Edited version of private advice

Authorisation Number: 1051528875944

Date of advice: 12 June 2019

Ruling

Subject: Employee option plan

Question

Will the Commissioner confirm that, in respect of options (Options) granted to an employee participant (Participant) under the Employee Option Plan (Plan) who ceases employment with the taxpayer and retains unexercised Options, that the taxpayer is required under section 392-10 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) to provide a statement to the Commissioner and to the Participant in the circumstances outlined in that section within 30 days of the Options being exercised and the taxpayer deciding to satisfy that exercise by issuing ordinary shares?

Answer

Yes

This ruling applies for the following period

1July 2018 until 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Background

The taxpayer is an Australian private company for the purpose of the Corporations Act 2001.

The taxpayer introduced the Plan as part its employee incentive and retention plans. Under the Plan, the taxpayer grants Options to certain eligible employees in respect of their employment with the company.

The operation of the Plan is governed by the Plan Rules (Plan Rules).

According to Clause X of the Plan Rules, the taxpayer has the complete power and discretion in respect of the following:

·  Selecting the persons to participate in the Plan;

·  Determining the terms and conditions of any offer including:

                      I.        The number of Options under an offer;

                    II.        The purchase price for those Options;

                   III.        The exercise price of the Options;

                  IV.        Any trustee or nominee holding arrangements required to be entered into in connection with those Options;

                    V.        The vesting, disposal and forfeiture restrictions applying to those Options; and

                  VI.        The manner in which the offer may be accepted.

·  Amending an offer;

·  Determining appropriate procedures, regulations and guidelines for the administration of the Plan;

·  Taking advice in relation to the exercise of any of its powers.

Clause X of the Plan Rules states in relation to the vesting of Options:

a)    An Offer may specify any:

1)    vesting conditions; or

2)    other vesting events,

which must be satisfied before an Option vests.

b)    The Board may, in its discretion, determine or vary any:

1)    vesting conditions; or

2)    other vesting events,

in respect of any Option

c)    If vesting conditions or other vesting events are not specified in an Offer the following vesting conditions apply to any Options offered under the Employee Option Plan:

1)    Options:

A.    only vest while the eligible persons remains employed with a Company Group Member or acts as a director of a Company Group Member (as applicable); and

B.    cease to vest for the duration any unpaid leave of absence (Unpaid Leave Period), such that any vesting dates occurring after the Unpaid Leave period are delayed by a period equivalent to the Unpaid Leave Period;

2)    Options vest:

A.    In respect of 25% of the Options the subject of an Offer, on the date which is 12 months after the issue date of the Option (Year1); and

B.    In respect of the remaining 75% of the Options the subject of the Offer, on a yearly basis over 3 year period after the end of Year 1.

Options only vest if vesting conditions/events satisfied:

d)    An Option will only vest on the occurrence or satisfaction of the condition or other vesting events specified in respect of that Option.

How to exercise an Option

e)    An Option holder may exercise an Outstanding Option during the Exercise Period or, with the Board's explicit consent, an unvested Option prior to the Expiry Date by:

1)    Giving the Company a signed Notice; and

2)    Paying the Exercise Price multiplied by the number of Options being exercised.

Participation in the Plan is open to eligible employees, who are defined as employees or salaried directors of one or more members of the taxpayer selected by the Board to participate in the Plan.

Participants are not required to provide any consideration for the acquisition of the Options.

Once the Option has vested, a Participant can exercise the Option, after which the taxpayer will issue the number of Shares being fully-paid shares, which corresponds to the number of Options.

Instead of issuing shares on exercise of the Options, the taxpayer has a discretion under the Plan to make a cash payment to the Participant, equal to the difference between the market value of the Shares on the exercise date and the exercise price, multiplied by the number of exercised Options (less any amount required by law to be withheld).

Clause X of the Plan Rules provides that the Board has absolute discretion in relation to Optionholder's Options when a Participant ceases employment with the taxpayer. The Board has discretion to cancel the Options, require the Options to be sold or allow the Participant to retain some or all of his or her Options.

Relevant legislative provisions

subsection 83A-10 (1) ITAA 1997

subsection 83A-10 (2) ITAA 1997

subsection 83A-25 (1) ITAA 1997

section 83A-35 ITAA 1997

section 83A-105 ITAA 1997

section 83A-110 ITAA 1997

section 83A-120 ITAA 1997

section 83A-330 ITAA 1997

section 83A-340 ITAA 1997

section 392-5 TAA 53

section 392-10 TAA 53

Reasons for decision

ESS interest

An ESS interest" in a company is defined in subsection 83A-10(1) of the ITAA 1997 to mean a beneficial interest in either:

(i) a share in the company; or

(ii) a right to acquire a beneficial interest in a share in the company.

Section 83A-340 of the ITAA 1997 states that, if a beneficial interest in a right is acquired and that right later becomes a right to acquire a beneficial interest in a share, Division 83A of the ITAA 1997 applies as if the right had always been a right to acquire the beneficial interest in the share (i.e. it is treated as having always been an "ESS interest").

Section 83A-340 of the ITAA 1997 provides the example of a right to acquire, at a future time, shares with a specified total value rather than a specified number of shares or rights to acquire an indeterminate number of shares. The right is treated as if it had always been an 'ESS interest" if and when itbecomes clear that itwill ultimately be satisfied by the issue of a definite number of shares.

The above is further explained in the EM at paragraphs 1.367 as follows:

At the time of acquisition it may be unclear whether a right to an employment benefit will result in the receipt of an ESS interest, or it may be unascertainable how many ESS interests will be received. In such circumstances, that right will be considered to have been an ESS interest from the time that the original right to an employment benefit was acquired, if and when it becomes clear that the right to the employment benefit will result in the receipt of a definite number of ESS interests.

Options granted under the plan represent a right to acquire shares or to receive a cash payment when the Options are exercised. Therefore, the Options will be 'indeterminate rights' under section 83A-340 and they will only be treated as ESS interests when the company decides to satisfy the exercise of the Options by issuing shares.

Section 83A-105 in Subdivision 83A-C of the ITAA 97 sets out the conditions that must be satisfied to be able to defer the inclusion in assessable income of any discount received on the acquisition of an ESS interest until the financial year in which the ESS deferred taxing point occurs. These conditions are as follows:

(i) the "ESS interest" is acquired at a discount under an "employee share scheme" (paragraph 83A-105(1)(a) and section 83A-20 of the ITAA 1997);

(ii) the employee is, at that time, employed by the company or a subsidiary of the company (paragraph 83A-105(1)(b) and subsection 83A-35(3) of the ITAA 1997);

(iii) all the "ESS interests" under the employee share scheme relate to ordinary shares (paragraph 83A-105(1)(b) and subsection 83A-35(4) of the ITAA 1997);

(iv) the predominant business of the company in which the "ESS interest" is acquired is not the acquisition, sale or holding of shares, securities or other investments or if it is, the employee is not employed by the company and employed by another company that is a subsidiary or holding company of that company, or a subsidiary of the holding company (paragraph 83A-105(1)(b) and subsection 83A-35(5) of the ITAA 1997);

(v) immediately after acquiring the "ESS interest", the employee does not hold a beneficial interest in more than 10% of the shares in the company or is not in a position to cast or control the casting of more than 10% of the maximum number of votes that might be cast at a general meeting of the company (paragraph 83A-105(1)(b) and subsection 83A-35(9) of the ITAA 1997);

(vi) if the ESS interest is a beneficial interest in a right to acquire a beneficial interest in a share, at the time the employee acquired the "ESS interest" there is a real risk of forfeiting or losing the right (other than by disposing of the right, exercising the right or letting the right lapse) or there is a real risk of forfeiting the underlying share (paragraphs 83A-105(1)(d) and 83A-105(3)(b) of the ITAA 1997).

The conditions in section 83A-105 of the ITAA 1997 are satisfied as follows:

(i) The Options are acquired under the Plan which constitutes an "Employee Share Scheme" for the purposes of subsection 83A-10(2) of the ITAA 1997 in that it is a scheme under which Options are provided only to employees of the company in relation to their employment;

(ii) the employees are not required to provide any consideration to acquire the Options. Options are therefore acquired at a discount under an "Employee Share Scheme" for the purposes of section 83A-20 of the ITAA 1997;

(iii) Options acquired under the employee share scheme are treated as rights of the employee to acquire fully paid ordinary shares in the company;

(iv) the predominant business of the company is not the acquisition, sale or holding of shares, securities or other investments;

(v) no employee will hold a beneficial interest in more than 10% of the shares of the company immediately after acquiring the Options, or be in a position to cast or control the casting of more than 10% of the maximum number of votes that may be cast at a general meeting of the company;

(vi) there is real risk of forfeiting the Options, for the following reasons.

The EM explains the real risk of forfeiture test at 1.156 as follows:

The 'real risk of forfeiture test' does not require employers to provide schemes in which their employee share scheme benefits are at a significant or substantial risk of being lost. However, real is regarded as something more than a mere possibility. Something is not a real risk if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility.

It is further explained at paragraph 1.158 of the EM that the 'real risk of forfeiture test' is intended to provide for deferral of tax when there is a real alignment of interests between the employee and employer, through the employee's benefits being at risk.

In order for the 'real risk of forfeiture test' to be satisfied, in relation to an ESS interest acquired by an employee under an employee share scheme, a reasonable person must consider that there is an actual possibility of forfeiture. Furthermore the risk of forfeiture must be 'real', not nominal, artificial or contrived. There must be more than a mere possibility.

In considering whether a condition in a scheme imposes a real risk of forfeiture, we will have regard to whether a reasonable person would consider that there is a genuine connection between the forfeiture condition and aligning the interests of the employee and employer.

We consider that a condition of an employee share scheme that imposes a minimum term of employment of at least 12 months provides more than a 'mere' or 'rare' possibility of forfeiture.

Under the Plan, the company has the discretion to permit employees who cease employment to retain the Options in special circumstances. The company confirms and the Commissioner accepts that the discretion will not be routinely exercised.

Therefore, we accept that there is a real risk that an employee will forfeit or lose their Options.

When the ESS deferred taxing point occurs

Section 83A-120 of the ITAA 1997 contains the rules for determining when the "ESS deferred taxing point" occurs for rights to acquire shares. This will be the earlier of the following times:

·  The time when the employee has not exercised the right and there is no real risk that, under the conditions of the employee share scheme, they will forfeit or lose the ESS interest. If at the time they acquired the ESS interest, the scheme genuinely restricted them from immediately disposing of the ESS interest- the scheme no longer so restricts them.

·  when the employee ceases the employment in respect of which they acquired the rights within the meaning of section 83A-330 of the ITAA 1997;

·  fifteen years after the employee acquired the rights;

·  when the employee exercises the right and there is no real risk that, under the conditions of the employee share scheme, they will forfeit or lose the ESS interest. If at the time they acquired the ESS interest, the scheme genuinely restricted them from immediately disposing of the ESS interest- the scheme no longer so restricts them.

If a Participant ceases employment with the company and retains their Options, and the Participant has not exercised the Options, Division 83A has no application. Therefore, there will not be an 'ESS deferred taxing point'.

Once the Options are exercised and the company issues shares, section 83A-340 of the ITAA 1997 will operate to treat the Options as having always been an 'ESS interest" with the consequence that a taxing point will be deemed to have occurred as at the time the Participant ceases employment with the company.

Reporting obligations

Section 392-5 of Schedule 1 to the TAA 1953 states that an entity must give a statement to the Commissioner and to an individual for a financial year if the entity provides an 'ESS interest' to the individual during the financial year or an ESS deferred taxing point for the interests occurs during the financial year and Subdivision 83A-C applies to the 'ESS interest'.

Paragraph 392-10(1)(b) states that the provider of an "ESS interest" must give the omitted information to the individual or the Commissioner if the provider becomes aware of a material omission in any information given to the individual or the Commissioner under this Division.

The EM provides an example when indeterminate rights to which section 83A-340 applies as giving rise to circumstances which would require a provider to comply with paragraph 392-10(1)(b), the EM states that:

if an employer becomes aware of an omission or change in any information provided to the Commissioner under the reporting requirements, such as it becomes clear that a right provided to an employee in a previous income year was a right to ESS interest, the employer must inform the Commissioner of any changes or omission as soon as possible.

When a Participant exercises the Options and the company decides to satisfy the Options by issuing Shares, the Participant will be deemed to have acquired an 'ESS interest' to which Subdivision 83A-C of the ITAA 1997 applies, and an 'ESS deferred taxing point' would occur as at the time they ceased employment with the company.

Accordingly, the company will be required to give the Commissioner and the Participant the information required under section 392-5 of Schedule 1 to the TAA 1953 in relation to the Options, and the information will need to be given no later than 30 days after the decision is made to issue shares to satisfy the exercise of the Options.

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