Edited version of private advice

Authorisation Number: 1051745376622

Date of advice: 11 September 2020

Ruling

Subject: Cancellation of options

Question 1

Does the cancellation of the options held by you give rise to CGT event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) in the 20XX income year?

Answer

Yes

Question 2

Is the capital gain that results from CGT event C2 able to be discounted under Division 115 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were first granted options to acquire shares in Company X in the 20XX income year.

In 20XX, Company Y as trustee for Y Trust, Company Z as trustee for Z Trust and Individual X (collectively the founding shareholders) and you entered into an option agreement (the First Option Agreement).

This granted you an option to purchase from all shareholders with effect from the date of this letter so many shares equal to 2% of all the issued shares in Company X (1/3 of 2% from each of the shareholders) at the date of exercise of the option

In 20XX, Y Trust and Individual X (being two of the three Founder Shareholders) entered into a second option agreement (the Second Option Agreement) with you granting you the option to purchase additional shares in Company X.

You have further advised in your application that the Second Option Agreement was as follows:

This granted you an option to purchase from the shareholders who are parties to this agreement, 1% of all the issued shares in Company X (i.e. each of the 2 shareholders will sell as many of their shares to you as are required so that the total number of shares sold by each shareholder equals 1/5 of 1% of the total issued shares of Company X at the date of exercise of the option.

In 20XX, the First Option Agreement was amended to vary the exercise date to XX XXXX 20XX. All other terms of the First Option Agreement did not change materially.

In 20XX, the terms of the First Option Agreement were again amended to include a partial buyback of a portion of the Options.

In 20XX the Founder Shareholders entered into a Share Purchase Agreement (SPA) with a subsidiary of Company Z to dispose of the shares in Company X.

Under an Option Cancellation Deed (the Cancellation Deed) dated XX XXXX 20XX, the First Option Agreement and the Second Option Agreement were cancelled in exchange for consideration payable by the relevant Founder Shareholders on completion of the SPA.

On XX XXXX 20XX, you, the Founder Shareholders and Company X entered into a Deed of Agreement to record, "for the sake of good order", that it had been agreed, prior to XX XXXX 20XX, that the 'Lapse Condition' of the Second Option Agreement should be extended.

As a result of the extension, the option would consequently lapse on the earlier of cessation of negotiations with Company Z in relation to the SPA (if the SPA was not entered into), completion or termination of the SPA (if the SPA was entered into) on XX XXX 20XX.

You were an Australian resident for income tax purposes at all times since holding the options in Company X granted under the First Option Agreement and the Second Option Agreement.

Assumptions

All the options were ESS interests.

Subdivision 83A-B of the ITAA 1997 applies in relation to the ESS interests and Subdivision 83A-C does not apply.

The options were issued with a market value greater than $1.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 83A-30

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 115-10

Reasons for decision

Detailed reasoning

Cancellation of options

Under section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) you make a capital gain or capital loss as a result of a CGT event.

Section 104-25 of the ITAA 1997 provides CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being cancelled. The time of the event is:

(a)  when you enter into the contract that results in the asset ending; or

(b)  if there is no contract - when the asset ends.

You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

CGT event C2 occurred when you entered into the option cancellation deed in the 20XX income year.

ESS interest

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.

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.

Your assessable income for the income year in which you acquire the ESS interest includes the discount given in relation to the interest. This is the case if Subdivision 83A-C does not apply to your circumstance, which it doesn't in this instance.

Since there is an ESS interest, section 83A-30 is relevant. It states that the ESS interest is taken to have been acquired for its market value (rather than its discounted value). This means that the cost base is likely to reflect the market value of the option at the date of grant.

50% discount

Under section 115-10 of the ITAA 1997, to qualify for the 50% general discount a capital gain must be made by an individual, a complying superannuation entity, a trust or a life insurance company. The capital gain must result from a CGT event happening after 11:45am on 21 September 1999 and must not have an indexed cost base. Also, the gain must result from a CGT event happening to an asset that was acquired at least 12 months before the CGT event.

You have held all options for more than 12 months; you are an individual and the CGT event occurred after 11:45am on 21 September 1999. Therefore, you are entitled to discount a capital gain that results from the cancellation of your options by 50%.

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