Edited version of your written advice

Authorisation Number: 1051448304157

Date of advice: 21 November 2018

Ruling

Subject: Fringe benefits tax – employee share loan benefit

Question

Do the loans fall within the definition of ‘employee share loan benefit’ under section 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) such that the taxable value of each loan fringe benefit is reduced to nil under section 19?

Answer

No. Although the loans fall within the definition of ‘employee share loan benefit’ under section 136(1), section 19 will not operate to reduce the taxable value of the fringe benefit.

This ruling applies for the following period:

31 March 20XX

The scheme commences on:

1 April 20XX

Relevant facts and circumstances

The Company is a public company.

The Company has offered certain employees the opportunity to participate in an Equity Plan (the Plan).

Under the rules of the Plan, participant employees are offered options to acquire shares in the Company at a predetermined price subject to satisfying the relevant vesting conditions and the payment of the relevant fee and exercise price.

A fee is payable to acquire the options. The Company advances a loan to each participant to fund the fee payable to acquire the options. The loans are interest-free and limited recourse.

The fee is equal to the market value of the options as determined by the income tax regulations in Division 83A oaf the Income Tax Assessment Regulations 1997.

The options lapse if not exercised. The options are not transferable.

The options are beneficially owned by the employees at all times when the loans are outstanding.

The Company has a history of paying dividends on its shares.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 section 19

Fringe Benefits Tax Assessment Act 1986 section 136(1)

Reasons for decision

Summary

The loans fall within the definition of employee share loan benefit under section 136(1). However, as any interest that would accrue on the loan to purchase options is considered preliminary to the derivation of any assessable income, any interest on the loans would not be deductible. Therefore, the taxable value of each employee share loan benefit will not be reduced under section 19(1)(b).

Detailed reasoning

An employee share loan benefit is defined in section 136 of the Fringe Benefits Tax Assessment Act 1986 as:

… in relation to a year of tax, means a loan fringe benefit in relation to an employee in relation to an employer in relation to the year of tax where:

(a) the sole purpose of the making of the loan is to enable the employee to acquire shares, or rights to acquire shares, in a company, being:

(i) the employer; or

(ii) an associate of the employer; and

(b) the shares or rights were beneficially owned by the employee at all times during the period during the year of tax when the employee was under an obligation to repay the whole or any part of the loan.

A loan fringe benefit is defined in section 136(1) as ‘a fringe benefit that is a loan benefit.’ Section 136(1) states that a ‘loan benefit means a benefit referred to in subsection 16(1)’, which provides:

Where a person (in this subsection referred to as the provider ) makes a loan to another person (in this subsection referred to as the recipient ), the making of the loan shall be taken to constitute a benefit provided by the provider to the recipient and that benefit shall be taken to be provided in respect of each year of tax during the whole or a part of which the recipient is under an obligation to repay the whole or any part of the loan.

The loan provided clearly fits within the definition of loan benefit. It must also satisfy the definition of a fringe benefit to be a loan fringe benefit.

Section 136(1) relevantly provides that a fringe benefit includes benefits provided to an employee by their employer in respect of their employment but does not include certain loans within the meaning of section 109D of the ITAA 1936. As the Company is a public company, section 109D has no application. Thus, the loan benefit is a fringe benefit.

As the loan is made for the sole purpose of enabling the employee to acquire rights to acquire shares in the Company, which is the employer of the employee, and the rights are beneficially held by the employee at all times during which they are under an obligation to repay the loan, the loan is considered to be a share loan benefit.

Section 18 provides that the taxable value of a loan fringe benefit is the amount by which the notional amount of interest exceeds the amount of interest that has accrued on the loan in respect of the year of tax. In this case, this would be the entirety of the notional amount of interest, as no interest has accrued on the loan.

However, section 19 provides for reductions in the taxable value. Relevantly, subsection 19(1) provides that the taxable value of a loan fringe benefit may be reduced to the extent that the employee would be entitled to an income tax deduction for interest paid on the loan. Subsection 19(1) relevantly provides that the taxable value may be reduced where:

(a) the recipient of a loan fringe benefit in relation to an employer in relation to a year of tax is an employee of the employer; and

(b) if the recipient had, on the last day of the period (in this subsection called the loan period) during the year of tax when the recipient was under an obligation to repay the whole or any part of the loan, incurred and paid unreimbursed interest (in this subsection called the gross interest), in respect of the loan, in respect of the loan period, equal to the notional amount of interest in relation to the loan in relation to the year of tax - a once-only deduction (in this subsection called the gross deduction) would, or would if not for section 82A of the Income Tax Assessment Act 1936, and Divisions 28 and 900 of the Income Tax Assessment Act 1997, have been allowable to the recipient under either of those Acts in respect of the gross interest; …

The deductibility of interest expense on loans to acquire shares has been considered in Taxation Ruling IT 2606 Income Tax: Deductions for Interest on Borrowing to Fund Share Acquisitions (IT2606). Paragraph 9 of IT 2606 states:

As a general rule, interest on money borrowed to acquire shares will be deductible under the first limb of subsection 51(1) (now section 8-1 of the ITAA 1997) where it is expected that dividends or other assessable income will be derived from the investment. Such an expectation will usually exist as shares by their very nature are inherently capable of generating dividends, whether in the short or long term. However, such an expectation must be reasonable and not a mere theoretical possibility; there must be a prospect of dividends or other assessable income being received.

(emphasis added)

In relation to options, Taxation Ruling TR 2004/4 – Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities relevantly explains at paragraph 33:

In the following examples, the outgoing incurred would not be deductible because the outgoing is incurred 'too soon', 'preliminary' or a 'prelude':

…

n interest incurred on a loan used to purchase options to acquire shares as the options do not give rise to an entitlement to dividends. Although the options may be converted into shares at a later date, from which dividends may be expected, the interest expense is considered to be both preliminary to and remote from any possible derivation of assessable income.

(emphasis added)

Thus, the Commissioner considers that the interest expense would be both preliminary to and remote from any possible derivation of assessable income. Therefore, the interest on the loan would not be an allowable deduction under section 8-1 of the ITAA 1997.

Thus the otherwise deductible rule in section 19 FBTAA will not apply.

Section 19 of the FBTAA will not apply to reduce the taxable value of the employee share loan benefit.

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