Edited version of your written advice

Authorisation Number: 1051444161447

Date of advice: 25 October 2018

Ruling

Subject: Employee share plan

Question 1

Are the irretrievable cash contributions made by the Company to the Trustee as the trustee of the Trust to fund:

● the subscription for, or acquisition on-market of, the Company’s Shares; or

● the administration of the Trust,

a ‘fringe benefit’ within the meaning of that term in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No.

Question 2

Will the Company obtain an income tax deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the irretrievable cash contributions made by the Company to the Trustee of the Trust to fund the subscription for, or acquisition on-market of, the Company’s Shares by the Trustee to satisfy the Performance Rights granted under the Plan?

Answer

Yes.

Question 3

Will the Company obtain an income tax deduction under section 8-1 of the ITAA 1997 for the costs incurred by the Company in relation to the on-going administration of the Plan and the Trust?

Answer

Yes.

Question 4

Under section 83A-210 of the ITAA 1997, is the deduction for the Company in respect of the irretrievable cash contributions to the Trust allowed in the year of income when the contribution is made to the Trust, provided it is in respect of Performance Rights to acquire the Company’s Shares that were granted to employees in the same or an earlier income year under the Plan?

Answer

Yes.

Question 5

Will the Commissioner make a determination that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to deny, in part or in full, any deduction under section 8-1 of the ITAA 1997 claimed by the Company in respect of:

(a) irretrievable cash contributions made by the Company to the Trustee of the Trust to fund the subscription for, or acquisition on-market of, the Company’s Shares by the Trustee to satisfy the rights granted under the Plan; or

(b) costs incurred by the Company in relation to the implementation and on-going administration of the Plan and the Trust?

Answer

No.

This ruling applies for the following period:

XXXX

The scheme commences on:

XXXX

Relevant facts and circumstances

1. The Company is an Australian resident company and is the head company of an income tax consolidated group (the Company TCG).

2. The Company has established an employee share plan (the Plan) as part of its remuneration strategy.

3. Under the Plan and in accordance with the Plan Rules, eligible employees who are invited to participate in the Plan (Participants) may be granted Performance Rights entitling them to acquire fully paid ordinary shares in the Company (Shares) subject to meeting Performance Hurdles, Vesting Conditions and Exercise conditions as defined in the Plan Rules.

4. The Plan operates as follows:

● The Company established a trust (The Trust) and executed the trust deed (Trust Deed) to facilitate the acquisition, holding and allocation of Shares to Participants in accordance with the Trust Deed.

● The Company makes irretrievable cash contributions to the trustee of the Trust (Trustee) to enable the Trustee to acquire Shares to satisfy the grants of Performance Rights.

● The Performance Rights are offered by the Company to Participants. When the Performance Hurdles, Vesting and Exercise Conditions are met the Shares are allocated to Participants by the Trustee at which point those shares become known as Allocated Plan Shares in accordance with the Trust Deed.

● Until the Trustee receives a direction from the Company or a Participant to transfer the legal or beneficial title in Allocated Plan Shares to a Participant, the Trustee holds the Allocated Plan Shares on trust for the benefit of Participants from time to time. Participants are absolutely entitled to Allocated Plan Shares and any other benefits attached to those Allocated Plan Shares.

5. The Trust Deed provides:

a. The Trustee must not accept any payment from Participants for the grant, exercise or allocation of Shares.

b. The irretrievable cash contributions are accretions to the corpus of the Trust.

c. Shares which have been acquired by the Trustee for the purpose of granting Performance Rights and not yet allocated to any Participant are known as Unallocated Shares.

d. The Trustee may, in respect of any Unallocated Shares, apply any capital receipts, dividends or other distributions received in respect of those Unallocated Shares to purchase further Shares as trust property.

e. The Company and the Trustee agree that the Trust will be managed and administered in a way that satisfies the requirements of subsection 130-85(4) of the ITAA 1997.

f. The Trustee is not permitted to carry out any activities in its capacity as Trustee which are not matters connected to or for the purposes of the Plan and is not permitted to do anything that may cause the Trust to fail the definition of an ‘Employee Share Trust’.

g. Upon termination of the Trust the balance of the capital or income of the Trust to which no Participant is entitled may be applied in whole or in part to a Participant in the Plan or any charity nominated by the Trustee as the Trustee thinks fit. The Trustee must not pay any balance to a member of the Group or the Company.

6. The Company pays for all the on-going administration costs of the Trust.

7. The Company is not a beneficiary of the Trust and has no legal or beneficial interest in the Shares held by the Trustee.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 83A-210

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Reasons for decision

Question 1

Subsection 136(1) of the FBTAA provides a ‘fringe benefit’, in relation to an employee, is a benefit in respect of the employment of the employee. However, paragraph 136(1)(ha) of the definition of ‘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)’.

An ‘employee share trust’ is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

Subsection 130-85(4) of the ITAA 1997 provides that an employee share trust for an ‘employee share scheme’ (having the meaning given by subsection 83A-10(2) of the ITAA 1997) is a trust whose sole activities are:

(a) obtaining shares or rights in a company; and

(b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of:

(i) the company; or

(ii) a subsidiary of the company; and

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

The terms ‘ESS interest’ and ‘employee share scheme’ are defined in section 83A-10 of the ITAA 1997 which states:

(1) An ESS interest, in a company, is 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.

(2) 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 employee’s employment.

The Trustee is empowered under the Trust Deed to subscribe for or purchase Shares in accordance with the Company’s direction to be held on trust until they are allocated to a Participant. In accordance with the Trust Deed the Trustee is not permitted to carry out any activities in its capacity as Trustee which are not matters connected to or for the purposes of the Plan. Further, the Trustee of the Trust is not permitted to do anything that may cause the Trust to fail the definition of an ‘Employee Share Trust’.

Performance Rights granted to an employee will be an ‘ESS interest’ as it is a beneficial interest in a right to acquire a beneficial interest in a Share pursuant to paragraph 83A-10(1)(b) of the ITAA 1997. This ESS interest is granted under the Plan in relation to a Participant’s employment with the employer entities within the Company TCG. Therefore, the Plan is an ‘employee share scheme’ for the purposes of subsection 83A-10(2) of the ITAA 1997. Accordingly, the irretrievable cash contributions made to the Trustee under the Plan will not be a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

Question 2

Subsection 8-1(1) of the ITAA 1997 provides that a deduction can be made from assessable income for any loss or outgoing to the extent that:

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

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

However, subsection 8-1(2) of the ITAA 1997 provides that a loss or outgoing is not deductible 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 exempt or non-assessable non-exempt income; or

(d) a provision of the income tax legislation prevents a deduction from being claimed.

Draft Taxation Ruling TR 2017/D5 Income Tax: employee remuneration trusts (TR 2017/D5) 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). It explains how the taxation law applies when a contribution is made by an employer to the trustee of an ERT and benefits paid or provided by the trustee of the ERT to employees.

TR 2017/D5 applies to employers, their employees and trustees who participate in an ERT as described at paragraphs 7 and 8 of TR 2017/D5. On the facts, the way in which the Trust has been established and operates is consistent with the essential elements of an ERT as set out in paragraphs 7 and 8 of TR 2017/D5.

Accordingly, an employer is entitled to a deduction under section 8-1 of the ITAA 1997 for a contribution paid to the trustee of an ERT 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’)

provided that the exceptions to deductibility in subsection 8-1(2) do not apply.

Incurrence

To qualify for a deduction under section 8-1 of the ITAA 1997, a contribution to the Trustee must be incurred.

Paragraph 76 of TR 2017/D5 provides that a contribution made to the trustee of an ERT is incurred only when the ownership of the contribution passes from an employer to the trustee of the trust and there are no circumstances in which the employer can retrieve any of the contribution – Pridecraft Pty Ltd v. Federal Commissioner of Taxation [2004] FCA FC 339; 2005 ATC 4001; 58 ATR 210; Spotlight Stores Pty Ltd & Anor v. Federal Commissioner of Taxation [2004] FCA 650; 2004 ATC4674; 55 ATR 745.

The Trust Deed provides that all funds received from the Company will constitute accretions to the corpus of the Trust and will not be repaid to the Company or paid to any Participant except in accordance with the Trust Deed or Plan Rules.

Upon termination of the Trust the balance of the capital or income of the Trust to which no Participant is entitled may be applied in whole or in part to a Participant in the Plan or any charity nominated by the Trustee as the Trustee thinks fit. The Trustee must not pay any balance to a member of the Group or the Company.

Accordingly, the contributions made by the Company to the Trust will be irretrievable and non-refundable to the Company. Therefore, it is considered that the irretrievable contributions made by the Company to the Trustee of the Trust will be incurred for the purposes of subsection 8-1(1) of the ITAA 1997.

Relevant nexus

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.

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 a 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; 4 AITR 236; (1949) 8 ATD 431; Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation (1980) FCA 150; 80 ATC 4542; (1980) 11 ATR 276).

Paragraph 9 of TR 2017/D5 provides that a contribution is deductible to the employer under section 8-1 of the ITAA 1997 where the following applies:

● it is an irrevocable payment of cash, made at a time when the employer carries on business for the purpose of gaining or producing assessable income

● the employer reasonably expects their business to benefit from their contribution via an improvement in employee performance, morale, efficiency or loyalty, and

● the contribution is intended to be and entirely dissipated in remunerating employees of that business within a relatively short period of the contribution being made (other than employees who are wholly engaged in affairs of capital of the business.

If an employer meets the criteria set out in paragraph 9 of TR 2017/D5, a contribution would satisfy the nexus of being necessarily incurred in carrying on that business.

The Company will make contributions to the Trustee of the Trust for the primary purpose of enabling the Trustee to acquire the Shares which will, in accordance with the Trust Deed, be allocated to and held for Participants under the Plan.

Further, paragraph 82 of TR 2017/D5 states that a contribution will be deductible under section 8-1 of the ITAA 1997 when and to what extent that within a relatively short period of the contribution being made, the contribution held in trust is intended to be permanently and entirely dissipated in providing remuneration to employees.

Paragraph 83 of TR 2017/D5 provides that a ‘relatively short period’ is less than five years from the date that the contribution was made by an employer to the trustee. When a contribution is intended to be retained within the ERT for a longer period it is questionable whether the contribution serves appropriate business-related needs for the employer and whether any advantages obtained from the contribution are revenue in nature.

Pursuant to the Trust Deed and the Plan Rules, the purpose of the contribution made by the Company to the Trustee is to be applied to the direct remuneration of Participants in the form of the Shares as and when employees become entitled under the Plan Rules.

Accordingly, the irretrievable contributions made by the Company to the Trustee of the Trust for remunerating its employees under the Plan is an outgoing incurred in carrying on the Company’s business for the purpose of gaining or producing assessable income.

The contribution must not be capital or of a capital nature

Even 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 of the ITAA 1997 to the extent to which it is capital or of a capital nature (paragraph 85 of TR 2017/D5).

Paragraph 86 of TR 2017/D5 states that the nature of an outgoing as either capital or revenue can generally be determined by examining the character of the advantage sought, the manner in which it is to be used, relied upon or enjoyed and the means adopted to obtain it.

A contribution to the trustee of an ERT 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 the year to year benefits that the employer derives from a loyal and contented workforce (paragraph 87 of TR 2017/D5).

On weighing up the facts in this case it is considered:

● the contributions by the Company to the Trust are for the purpose of acquiring the Shares to meet the Company’s commitments arising under the Plan. They are primarily outgoings incurred in the ordinary course of carrying on its business;

● the contributions will be applied within a relatively short period of time to acquire the Shares for the benefit of Participants after the Performance Hurdles, Vesting and Exercise Conditions are satisfied;

● the amount of the contribution is provided sufficiently by the Company as required by the Trustee to acquire the requisite number of the Company shares under the terms of the Trust Deed;

● Participants will receive absolute entitlement to the Company shares upon allocation to them of the Shares by the Trustee; and

● the Plan provides Participants with an opportunity to receive an equity interest in the Company upon meeting Performance Hurdles, Vesting Conditions and Exercise Conditions which are linked to performance and retention of Participants.

Therefore, in accordance with TR 2017/D5 the contributions made by the Company are not considered capital in nature. No other provision of the ITAA 1936 or ITAA 1997 prevents the Company from deducting the contribution.

Accordingly, the irretrievable cash contributions made by the Company to the Trustee of the Trust to fund the acquisition of the Company shares will be an allowable deduction to the Company under section 8-1 of the ITAA 1997.

Question 3

The Company incurs various costs in relation to on-going administration of the Trust. For example, the Company will incur costs associated with the services provided by the Trustee of the Trust.

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

● costs incurred in gaining or producing the assessable income of the Company; or

● costs necessarily incurred in carrying on the business of the Company for the purpose of gaining or producing the assessable income of the Company.

The view that the costs incurred by the Company are deductible under section 8-1 of the ITAA 1997 is consistent with ATO ID 2014/42 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.

Consistent with the detailed reasoning above in Question 2, 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) of the ITAA 1997. Accordingly, the Company is entitled to an income tax deduction, pursuant to section 8-1 of the ITAA 1997, in respect of costs incurred in relation to the implementation and on-going administration of the Trust.

Question 4

The deduction for the irretrievable cash contributions under section 8-1 of the ITAA 1997 would generally be allowable in the income year in which the Company incurred the outgoing but under certain circumstances, the timing of the deduction is specifically determined under section 83A-210 of the ITAA 1997.

Section 83A-210 of the ITAA 1997 states:

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 of the ITAA 1997 will only apply if there is a relevant connection between the money provided to the trustee and the acquisition of ESS interests (directly or indirectly) by the employee under an employee share scheme in relation to the employee's employment (ATO ID 2010/103 Income Tax: Employee share scheme: timing of deduction for money provided to the trustee of an employee share trust).

Arrangement

For the purposes of section 83A-210 of the ITAA 1997, the term ‘arrangement’ is widely defined in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

In the present case, the implementation of the Plan, the settlement of the Trust under the Trust Deed and the provision of money by the Company to the Trustee to acquire and hold shares on behalf of the Participants are considered to be an ‘arrangement’ for the purposes of subparagraph 83A-210(a)(i) of the ITAA 1997.

‘ESS interest’ and ‘employee share scheme’

The terms ‘ESS interest’ and ‘employee share scheme’ are defined in section 83A-10 of the ITAA 1997. It states:

(1) An ESS interest, in a company, is 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.

(2) 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.

Performance Rights granted to an employee will be an ‘ESS interest’ as it is a beneficial interest in a right to acquire a beneficial interest in a Share pursuant to paragraph 83A-10(1)(b) of the ITAA 1997. This ESS interest is granted under the Plan in relation to a Participant’s employment with the employer entities within the Company TCG. Therefore, the Plan is an ‘employee share scheme’ for the purposes of subsection 83A-10(2) of the ITAA 1997.

The granting of the Performance Rights, the provision of contributions to the Trustee under the Plan and the Trust Deed, the acquisition and holding of the Shares by the Trustee and the allocation of Shares to Participants are all interrelated components of the Plan. All the components of the scheme 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. Consequently, the provision of money to the Trustee to acquire Shares is considered to be for the purpose of enabling the Participants to acquire the Performance Rights (an ‘ESS interest’). If that money is provided before the Performance Rights are acquired by Participants, section 83A-210 of the ITAA 1997 will apply.

Further, if any amount of money is used by the Trustee to purchase excess Shares intended to satisfy a future obligation arising from a future grant of Performance Rights, the excess payment occurs before the affected employees acquire the relevant Performance Rights (an ‘ESS interest’). Section 83A-210 of the ITAA 1997 will apply in that case, and such an amount will only be deductible in the year of income when the relevant Performance Rights are subsequently granted to the affected employees.

However, section 83A-210 of the ITAA 1997 will not apply to a deduction for a contribution that will be used to purchase Shares to satisfy Performance Rights that have already been granted. Therefore, a deduction is allowable to the Company under section 8-1 of the ITAA 1997 in the income year in which the contribution is made to the Trustee of the Trust if the contribution is in respect of Performance Rights to acquire the Company’s Shares which are granted to Participants in the same or earlier income year under the Plan.

Question 5

Part IVA of the ITAA 1936 is a general anti-avoidance provision. It gives the Commissioner the discretion to cancel a tax benefit that has been obtained, or would but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

The following requirements must be met before the Commissioner can make a determination under subsection 177F(1) of the ITAA 1936:

(a) a ‘tax benefit’, as defined in section 177C of the ITAA 1936, was or would (but for subsection 177F(1) of the ITAA 1936) have been obtained;

(b) the tax benefit was, or would have been, obtained in connection with a ‘scheme’ as defined in section 177A of the ITAA 1936; and

(c) having regard to section 177D of the ITAA 1936, the dominant purpose of the scheme was to obtain a tax benefit.

In the present case, the Plan constitutes a ‘scheme’ for the purposes of section 177A of the ITAA 1936. The deductions claimed by the Company are tax benefits under subsection 177C(1) of the ITAA 1936. However, it cannot be objectively concluded that the scheme was entered into for the dominant purpose of enabling the Company to obtain the tax benefits.

Therefore, the Commissioner will not make a determination under subsection 177F(1) of the ITAA 1936 to deny, in part or full, any deduction claimed by the Company for the irretrievable contributions made to the Trustee of the Trust to fund the subscription for, or acquisition on-market of, Shares by the Trustee, or costs incurred by the Company in relation to the implementation and on-going administration of the Plan and the Trust.

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