Edited version of your written advice

Authorisation Number: 1051220668801

Date of advice: 5 May 2017

Ruling

Subject: Employee Share Scheme - Startup Concessions

Question

Are the 'A' ordinary shares in Company Two considered to be 'ordinary shares' for the purposes of subsection 83A-45(2) Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following periods:

1 July 2016 to 30 June 2017.

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Company One is a company incorporated in Australia during 201X.

Company One is wholly-owned by Company Two, a company incorporated overseas during 201X.

Neither Company One nor Company Two are listed companies. Company Two has no related corporate bodies that control more than 50% of the votes or holds more than 50% of the capital.

The business of the group is developing and commercialising a specific technology - the group is in the R&D phase. The group currently has no turnover.

Company One plans to establish an Employee Share Scheme (ESS) for its Australian-resident employees granting Employee Share Options (Options) to acquire A class shares in Company Two.

Under the terms of the ESS the share options will be granted with an exercise price at least equal to the market value of Company Two shares.

The employer, Company One, is an Australian-resident.

The share options will not vest or be capable of exercise until at least three years have elapsed from the date of grant

No option holder under the proposed ESS will have a beneficial interest in greater than 10% of the share capital of Company Two.

The share capital of Company Two is divided into two classes of shares: A ordinary shares and B ordinary shares. Both classes of shares carry equal rights to vote at company meetings and to dividends.

In the event of the liquidation (or other wind-up event) of the company the A class shares will receive a distribution of an amount of capital, and the balance of the capital will be equally divided between the 'A' and 'B' shares.

There are a large number of A class shares and a very small number of B class shares currently issued. Future share issues will be predominantly A class.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Reasons for decision

Summary

The A class shares in Company Two are ordinary shares for the purposes of the ESS rules.

Detailed reasoning

The ESS rules are contained in Subdivision 83A of the Income Tax Assessment Act 1997 (ITAA 1997). Under subsection 83A-45(2), the ESS interest you acquire must relate to “ordinary shares” in the company in question.

Ordinary shares is not a term defined in the ITAA 1997, and so “ordinary share” takes its ordinary meaning. The EM at paragraph 1.164 in relation to the ordinary share condition in Subdivision 83A-C of the ITAA 1997 notes that:

Deferred taxation is restricted to interests over ordinary shares to encourage the alignment of employee and employer interests. ESS interests that are not ordinary shares, such as preference shares, may have less 'risk' associated with them because they pay a more stable income stream and have priority over ordinary shares if the company winds up. They are therefore less likely to align the shareholder's interest with that of the company.

In Australia there are generally considered to be two types of share - ordinary and preference. One definition of an ordinary share is that it is a share that is not a preference share - it does not provide preferential treatment to the shareholder ahead of other classes of share. Preferential treatment may be via privileged access to dividends or precedence in the distribution of capital on winding up the company.

ATO ID 2010/62 states that:

Whether a share is an ordinary share in a company for the purposes of … 83A … is to be determined by considering the rights attached to the share in relation to distributions of profits and capital and on winding up of the company, as compared to other shares in the company. Shares that have a priority as to dividends or distributions in the event of winding up are preference shares. If shares are not preference shares, they are ordinary shares.

The A class shares in Company Two have preferential access to the distribution of capital if the company is wound up. If there were a large number of shareholders of each class of share, it would be difficult to maintain that the A class shares were ordinary while they possessed this preferential right. However, the A class shares in Company Two represent almost 100% of the shares currently on issue, and this percentage will increase as more stock is issued. While the A class shares do carry additional rights to the B class shares, it would be inappropriate to refer to a very small percentage of the issued capital as the “ordinary” shares.

The A class shares are the ordinary shares in Company Two, while the B class shares may be better classified as a reserve class of (ordinary) shares. For the purposes of the ESS provisions, rights to acquire interests in A class shares in Company Two will be considered rights to acquire ordinary shares.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

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