Edited version of your written advice

Authorisation Number: 1051211537719

Date of advice: 6 April 2017

Ruling

Subject: Employee Share Scheme Reporting Obligations

Question:

Will the fact that an ESS interest acquired by an employee is converted into a Restricted Security by virtue of the employee accepting an employer-funded loan affect the time that a reporting obligation arises for the employer under paragraph 392-5(1)(b) of the Tax Administration Act 1953?

Answer:

No. It does not constitute a genuine disposal restriction and cannot affect the timing of a deferred taxing point for the employee and therefore cannot affect the time that a reporting obligation arises for the employer under paragraph 392-5(1)(b) of the TAA 1953.

This ruling applies for the following periods:

1 July 2015 to 30 June 2016

Relevant facts and circumstances

Background

1. Company A is listed on the Australian Securities Exchange.

2. Company A offers shares and rights to acquire shares to its employees under an Employee Share Scheme ('ESS') as a means of recruiting and retaining high performing employees.

3. Certain senior employees of Company A are offered rights to acquire shares in Company A subject to vesting conditions, that may be time and/or performance based.

4. Different vesting conditions can apply to different tranches of rights granted to each employee by Company A, as set out in the 'Employee Incentive Scheme Offer' Letter ('Offer Letter') that is provided to employees.

5. The Offer Letter invites employees to apply for rights to acquire fully-paid ordinary shares ('Shares') in Company A.

6. The issues of the Shares is subject to the satisfaction of vesting conditions, examples of which are set out in the Offer Letter in Schedules 1 and 2, as outlined below:

i. Employment must be continuing on the issue date specified below and notice of termination of employment must not have been given by either party on or before such issue date.

ii. Achievement of individual key performance indicators, including personal performance hurdles.

iii. The shares will be issued, subject to satisfaction of the relevant performance hurdles, within one week of the assessment being completed (or as otherwise agreed between Company A and the employee) but no earlier than 30 June 2017 and no later than 30 November 2020.

7. Once the vesting conditions are met, the rights are automatically exercised and the employee is entitled to subscribe for shares pursuant to the terms of Company A's Employee Performance Securities Plan ('the Plan').

Company A ESS Scheme

8. Each grant contains a fixed number of rights for each employee, divided into tranches, and granted for nil consideration.

9. The subscription price of the shares is set at the market value of a Company A share at or around the date of the Offer Letter.

10. On satisfaction of the vesting conditions for each tranche, and provided the employee remains employed by Company A, the rights in that tranche are automatically exercised so that the employee is entitled to subscribe for the predetermined number of shares in that tranche.

11. On exercise of the rights, the company offers a limited recourse loan to each employee to fund the subscription price of the shares ('the Loan').

12. It is not mandatory that an employee accept the offer of the Loan.

13. The shares are acquired by Company B as trustee of Company C, and are held on trust for the benefit of each employee.

14. The rules of the Plan ('Plan Rules') provide that the shares are 'Restricted Securities' until they become 'Unrestricted Securities', as provided for in the Plan Rules. However, where no Loan is provided to fund the subscription price of the shares, such shares would be “Unrestricted Securities” from the acquisition time.

15. If a Loan is provided by Company A to the employee to acquire the shares, those shares are 'Restricted Securities', as stated in the Plan Rules.

16. Pursuant to the Plan Rules, 'Restricted Securities' cannot be 'sold or transferred, mortgaged (or otherwise encumbered) or otherwise dealt with by the Participant (or by the Trustee other than as expressly permitted under this Plan'.

17. Each share only becomes an 'Unrestricted Security' as the Loan is repaid as stated in the Plan Rules.

18. Where the Loan is partly repaid, only those shares that relate to that portion of the Loan that is repaid become 'Unrestricted Securities'.

19. Once the Loan is repaid in full, all of the 'Restricted Securities' become 'Unrestricted Securities', as stated in the Plan Rules.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 13A

Income Tax Assessment Act 1936 Paragraph 139CB(1)(c)

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 Section 83A-120

Income Tax Assessment Act 1997 Paragraph 83A-120(7)(d)

Income Tax Assessment Regulations 1997

Tax Administration Act 1953 Paragraph 392-5(1)(b)

Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 Explanatory Memorandum

Reasons for decision

DETAILED REASONING

20. For the purpose of this ruling, a determination is to be made whether the fact that an ESS interest acquired by a Company A employee is converted into a Restricted Security by virtue of the employee accepting an employer-funded loan will affect the time that a reporting obligation arises for the employer under paragraph 392-5(1)(b) of the Tax Administration Act 1953?

RECORD KEEPING OBLIGATIONS - TAA 1953

21. Section 392-5 of the TAA 1953 outlines the circumstances where an entity (the provider) must give the Commissioner and an individual a statement in relation to ESS interests. In summary, a statement must be given in relation to the financial year if:

a. the provider has provided an ESS interest to an individual during the year and Subdivision 83A-B or 83A-C of the ITAA 1997 applies to the interests, or

b. the provider has provided an ESS interest to an individual, during the year or during an earlier year, Subdivision 83A-C of the ITAA 1997 applies to the interests and the ESS deferred taxing point for the interests occurs during the year.

22. The provider must give the statement to the Commissioner in the approved form, per subsection 392-5(2) of the TAA 1953.

23. In order for a company to fulfil its ESS reporting requirements as outlined within Division 392 of the TAA 1953, the company is required to know whether employees participated in an ESS and received ESS interests.

24. The fact that an ESS interest acquired by a Company A employee is converted into a Restricted Security by virtue of the employee accepting an employer-funded loan does not constitute a genuine disposal restriction, and so cannot affect the timing of a deferred taxing point for the employee. Accordingly, the time that a reporting obligation arises for the employer under Division 392 of the TAA 1953 is not affected.

EMPLOYEE SHARE SCHEMES - DIVISION 83A ITAA 1997

25. Division 83A of the ITAA 1997 provides for the taxation of ESS interests acquired under an ESS at a discount.

26. Subsection 83A-10(1) defines an ESS interest in a company as a beneficial interest in (a) a share in the company, or, (b) a right to acquire a beneficial interest in a share in the company.

27. Subsection 83A-10(2) defines an ESS as a 'scheme' under which ESS interests in a company are provided to employees or associates of employees of (a) the company or (b) subsidiaries of the company, in relation to the employees' employment.

28. The term 'scheme' is defined in Section 995-1(1) of the ITAA 1997 as “any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

29. In applying these definitions, the rights issued to Company A's employees, pursuant to Company A's Offer Letter, and subject to the terms of Company A's Plan Rules, are determined to be ESS interests, as they give those employees a beneficial interest in a right to acquire shares in the company.

ESS DISCOUNTS - SUBDIVISION 83A-B ITAA 1997

30. Subdivision 83A-B of the ITAA 1997 applies to an ESS interest if it is acquired under an ESS at a discount, pursuant to subsection 83A-20(1) unless Subdivision 83A-C applies.

31. Subsection 83A-25(1) provides that, generally, the discount given in relation to an ESS interest acquired under an ESS is included in an employee's assessable income in the income year in which the interest is acquired under Subdivision 83A-B of the ITAA 1997, unless Subdivision 83A-C applies.

32. Pursuant to subsections 83A-20(1) and section 83A-105 of ITAA 1997, Subdivision 83A-B or 83A-C cannot apply to an ESS interest acquired under an employee share scheme on or after 1 July 2009 unless that interest is acquired at a discount.

33. The term 'discount' is not defined for the purposes of Division 83A of the ITAA 1997. However, the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 ('2009 EM') states at paragraph 1.102 that the term 'discount' is

“... the market value of the ESS interest less any consideration paid, or to be paid, by the employee…”.

34. In applying these definitions, Company A's rights to shares are determined to be issued as a discount, as the rights are granted for nil consideration and the subscription price payable on the automatic exercise of the rights is set at the market value of the shares on the date when the shares are granted.

35. Accordingly, Company A's rights to shares will be taxable under the ESS provisions in Division 83A of the ITAA 1997.

36. Further, Company A's employees would need to include the value of the discount in their assessable income in the year in which the interest is acquired, under Subdivision 83A-B of the ITAA 1997, unless Subdivision 83A-C applies.

37. In that instance, if the tax deferral conditions of Subdivision 83A-C apply, then the taxation of a discount on an ESS interest will be deferred until the deferred taxing point is determined pursuant to Section 83A-120.

DEFERRED INCLUSION OF GAIN IN ASSESSABLE INCOME - SUBDIVISION 83A-C

ESS DEFERRED TAXING POINTS

38. Section 83A-100 provides that if there is a real risk of forfeiture of the share, right or stapled security acquired under an employee share scheme, the discount is not to be included in assessable income when it was acquired. Instead, in the first income year in which the share, right or security is able to be disposed of, assessable income will include any gain made to that time. If employment is ceased earlier, or if 15 years pass, the gain is included in that income year instead. The deferred taxing point can also apply to:

a. A share or stapled security you acquire under salary sacrifice arrangements, if you get no more than $5,000 worth of shares under those arrangements; or

b. A right, if the scheme restricted you immediately disposing of the right, and stated that this Subdivision applies.

39. For the purpose of this application, it is assumed that the employee is still employed by Company A and the exercise of the rights occurs prior to the end of the 15 year period from the date of grant of the rights. In this scenario, once the rights have vested and been exercised, there is no condition in the Plan which would cause the forfeiture of the employee's shares.

40. If Subdivision 83A-C of the ITAA 1997 applies to the ESS interest, the employee will include an amount in the income year in which the ESS deferred taxing point for the ESS interest occurs.

41. Subsection 83A-120(1) applies if the ESS interest is a beneficial interest in a right to acquire a beneficial interest in a share.

42. Pursuant to subsection 83A-120(2), the ESS deferred taxing point for the ESS interest is the earliest of the times mentioned in subsections 83A-120(4)-(7).

43. Subsection 83A-120(7) states that the fourth possible taxing point is the earliest time when:

a. You exercise the right; and

b. (repealed by No 105 of 2015)

c. There is no real risk that, under the conditions of the scheme, after exercising the right, you will forfeit or lose the beneficial interest in the share (other than by disposing of it); and

d. If, at the time you acquired the ESS interest, the scheme 'genuinely restricted' you 'immediately' disposing of the beneficial interest in the share if you exercised the right - the scheme no longer so restricts you.

44. If the deferred taxing point is determined pursuant to subsection 83A-120(7) then if, at the time you acquired the ESS interest, the scheme 'genuinely restricted' you 'immediately' disposing of the beneficial interest in the share if you exercised the right the time when such restriction is no longer applicable, will determine the deferred taxing point.

GENUINE DISPOSAL RESTRICTION

45. The term 'genuinely restricted' is not defined per se in taxation legislation. The Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 (2009 EM) states the following in relation to genuine selling restrictions for shares and rights to acquire shares:

1.192 Genuine restrictions preventing disposal could include a condition of the scheme that contractually prevents disposal of shares. If disposing of an ESS interest would be a criminal offence, for example under a law regulating insider trading, then the employee would also be considered genuinely restricted from disposing of the share.

1.193 A company's internal share trading policy is only considered to be a restriction preventing disposal for the purposes of deferring the taxing point if the penalty for breaking the policy constitutes an effective sanction. This means that if there is no legal prohibition on the disposal of the ESS interest, there must be serious and enforced consequences for breaching the policy.

1.194 A restriction that otherwise meets the conditions for a genuine restriction, but is able to be lifted in cases of severe financial hardship, is nonetheless considered to be a genuine restriction.

1.195 Restrictions preventing disposal are considered to be lifted once an opportunity arises in which a taxpayer can realise the share.

1.196 In the case of a trading window, or restrictions that may lift and then re-engage, if the employee does not avail themself of the opportunity to dispose of the share and the window subsequently closes, there is no further delay in the taxing point. The taxing point would still be at the commencement of the first trading window.

1.197 The restriction and conditions covered by the deferred taxing points are only those that existed when the employee acquired the ESS interest. Conditions and restrictions that have been added subsequent to acquisition are ignored for the purposes for determining the deferred taxing point.

…

1.200 The taxing point is the point at which the taxpayer can take some action to realise the benefit. It does not matter whether or not they chose to do so.

46. On the ATO website at ATO - ESS genuine disposal restrictions, the ATO explains what we consider to be genuine disposal restrictions under an employee share scheme (ESS) and when we consider they will no longer apply. A number of examples are provided at this site:

a. As shown in Example 5, the ATO considers that a genuine disposal restriction can exist where a 'condition of the scheme that prohibits the employee from disposing of a share for a fixed period of time, where the disposal restriction is enforced by a holding lock or by the shares being held in trust'.

b. As shown in Example 10, the ATO's view is that there is no genuine disposal restriction where the employee can take action to dispose of the ESS interest or in the event that the employee requires approval from the Board to dispose of the ESS interest, those requests to the Board are routinely approved.

47. The ATO also provides some insight into the phrase 'genuine disposal restriction' in ATO ID 2008/121 which states:

a. The expression 'a restriction preventing the taxpayer from disposing of a share' used in paragraph 139CB(1)(c) of Division 13A of the ITAA 1936 is not defined, therefore it should take on its ordinary meaning having regard to its context and the underlying purpose or object of Division 13A.

b. The Commissioner considers 'a restriction preventing a taxpayer from disposing of a share' to ordinarily be a restriction applied by the taxpayer's employer or an agent or associate of the employer, that prevents the taxpayer from disposing of the share.

c. Such a restriction will generally arise under the terms of a formal ESS or under the terms of an employment contract and the mechanism for effecting the restriction may include a holding lock on the share put in place by a share registry, or the holding of the share by a trustee.

48. The relevant clause in the Plan Rules which restricts an employee from immediately disposing of their shares is Clause x of the Plan Rules, which states:

“All Plan Securities will be Restricted Securities until they become Unrestricted Securities in accordance with this Deed or the conditions applicable to them. While Plan Securities are Restricted Securities, they may not be sold or transferred, mortgaged (or otherwise encumbered) or otherwise dealt with by a Participant (or by the Trustee other than as expressly permitted under this Plan).

49. The Plan Rules stipulates that, subject to Clause xx, Plan Securities which are funded by a Loan will be Restricted Securities.

50. Clause xxx of the Plan Rules states that unless otherwise determined by Company A, the employee may repay all or part of the amount of the Loan outstanding at any time and the Plan Securities will become Unrestricted Securities upon repayment of the Loan. The shares will become Unrestricted Securities on a pro-rata basis as the Loan is paid down.

51. Pursuant to EM 2009 at paragraph 1.195, it is noted that the 'restrictions preventing disposal are considered to be lifted once an opportunity arises in which a taxpayer can realise the share'.

52. As the employee can take action at any time to repay the loan as per Clause xx of the Plan Rules, so that the Restricted Securities become Unrestricted Securities, then they are not under a genuine disposal restriction. The fact that an employee does not take action to repay the loan does not amount to a genuine disposal restriction.

53. Further to Clause y of the Plan Rules, employees have a choice to fund the acquisition of their Securities via a Loan, and so the employee is not contractually bound to enter into a Loan for the vested shares.

54. In addition, it is clear that the employee has to take action for the restrictions to come into force in the first instance. If the employee doesn't take out the loan to fund the acquisition of the shares, then the shares will be Unrestricted Securities from the outset.

55. Additionally, there does not appear to be a time limit imposed for the employee to repay the loan, it is at the employee's option as per Clause xx of the Plan Rules.

56. Notwithstanding that the employee is subject to the actions of the Trustee, the employee has the power to direct the Trustee to deal with the Unrestricted Securities under the Plan Rules as per Clause z, so the shares are not subject to a genuine disposal restriction.

57. Paragraph 83A-120(7)(d) of the ITAA 1997, considers the employee's ability to 'immediately' dispose of the shares on exercise of the rights. The term “immediately” in this instance would allow certain steps to be taken by the employee, such as directing the Trustee to deal with the shares, without causing a genuine time restriction as the employee can take steps to deal with their shares.

CONCLUSION FOR QUESTION

58. Relevantly for this ruling, the ATO considers that an employee share scheme does not genuinely restrict disposal of an ESS interest if the employee can take action to dispose of the ESS interest. Any genuine disposal restrictions are lifted on the first date on which an employee has an opportunity to dispose of their ESS interests. This will be the first time an employee can take some action to realise the benefit. It does not matter whether or not they chose to do so.

59. The fact that an ESS interest acquired by a Company A employee is converted into a Restricted Security by virtue of the employee accepting an employer-funded loan does not constitute a genuine disposal restriction and therefore cannot affect the time that a reporting obligation arises for the employer under Division 392 of the Tax Administration Act 1953.

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