Edited version of private advice

Authorisation Number: 1051771039672

Date of advice: 23 October 2020

Ruling

Subject: Employee share trusts

Question 1

Is Trust A ('the Trust') an employee share trust as defined in subsection 130-85(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will section 130-90 of the ITAA 1997 apply to disregard any capital gain or capital loss made by the Trust as a result of capital gains tax ('CGT') events E5 or E7 where the Participant is a foreign resident for tax purposes during the vesting period and the Participant acquires the share for the same or less than the cost base of the share in the hands of the Trustee?

Answer

Yes

This ruling applies for the following periods:

Income tax year ended 30 June 20xx

Income tax year ended 30 June 20xx

Income tax year ended 30 June 20xx

Income tax year ended 30 June 20xx

Income tax year ended 30 June 20xx

Relevant facts and circumstances

The Company

The Company is an Australian public company whose shares are listed for trading on the ASX. It has one class of shares on issue, namely ordinary shares.

The Company is the head company of an income tax consolidated group ('TCG'). The Company has foreign subsidiaries (together, 'the Group').

The Company and members of the Group are not involved predominantly in the business of acquiring, selling or holding shares, securities or other investments.

The Plan

The Company established an ESS Plan ('the Plan').

The Plan is part of the Company's global remuneration framework which is designed to attract, retain, motivate and reward high performance individuals with the key skills required by the Company and its related body corporate to undertake their daily activities and to align the interests of these Participants with the interests of the Company and shareholders.

The Plan provides the following types of awards as long-term incentive to Participants:

i. Options

ii. Performance Rights, and

iii. Service Rights.

The Options, Performance Rights and Service Rights (collectively referred to as 'Awards') are over ordinary shares in the company.

Awards under the Plan can be made to employees, officers and directors of the Company or a related body corporate ('Participants').

Awards made under the Plan are provided to both Australian resident and foreign resident employees of the Group. (Amounts paid to foreign resident employees by overseas Group members for work performed overseas are not subject to PAYG withholding obligations under Schedule 1 to the Taxation Administration Act 1953.)

Awards under the Plan are also provided to employees, officers and directors of foreign resident contractors who work for foreign subsidiaries of the Group, but are employed by third-party payroll providers. These contractors' employees, officers and directors do not have Awards provided to them through the Trust and are not included in this ruling.

When shares are provided to employees of overseas Group members, the Company has a policy which permits the company to charge a fee to the overseas Group employer for the provision of the shares to the foreign resident employee.

Options are issued for nil consideration with various exercise prices. Performance Rights are issued for nil consideration and may not have an exercise price. Service Rights are issued for nil consideration and do not have an exercise price.

The Options, Performance Rights and Service Rights are issued subject to performance hurdles or continued service requirements. The Participant cannot exercise the Award and may risk losing the Options, Performance Rights or Service Rights until the conditions are met.

The Company has confirmed that any cash payment to Participants with respect to any Cash Rights will be paid by the Company directly to the Participant. Such payment will not be made via the Trust.

The Company will have ongoing administration costs with respect to the Plan. Ongoing administration costs are paid directly by the Company, not by the trustee of the Trust ('the Trustee'). These include:

·         preparation of income tax returns

·         ASIC fees

·         Preparation of accounts and audit

·         Accounting services

·         Obtaining legal advice

The Trust

At establishment of the Plan, the Company established the Trust to assist with the administration of the Plan.

The Trust is established for the sole purpose of obtaining Shares for the benefit of Participants, including subscribing for or acquiring, allocating, holding and delivering Shares under the Plans for the benefit of Participants.

The Company arranges for the Trustee of the Trust to subscribe for newly issued Shares or to purchase Shares on or off market so that the Shares can be provided to Participants on exercise of the Options, Performance Rights or Service Rights in accordance with the Plans.

The off-market share acquisitions are contemplated being valued using a value-weighted average price ('VWAP') method or through independent valuation. The valuation of shares acquired off-market will not exceed market value.

The Company is required to make cash contributions to the Trust for the price of the shares.

The contributions by the Company or any Associated Company constitute accretions to the corpus of the Trust and will not be repaid to the Company.

Neither the Company nor any member of the Group (including the Trustee) are entitled to obtain any beneficial interest in the Trust Assets, other than in respect to the Trustee's right of indemnity.

No specific Participant is entitled to receive any funds from the corpus of the Trust or Net Income of the Trust.

The contribution by the Company to the Trust is made at the time the Company directs the Trustee to purchase the shares, which may be in advance of the time any Participant exercising their Options or Rights.

The Trustee has the power to reinvest dividends and participate in or decline to participate in Share entitlements. 'Share entitlements' means a right to a share or an option to acquire such a right.

Upon exercise of Options, Performance Rights or Service Rights by Participants, the Company determines how many Shares are to be issued and then confirms this number to the Trustee. The Shares may continue to be held by the Trustee post exercise on behalf of the employee or they may be delivered by the Trustee to Participants upon request by the Participant and approval by the Company.

The Trust Deed determines how the Trustee is to deal with any Shares held in the Trust.

Subject to the Trust Deed and the Plan Rules, the Trustee in its discretion has the full power to do all things a trustee is permitted to do by law in respect of the Trust and the Trust Assets. The Trust Deed confirms that Company and the Trustee agree that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' as defined in section 130-85(4) of the ITAA 1997.

The limitations on Trustee are outlined in the Trust Deed.

Termination of the Trust disallows Trust Assets to be returned to the Company or member of the Group on winding up of the Trust.

Neither the Company nor any member of the Group is a beneficiary of the Trust.

Reasons for decision

All references to legislation refer to the Income Tax Assessment Act 1997.

Question 1 Detailed Reasoning

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) in relation to the employee's employment.

Subsection 130-85(4) provides that an employee share trust for an 'employee share scheme' has the meaning given by subsection 83A-10(2):

An employee share scheme 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).

Company A EST Trust ('the Trust') obtains the Company shares to satisfy the obligations of the Options, Performance Rights and Service Rights according to the Company A ESS Plan ('the Plan') to Participants who are employees of the Company. The Options, Performance Rights and Service Rights provided in the Plan are ESS interests because they are beneficial interests in rights to acquire beneficial interests in shares in the Company. Therefore, the requirements of (a) and (b) in 130-85(4) are satisfied.

The Commissioner's view on merely incidental activities is provided in TD 2019/13 Income tax: what is an 'employee share trust'? ('TD 2019/13'). Paragraph 6 of TD2019/13 states that when testing whether a trust satisfies the definition in 130-95(4) it is necessary to examine the activities actually undertaken by the trustee.

TD 2019/13 provides examples of activities that are merely incidental at paragraph 12, and examples of activities that are not merely incidental at paragraph 13.

The Company A EST Trust Deed ('the Trust Deed') provides the general power to allow the Trustee to 'do all things a trustee is permitted to do so by law in respect of the Trust, the Plan Shares and the Trust Assets', and includes a list of such activities.

Upon consideration of the activities described within the Trust Deed, it can be concluded that none of the activities described fit the description of activities that are not merely incidental in paragraph 13 of TD 2019/13.

Further, it is noted that the Trust Deed requires the Trustee to manage and administer the Trust so that the Trust satisfies the definition of 'employee share trust' in subsection 130-85(4).

It can be concluded that the Trust is an employee share trust as defined in subsection 130-85(4).

Question 2 Detailed Reasoning

CGT Event E5

Pursuant to section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens.

Under subsection 104-75(1), CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee.

The time of the event is when the beneficiary becomes absolutely entitled to the asset according to subsection 104-75(2).

If CGT event E5 happens, the trustee may make a capital gain or capital loss if the market value of the asset, at the time of the event, is more than its cost base or less than the asset's reduced cost base respectively. The trustee makes a capital loss under subsection 104-75(3) if that market value is less than the asset's reduced cost base.

In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies.

Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (TR 2004/D25) explains the principles set out in the leading English trust law case of Saunders v. Vautier (1841) 49 ER 282 in relation to 'absolutely entitled' as follows:

... if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway.

A Participant (including foreign resident employees of the Company and the Group) will become absolutely entitled to the Options, Performance Rights and Service Rights, in accordance with the Plan Rules, the Options sample, Performance Rights sample and Service Rights sample, when the Options, Performance Rights and Service Rights have vested. On a Participant electing to exercise vested Awards, the Company will allot shares to the Participant. The Participant has the right to request the Trustee to transfer the Shares into their name and deal with the Shares at their own will. At this point, the Participant will become absolutely entitled to the Shares as against the Trustee, and CGT event E5 happens pursuant to subsection 104-75(1).

However, any capital gain or loss that the Trustee makes from CGT event E5 is disregarded if section 130-90 applies.

Section 130-90 states:

130-90(1A) [...]

130-90(1) Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if:

(a)  the CGT event is CGT event E5 or E7; and

(b)  the CGT event happens in relation to a *share; and

(c)   the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d)  the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

(2) Subsection (1A) or (1) does not apply if the beneficiary acquired the beneficial interest in the *shares for more than its *cost base in the hands of the *employee share trust at the time the *CGT event happens.

Therefore, to qualify for the exemption in section 130-90, there must be an 'employee share trust' and an 'ESS interest'.

As previously discussed under Question 1, the Trust satisfies the definition of 'employee share trust' in subsection 130-85(4) and the granting of Options, Performance Rights and Service Rights that may be exercised to acquire shares in the Company under the Plan to the Participants (including foreign resident employees of the Company and the Group) falls within the definition of an 'ESS interest' in subsection 83A-10(1).

The Options, Performance Rights and Service Rights granted under the Plan are ESS interests to which Subdivision 83A-B or 83A-C applies because the Participants (including foreign resident employees of the Company and the Group) acquire the ESS interests under an employee share scheme for nil consideration, which are at discount.

As such, any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening is disregarded by virtue of section 130-90(1).

Note that subsection 130-90(1) does not apply if the beneficiary acquired the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time CGT event E5 happens (subsection 130-90(2)).

CGT Event E7

CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest or part of it, in the trust capital (section 104-85). The timing of the event is when the disposal occurs (subsection 104-85(2)).

If CGT event E7 happens, the trustee may make a capital gain if the market value of the asset, at the time of the disposal, is more than its costs base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base (subsection 104-85(3)).

When the Trustee transfers a share to a Participant when vesting conditions are met in satisfaction of its obligation under the Trust Deed and Plan Rules, CGT event E7 will occur pursuant to section 104-85 and any capital gain or loss will generally be assessed for CGT purposes to the Trustee.

However, section 130-90 applies to disregard any capital gain or loss arising as a result of the shares being disposed of by the Trustee to the Participant under CGT event E7 if the Trust is an employee share trust and the Shares are an ESS interest. As discussed above, these two conditions are met in the present circumstances.

Consequently, section 130-90 will apply to disregard a capital gain or capital loss that arises for the Trustee at the time CGT event E7 happens if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee.

Conclusion

Any capital gain or loss made by the Trustee of the Trust arising as a result of either CGT Event E5 or CGT Event E7 will be disregarded under section 130-90.

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).