee to purchase Shares from third parties or Participants or to subscribe for new Shares to allow Options under the Plan to be satisfied. The definition of Irrevocable Contributions in the Deed makes it clear that the contributions to the Trustee are not repayable to the taxpayer and the taxpayer can make no claim for return of the contributions. The Deed does not otherwise confer on the taxpayer any interest in the Trust Property.

Therefore, it is considered the contributions made to the Trust by the taxpayer will be incurred at the time the contributions are made.

For the purpose of gaining or producing assessable income

Further, to be deductible under section 8-1 of the ITAA 1997, a contribution must have been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

In order to satisfy the second limb of section 8-1 of the ITAA 1997, 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 (Ronpibon); Magna Alloys and Research Pty Ltd v. Federal Commission of Taxation (1980) 49 FLR 183 (Magna Alloys)).

Draft Taxation Ruing 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 Trust has been established and operates is in line with the elements of an ERT stated in paragraph 9 of TR 2014/D1.

Paragraph 14 of TR 2014/D1 provides 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 ERT, and

At the time the contribution is made, the primary purpose of the contribution is for it to be applied, within a relatively short period 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.

The taxpayer is carrying on a business and when the taxpayer makes a contribution to the Share Trust, its primary purpose is for the contribution to be applied to the acquisition of Shares to be held for, and allocated to, employees to satisfy the exercise of Options granted to the employees under the Plan as remuneration. The granting of the Options under the Plan, the provision of funds to the Trust and the acquisition and allocation of Shares by the Trustee are all interrelated components of an employee share scheme to which Division 83A of the ITAA 1997 applies and all must be carried out to allow the scheme to operate as intended and enable the direct provision of remuneration to the employees.

Therefore, the contributions to the Trust is an employee remuneration cost incurred in carrying on the business for the purpose of deriving assessable income and is deductible under section 8-1 of the ITAA 1997.

Not of a capital nature

Where a contribution satisfies either limb of subsection 8-1(1) of the ITAA 1997, it may still be capital or of a capital nature. Pursuant to subsection 8-1(2) of the ITAA 1997, the contribution will not be deductible to an employer under section 8-1 to the extent to which it is capital or of a capital nature.

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; [1938] HCA 73 (Sun Newspapers):

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...

As explained in paragraphs 186, 187 and 190 of TR 2014/D1, a contribution to the trustee of an employee share trust is of capital or of a capital nature, where the contribution secures for an employer an asset or advantage of an enduring or lasting nature that is independent of year to year benefits that the employer derives from a loyal and contented workforce. Where a contribution by an employer to the trustee of an employee share trust ultimately and is substance is used to subscribe for equity interests in the employer it is in whole or in part of a capital nature. The employer has obtained the advantage that flows from enlarging its own equity structure by the movement of value from profit to share capital. Where there are dual benefits to be obtained in making the contributions, apportionment may be required (paragraphs 191 to 197 of TR 2014/D1)

However, in TR 2014/D1 the Commissioner accepts that no part of the contribution should be apportioned to the obtaining of a capital advantage where the advantage is expected to be small or trifling compared to the benefit of remunerating employees within a relatively short period of time (paragraph 199) and that contributions made to facilitate an employee acquiring shares and/or rights to shares under an employee share scheme to which Subdivision 83A of the ITAA 1997 applies need to be considered within that statutory context.

As previously discussed, the contributions to be made to the Trustee by the taxpayer are to be used to acquire Shares to be held for, and allocated to, employees to satisfy the exercise of Options granted to the employees under the Plan as remuneration. All the components of the scheme operate together to achieve the intended purpose of attracting, motivating, rewarding and aligning the interests of employees with that of the taxpayer within the statutory scheme established under Division 83A. The amount of the contribution will correspond closely with the amounts needed to fund the acquisition of Shares to satisfy the Options and is likely to be applied within 3 years from the vesting date.

On weighing up the facts we consider that the contributions made by the taxpayer are not considered capital in nature, or any capital component is sufficiently small or trifling such that the Commissioner would not seek to apportion the deduction.

Accordingly, the irrevocable contributions made to the Trust to fund the subscription for, or acquisition of, Shares will be deductible under section 8-1 of the ITAA 1997.

Question 2

Will the irrevocable contributions made by you to the Trustee of the Trust to fund the subscription for, or acquisition of, shares in you under the Plan be deductible at a time determined by 83A-210 of the ITAA 1997 if the contributions are made before the acquisition of the ESS interests?

Detailed reasoning

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

Section 83A-210 provides that if:

At a particular time, you provide another entity with money or other property:

under an arrangement; and

for the purposes of enabling an individual (the ultimate beneficiary) to acquire, directly or indirectly, an ESS interest under an employee share scheme in relation to the ultimate beneficiary's employment (including past or prospective employment); and

That particular time occurs before the time (the acquisition time) the ultimate beneficiary acquires the ESS interest;

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

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

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

Section 83A-210 will only apply if there is a relevant connection between the money provided to the trustee of the EST, and the acquisition of ESS interests (directly or indirectly) by the employee under an employee share scheme.

Section 83A-340 provides for the application of Division 83A to indeterminate rights (e.g. rights under which the provider must provide you with either ESS interests or cash whichever the provider chooses). If you acquire a right which later becomes a right to a beneficial interest in a share, Division 83A applies as if the right had always been a right to shares.

Application to this case

Options acquired under the Plan are indeterminate rights for the purposes of section 83A-340. This is because the Options may (at the time of acquisition) be satisfied by either delivery of a share or payment of a cash equivalent and the determination of the payment type is at the discretion of the employer (Rule 7.2 of the Plan Rules). Such rights are not considered to be a right to acquire a beneficial interest in a share (i.e. an ESS interest for the purposes of Division 83A) unless and until the time when the proportion of the rights that will be satisfied by the provision of shares is determined. However, once this proportion is determined, section 83A-340 operates to treat these rights as though they had always been a right to acquire a beneficial interest in a share.

Under the Plan the granting of the Options, the provision of contributions to the Trustee and the acquisition, holding and allocation of Shares by the Trustee to the Participants are all interrelated components of the scheme. Consistent, with ATO Interpretative Decision ATO ID 2010/103 Income Tax Employee share scheme: timing of deduction from money provided to the trustee of an employee share trust, the provision of money to the trustee is considered to be for the purpose of enabling the employees to indirectly acquire the Options.

If the Options do subsequently become an ESS interest, then section 83A-340 operates to deem the Options to always have been an ESS interest. Where this occurs, section 83A-210 would apply (retrospectively) to modify the timing of the deduction claimed under section 8-1 where the taxpayer provides the irretrievable contribution to the Trustee before the employees acquired the Options.

Therefore, as long as contributions are provided to the Trustee after the Options are acquired, and the Options ultimately become ESS interests the deduction will be allowable in the year the contribution is made and section 83A-210 will not apply to modify the timing of the deduction for those Options that become rights to shares under section 83A-340 of the ITAA 1997.

However it is important to note that Options which are ultimately determined to be satisfied by the provision of cash will never become ESS interests and no amount of any contribution to the Trust would be allowable as a deduction in respect of the provision of those Options.

Consequently the amount of any contribution which is to be deductible in any particular year can only be determined with the hindsight attendant upon the knowledge that such Options have in fact become ESS interests. Once this has been established such contributions can be matched to ESS interests that have been issued to employees and where necessary the relevant earlier income year returns can be amended to allow the deduction. Item 28 of subsection 170(10AA) of the ITAA 1936 provides that nothing in section 170 of the ITAA 1936 prevents the amendment, at any time, of assessment for the purpose of giving effect to section 83A-340 of the ITAA 1997.

For example, where 100 options (satisfiable by shares or cash at the employer's discretion) are issued in Year One by the employer to participants and the employer immediately contributes to the trust $100 to acquire 100 shares to satisfy those options, then no entitlement to a deduction would arise until the number of those options which are to be satisfied by the provision of shares is determined.

If in Year Two it is determined that 50 of the Options are to be satisfied by the provision of shares and 50 by the provision of cash then the Year One return of the employer could be amended to include the deduction for the $50.

If in a subsequent year a further 50 Options are provided to participants then section 83A-210 would apply to allow the further $50 deduction in the income year in which those ESS interests were issued once it has been established that those Options have become ESS interests.

Question 3

Are you entitled to a deduction under section 8-1 of the ITAA 1997 for the costs you incur, other than those which are capital in nature, in relation to the implementation and on-going administration of the Trust?

Detailed reasoning

It is expected that the taxpayer will incur various costs in relation to the implementation and on-going administration of the Trust, including accounting and audit expenses, costs of complying with taxation obligations, ASIC fees and other ongoing administrative expenses.

The Deed provides that the company will pay all expenses, costs, fees and charges incurred in establishing and operating the Trust. Further, the taxpayer must indemnify the Trustee from all liabilities and claims connected with the performance of the functions of the Trustee under the Plan.

The costs incurred by the taxpayer in relation to the implementation and on-going administration of the Plan are deductible under section 8-1 of the ITAA 1997 as either:

Costs incurred in gaining or producing the assessable income of the taxpayer; or alternatively

Costs necessarily incurred in carrying on the taxpayer's business for the purpose of gaining or producing its assessable income.

This view is consistent with ATO Interpretative Decision ATO ID 2014/42 Income Tax: Income: 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. Also, 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, and are deductible under section 8-1 of the ITAA 1997.

Question 4

Will the irrevocable cash contributions made by you to the Trustee to fund the subscription for, or acquisition of, your shares by the Trustee constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Detailed reasoning

The term 'fringe benefit' is defined in subsection 136(1) of the FBTAA to include benefits provided by an employer, an associate of the employer or an arranger with the employer, to employees, in respect of the employment of the employee but does not include benefits listed in paragraphs (f) to (s) of the definition.

Paragraph (ha) of the definition of a fringe benefit in subsection 136(1) of the FBTAA excludes the following benefit from being a fringe benefit:

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); ….

Subsection 995-1(1) of the ITAA 1997 provides that the meaning of 'employee share trust' is defined 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:

Obtaining shares or rights in a company; and

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:

The company; or

A subsidiary of the company; and

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

An Option that is satisfied with the provision of Shares becomes a right to acquire a share and, pursuant to section 83A-340, is treated as if had always been a right to acquire a share (an ESS interest) and the beneficial interest in the Share that is acquired pursuant to the exercise of the Option is an ESS interest within the meaning of subsection 83A-10(1) of the ITAA 1997.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which rights (which have later become) rights to acquire Shares are provided to employees in relation to the employee's employment.

Under the Plan, the taxpayer has also established the Trust to acquire Shares in the taxpayer and to allocate the shares to employees to satisfy the Options acquired under the Plan. The beneficial interest in the Share is itself provided under an employee share scheme because it is provided under the same scheme under which the Options are provided to the employee in relation to the employee's employment, being an employee share scheme as defined in subsection 83A-10(2) of the ITAA 1997.

Therefore, paragraph 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

The Trust acquires Shares in the taxpayer,

The Trust ensures that ESS interests as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in those Shares, are provided under an ESS, as defined in subsection 83A-10(2) of the ITAA 1997, by allocating those Shares to the employees to satisfy the Options in accordance with the Plan and Deed.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will require the Trustee to undertake incidental activities that are a function of managing the employee share scheme and administering the Trust.

Having regard to the terms of the Deed and the Plan, there are no activities that the Trust will undertake that are not incidental to the activities mentioned in paragraphs 130-85(4)(a) and (b). In particular, the Trust does not provide any additional benefits to Trustee's such as financial assistance. Further, if the Options are settled in cash, the cash payment is made by the taxpayer and not the Trust and the Cashless Exercise Facility is managed by the taxpayer with the taxpayer directing the Trustee to provide the reduced number of Shares.

This conclusion is consistent with 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.

Therefore, it is accepted that the contributions made to the Trustee of the Trust by the taxpayer are excluded from being a fringe benefit by paragraph 136(1)(ha) of the FBTAA.

Accordingly, the irrevocable cash contributions the taxpayer makes to the Trustee of the Trust, to fund the subscription for, or acquisition of, the Shares in accordance with the Deed will not constitute a fringe benefit under subsection 136(1) of the FBTAA.

Question 5

Will the provision of ESS interests to your employees constitute a fringe benefit within the meaning of section 136(1) of the FBTAA?

Detailed reasoning

As discussed above, certain benefits are excluded from being a 'fringe benefit' by virtue of paragraphs (f) to (s) of the definition in subsection 136(1) of the FBTAA.

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

A payment of salary or wages or a payment that would be salary or wages if salary or wages included exempt income for the purposes of the Income Tax Assessment Act 1936; or

Paragraph (h) 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 an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83A-B or 83A-C of that Act applies; or ….

The Commissioner accepts that the Plan is an employee share scheme and that Options are indeterminate rights that may later become rights to Shares, and therefore, ESS interests (within the meaning of subsection 83A-10(1) of the ITAA 1997) to which Subdivision 83A-B or 83A-C of the ITAA 1997 will apply.

ATO Interpretative Decision ATO ID 2010/142 Fringe Benefits Tax: Employee share scheme: indeterminate rights not fringe benefits states that: The grant of indeterminate rights to employees of a company in relation to their employment is excluded from the definition of fringe benefit by paragraph 136(1)(f) or 136(1)(h) of the FBTAA.

Therefore, the granting of the Options at a discount under the Plan to Participants will not be a 'fringe benefit' because it is excluded by paragraph 136(1)(f) or (h) of the FBTAA.

The provision of Shares by the Trustee

As mentioned above, in general terms, 'fringe benefit' is defined in subsection 136(1) of the FBTAA 1986 as being a benefit provided to an employee or an associate of an employee 'in respect of' the employment of the employee.

When an employee participates in the Plan, they obtain an Option (being an indeterminate right that may later become a right to acquire a beneficial interest in a share in the taxpayer). If that occurs, the right constitutes an ESS interest. When the Option is exercised, any Share received to satisfy the Option would be in respect of the exercise of the Option, and not in respect of employment (refer ATO Interpretative Decision ATO ID 2010/219 Fringe Benefits Tax Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme).

Question 6

Will the Commissioner of Taxation make a determination that Part IVA of the ITAA 1936 applies to deny, in part or in full, a deduction claimed by you for the irrevocable cash contribution made by you to fund the subscription for, or acquisition of, your shares by the Trust?

Detailed reasoning

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

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

A tax benefit (177C(1)) arises that was obtained or would be obtained in connection with the scheme but for Part IVA of the ITAA 1936; and

Having regard to the matters in paragraph 177D(2) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies.

On the basis of an analysis of these 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 the taxpayer for the irrevocable contributions made to the Trustee of the Trust to fund the subscription for, or acquisition of, Shares to satisfy exercise of the Options.

The Scheme

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

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

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

It is considered that this definition is sufficiently wide to cover the proposed employee arrangement under the Plan, which consists of the creation of the Trust, including the Deed, and the payment of the irrevocable cash contributions to the Trustee, the acquisition of Shares by the Trustee, and the allocation of Shares to the Participants.

Tax Benefit

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

Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out…

In order to determine the tax benefit that would be derived by the taxpayer from this scheme, it is necessary to examine alternative hypotheses or counterfactuals, that is, other schemes the company might reasonably have been expected to enter into to achieve its aims in relation to employee remuneration.

The applicant considers the following as alternate actions at page 11 of Attachment 1 to the private binding ruling application:

Alternative 1:

The taxpayer could renumerate employees via payments of salary bonuses or superannuation contributions (that is, cash equivalent amounts based on the value of the shares) rather than through the grant of Options and delivery of Shares. Under this alternative, payments of the cash amounts would be deductible to the taxpayer.

Alternative 2:

The taxpayer could fund the purchase of Shares from existing Shareholders in the name of the Participant at the time the rights vest or are exercised. Under this alternative, a tax deduction would be available to the Company for the purchase price of the Shares.

Alternative 3:

The taxpayer could issue new Shares directly to Participants when the Options are exercised. In such a case, the Company would not receive a deduction for the cost/value of the Shares issued.

We also note that if the taxpayer sought to establish an alternative scheme whereby it issued shares in itself directly to employees as remuneration, it would not be entitled to a deduction for the value of the shares unless section 83A-205 of the ITAA 1997 was satisfied. Under 83A-205 the deduction would be equal to the amount allowable as a reduction available to the individual employee under section 83A-35 of the ITAA 1997 (which is capped at $1,000).

A comparison between the scheme and alternative 1 and 2 would likely reveal no tax benefit because the deductible amounts under both of them would be the same or similar from the taxpayer's perspective.

However, a tax benefit (for the purposes of subsection 177A(1) of the ITAA 1936) may be available where the scheme is compared to the alternatives discussed above under Alternative 3 as any deduction that the taxpayer would be entitled to where shares are issued directly to employees is likely to be lower than that available under the Plan, a tax benefit may be considered to have been obtained.

In the event that the alternatives under Alternative 3 were considered a reasonable alternative to entering into the scheme, the Commissioner has considered if the scheme was entered into for the dominant purpose of obtaining a tax benefit.

Dominant purpose

Pursuant to 177D(1), paragraphs 177D(2)(a) to (h) of the ITAA 1936 set out the following factors that must be considered in deciding whether a scheme was entered into for the purpose of obtaining a tax benefit:

The manner in which the scheme was entered into or carried out;

The form and substance of the scheme;

The time at which the scheme was entered into and the length of the period during which the scheme was carried out;

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

Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

Any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Subsection 177A(5) of the ITAA 1936 requires the purpose to be the dominant purpose. Therefore, in considering whether Part IVA applies or not, the necessary comparison to be made in relation to the factors listed in paragraph 177D(2) is between the scheme as proposed and the relevant counterfactual.

(a) The manner of the scheme

The taxpayer contends that the presence of the Trust provides other commercial benefits. In particular, benefits include:

The Trust will provide flexibility for the taxpayer to satisfy its obligations under the Plan by facilitating the acquisition of Shares from existing participants or third parties or through a new issue of Shares, providing flexibility relating to capital management, the ability to 'recycle' shares and to satisfy Corporations law and financial services requirements.

The Trust establishes independent records and accounts for participating employees and using a single vehicle for employee share schemes allows for consolidation of administration.

It is accepted that the Trust provides benefits to the operation of the scheme that would not be available if the Shares were provided directly by the taxpayer as in the relevant counterfactual.

(b) The form and substance of the scheme

The substance of the scheme is the provision of remuneration in the form of Options to eligible employees who participate in the Plan. The scheme includes the granting of the Options under the Plan, the provision of funds to the Trust and the acquisition and allocation of Shares by the Trustee to satisfy the Options all being interrelated components of an employee share scheme to which Division 83A of the ITAA 1997 will apply.

While the inclusion of the Trust in the scheme confers a tax benefit (when compared to some of the alternatives considered), it cannot be concluded that it is the only benefit provided as outlined above. The Company has argued that the form of the arrangement with the Trust provides the scheme with non-tax benefits and this is accepted.

(c) The timing of the scheme

The scheme has not been established at a time to provide a substantial year-end deduction to the company nor with a contribution sufficiently large to fund the Trust for several years, but by recurring contributions. There is nothing in these facts to suggest a dominant purpose of seeking to obtain a tax benefit in relation to the scheme.

(d) The result of the scheme

The result of the scheme is to provide the Company with allowable deductions for the contributions it makes to the Trust. However, it is noted that the contributions are irrevocable and reflect a genuine non-capital outgoing on the part of the taxpayer to achieve a business outcome. It is to be expected that a deduction would normally be allowable in these circumstances.

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

As noted above, the taxpayer makes irrevocable contributions to the Trust and those contributions constitute a real expense with the result that the Company's financial position is changed to that extent. While it is arguable that the quantum of the deductions is higher with the Trust as part of the scheme than would be the case if the taxpayer invoked alternatives to the scheme that involved providing Shares to Participants directly, there is nothing artificial, contrived or notional about the taxpayer's expenditure.

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

The contributions by the taxpayer to the Trust will form part of the corpus of the Trust and must be dealt with by the Trustee in accordance with the terms of the Trust Deed i.e. for the acquisition of Shares to provide to Participants in employee share schemes. The taxpayer is not a beneficiary of the Trust and its contributions cannot be returned to it in any form except where the Trustee acquires Shares from the Company by subscribing for new issues at Market Value.

The financial position of Participants in the Plan will change as a result of participating in the scheme. However this will be the case regardless of whether the Shares are acquired through the Trust or provided directly by the Company.

Therefore, the contributions made by the Company amount to a real change to the financial position of the Trustee. The financial position of Participants in the schemes will also undergo a real change. There is nothing artificial, contrived or notional about these changes.

(g) Any other consequence

Not relevant to this scheme.

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

The relationship between the taxpayer and the Participants in the scheme is one of employer/employee. The Trustee is independent of the taxpayer and is under a fiduciary obligation to act in the interests of the employees who participate in employee share schemes and in particular, in this case, the Plan. There is nothing to suggest that the parties to the employee share schemes are not acting at arm's length to one another. Accordingly, there is nothing in relation to this factor to indicate a dominant purpose of obtaining a tax benefit.

Conclusion

The Commissioner will not make a determination that Part IVA of the ITAA 1936 applies to deny in part or in full any deduction claimed by the Company for the irretrievable contributions made to the Trustee of the Trust.

While the Company receives a tax benefit by making the contributions under the Plan, the Company did not enter the Plan for the dominant purpose of obtaining a tax benefit.

Question 7

Is the Employee Share Trust (the Trust) an employee share trust as defined in subsection 130-85(4) of the (ITAA 1997)?

Detailed reasoning

Subsection 995-1(1) of the ITAA 1997 provides that the meaning of 'employee share trust' is defined 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:

Obtaining *shares or rights in a company; and

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:

The company; or

A subsidiary of the company; and

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

An Option that is satisfied with the provision of Shares becomes a right to acquire a share and, pursuant to section 83A-340, is treated as if had always been a right to acquire a share (an ESS interest) and the beneficial interest in the Share that is acquired pursuant to the exercise of the Option is an ESS interest within the meaning of subsection 83A-10(1) of the ITAA 1997.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which rights (which have later become) rights to acquire Shares in the taxpayer are provided to employees in relation to the employee's employment.

Under the Plan, the taxpayer has also established the Trust to acquire Shares in the taxpayer and to allocate the shares to employees to satisfy the Options acquired under the Plan. The beneficial interest in the Share is itself provided under an employee share scheme because it is provided under the same scheme under which the Options are provided to the employee in relation to the employee's employment, being an employee share scheme as defined in subsection 83A-10(2) of the ITAA 1997.

Therefore, paragraph 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

The Trust acquires Shares in the taxpayer,

The Trust ensures that ESS interests as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in those Shares, are provided under an ESS, as defined in subsection 83A-10(2) of the ITAA 1997, by allocating those Shares to the employees to satisfy the Options in accordance with the Plan and Deed.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will require the Trustee to undertake incidental activities that are a function of managing the employee share scheme and administering the Trust.

Having regard to the terms of the Deed and the Plan, there are no activities that the Trust will undertake that are not incidental to the activities mentioned in paragraphs 130-85(4)(a) and (b). In particular, the Trust does not provide any additional benefits to Trustee's such as financial assistance. Further, if the Options are settled in cash, the cash payment is made by the taxpayer and not the Trust and the Cashless Exercise Facility is managed by the taxpayer with the taxpayer directing the Trustee to provide the reduced number of Shares.

This conclusion is consistent with 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.

In considering the relevant documents, the Trust Deed and the Plan rules, it is considered that the Trust is an employee share trust.

Question 8

Does Division 7A of Part III of the ITAA 1936 apply to deem as a dividend the irrevocable cash contributions made by the taxpayer to the Trustee to fund the subscription for or acquisition of shares in the taxpayer to enable the Trustee to provide those shares to employees under the terms of the Employee Option Plan?

Detailed reasoning

Subdivision B of Division 7A of Part III of the ITAA 1936 (Division 7A) treats certain payments, loans and debt forgiveness made by a private company to a shareholder (or their associate) as a dividend paid by the company.

Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or
(b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time

Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is the amount paid, subject to the private company's distributable surplus calculated under section 109Y of the ITAA 1936.

Subdivision D of Division 7A sets out certain payments and loans that are not treated as dividends under Subdivision B.

'Entity' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by subsection 960-100(1). An entity includes the trustee of a trust (subsection 960-100(2)).

Therefore, the contributions made to the Trustee of the Trust would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Shares at the time the contribution is made.

However, Division 7A does not apply to a payment made to a shareholder, or an associate of a shareholder, in their capacity as an employee (as defined in the FBTAA) or an associate of such an employee by virtue of subsection 109ZB(3) of the ITAA 1936.

'Associate' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by section 318 of the ITAA 1936. An 'associate' of a natural person (other than in the capacity of trustee) includes a trustee of a trust where the individual benefits under the trust

The Trustee of the Trust is an associate of any employees of the taxpayer that are Participants in the Plan as they are beneficiaries under the Trust.

Contributions are made to the Trust when the taxpayer directs the Trustee to purchase Shares to hold for the purposes of exercising its obligations under the Plan to allocate Shares to Participants, as directed by the taxpayer, to satisfy the exercise of Options. Having regard to the operation of the Plan and the Deed, we accept that the payments are made to the Trustee shareholder in its capacity as an associate of an employee being the relevant Participant in the Plan.

In the private binding ruling application the taxpayer contends that payment to the trustee of the Trust falls within the exception in section 109J of the ITAA 1936. Section 109J states:

A private company is not taken under section 109C to pay a dividend because of the payment of an amount, to the extent that the payment:

(a) discharges an obligation of the private company to pay money to the entity; and
(b) is not more than would have been required to discharge the obligation had the private company and entity been dealing with each other at arm's length.

Contributions made by the taxpayer to the Trustee are settlements of corpus which the Trustee is bound to deal with according to the terms of the Trust Deed. The Trustee has an obligation to the beneficiaries to carry out the Trust in terms of the Trust Deed. However, settlements of corpus are made unilaterally by the taxpayer and not made in discharge of any antecedent obligation on the part of the taxpayer, that is, it is a voluntary undertaking. It involves no discharge of any obligation capable of being the trigger event for section 109J.

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