Edited version of private advice

Authorisation Number: 1051788356648

Date of advice: 8 December 2020

Ruling

Subject: Employee share trust

Question 1

Will the Commissioner of Taxation seek to apply Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) to deem as a dividend the cash contribution made by the Company to the Trustee of the Trust to fund the subscription for, or acquisition from existing shareholders, of shares in the Company to enable the Trustee to provide those shares to employees under the terms of the Company's employee share ownership plan?

Answer

No

Question 2

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

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 202X

Year ended 30 June 202Y

Year ended 30 June 202Z

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

The XYZ Employee Share Trust ('Trust') has been established by XYZ Pty Limited ('Company') an Australian private company for the sole purpose of obtaining fully paid ordinary shares in the Company for the benefit of eligible individuals under the Company's Employee Share Ownership Plans ('Plans').

All eligible individuals (the Participants) permanently live and work in Australia. The Plans are part of the Company's remuneration framework which is designed to attract, retain, motivate and reward high performance individuals with the key skills required by the Company to undertake its daily activities and to align the interests of these participants with the interests of the Company and shareholders.

The Plans provides long term incentive awards to the Participants in the form of Options and Rights over the Company's' ordinary shares (Shares). The Plans rules provide flexibility for the Options to be issued with various exercise prices, including nil and at a premium. Rights do not have an exercise price.

All Options issued under the Plans are treated by the Company as ESS interests under Division 83A of the ITAA 1997 and either Subdivision 83A-B or 83A-C of the ITAA 1997 is applied to determine their tax treatment.

The grant of Options and Rights do not confer a right to vote until the option or rights vests, have been exercised and the share issued to the participant.

The vesting of some Options and all Rights are subject to performance hurdles or continued service period. Where the vesting conditions are satisfied, the awards will vest.

The Company will generally arrange for the Trustee of the Trust to subscribe for or purchase Shares to be provided to Participants on exercise of Options in accordance with the Plans.

To make good its obligations under the Trust Deed to meet all costs incurred by the Trustee in facilitating the Plans, the Company will make cash contributions to the Trust for the price of the shares. The contributions will be made at the time the Company directs the Trustee to purchase the shares for provision to the Participants. No contributions will be made until after the employees have been issued with an ESS interest in the company.

Upon exercise of Options and Rights by Participants, the Company will, in compliance with the Plan Rules and the exercise notice, determine how many Shares are to be issued and then, where applicable, give instruction to the Trustee. The Shares can then either continue to be held on behalf of the Participant in the Trust or they can be delivered by the Trustee to Participants.

The Trust will be governed by two key documents, as at the time of this ruling:

•         the trust deed for the trust, including variations to the trust deed (the Trust Deed);

•         the Company's Plan rules ('Plan Rules').

The Trust Deed

The Company has established the Trust for the purpose of operating in connection with the Company's employee Option Plans which are made available by the Company to employees from time to time. The Trustee has agreed to act as trustee of the Trust and to receive funds from the Company and apply the funds as set out in the Trust Deed. The Trustee is to deal with any Shares held in the Trust as set out in the Trust Deed.

The stated purpose of the Trust as outlined in item B of the Introduction to the Trust Deed, is for the sole purpose of subscribing for, acquiring and holding Shares for the benefit of Participants under the Plans

Subject to the Trust Deed and the terms of the Plans, 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 limitations on the Trustee are outlined in the Trust Deed.

On the termination of the trust, no amount can be paid to the benefit of the company.

Relevant legislative provisions

Division 7A Income Tax Assessment Act 1936

Subsection 130-85(4) Income Tax Assessment Act 1997

Reasons for Decision

These reasons for decision accompany the Notice of private ruling for XYZ Employee Share Trust.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

The payments made by the Company to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936. Pursuant to s109ZB ITAA 1936, the payments made to the Trustee of the Trust in accordance with the Plans and the Trust Deed, enabling Trustee to purchase Shares to hold for the purposes of exercising its obligations under the Trust Deed will be payments made to the Trust in its capacity as an associate of an employee being the relevant Participant in the Plan.

Detailed reasoning

Subdivision B of Division 7A of Part III of the ITAA 1936 ('Division 7A') treats certain payments, loans and debt forgiveness made by a private company to a shareholder (or their associate) as a dividend paid by the company.

Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or

(b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time

Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is the amount paid, subject to the private company's distributable surplus calculated under section 109Y of the ITAA 1936.

'Entity' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by subsection 960-100(1). An entity includes the trustee of a trust (subsection 960-100(2)).

Payments made to the Trustee of the Trust would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Shares at the time the contribution is made.

However, Division 7A does not apply to a payment made to a shareholder, or an associate of a shareholder, in their capacity as an employee (as defined in the FBTAA) or an associate of such an employee by virtue of subsection 109ZB(3) of the ITAA 1936.

'Associate' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by section 318 of the ITAA 1936. An 'associate' of a natural person (other than in the capacity of trustee) includes a trustee of a trust where the individual benefits under the trust.

In this case, the Trustee of the Trust is an associate of any employees of the taxpayer that are Participants in the Plans as they are beneficiaries under the Trust.

The Commissioner accepts that the payments made to the Trustee of the Trust in accordance with the Plan and the Trust Deed, enabling Trustee to purchase Shares to hold for the purposes of exercising its obligations the Trust Deed will be payments made to the Trust in its capacity as an associate of an employee being the relevant Participant in the Plan, under s109ZB of the ITAA 1936.

As such, the payments made by the Company to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936.

Question 2

Summary

The XYZ Share Trust is an employee share trust as defined in subsection 130-85(4) ITAA 1997. The Trust Deed provides for the Trustee to act for sole activities in accordance with ss130-85(4).

To continue to qualify as an employee share trust the contemporaneous activities of the Trustee must be limited to those activities described in paragraphs 130-85(4)(a), (b) and (c).

Detailed reasoning

An employee share trust is defined in subsection 130-85(4) as 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)

An ESS interest, in a company, is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company or the right to acquire a beneficial interest in a share in the company.

An employee share scheme is defined in subsection 83A-10(2) as 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 employees' employment. For the purposes of this subsection, section 995 defines the term 'scheme' as any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The Company has established the Trust (under the Trust Deed) to facilitate the Plan by acquiring Shares and allocating those Shares to Participants, in order to satisfy the Options acquired under the employee share scheme.

In this case, the ESS interests are the Options granted to the Participants of the Option Plan.

The right to acquire beneficial interest (Options to acquire) the Company's shares is provided under an employee share scheme to the Participant in relation to the Participant's employment, as defined in subsection 83A-10(2).

The Trust will be an employee share trust as defined in subsection 995-1(1), to the extent the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraph 130-85(4)(a) and paragraph 130-85(4)(b).

TD 2019/13: Income tax: what is an 'employee share trust'? provides guidance on when a trust will be an employee share trust. TD 2019/13 states:

When testing whether a trustee of a trust (in that particular capacity) meets the requirements of subsection 130-85(4), it is necessary to examine the actual activities that the trustee has undertaken. Whilst the relevant trust documents may include powers and/or duties that are broad reaching, the mere existence of those powers or duties in the trust documents does not, of itself, mean that the trustee has breached the requirements to be an employee share trust.

To qualify as an employee share trust, a trustee's activities must be limited to those described in paragraphs 130-85(4)(a), (b) and (c).

TD 2019/13 also outlines the activities that would be considered as 'merely incidental' purposes of s130-85(4)(c):

Activities are merely incidental under paragraph 130-85(4)(c) if they are a natural incident or consequence of the trust obtaining, holding and providing shares or rights under an ESS. If the activities undertaken by the trustee are not a natural incident or consequence of obtaining, holding and providing shares or rights under an ESS, or if the activity is undertaken for or follows from some other purpose, such activities are not merely incidental.

The Commissioner is also satisfied that cash contributions payments made by Company to the Trustee are for the sole purpose of procuring the Company's shares for the benefit of Participants in accordance with the Trust Deed and in connection with the Plans. The Commissioner is also satisfied that the powers under the deed are limited to activities that are merely incidental in supporting the sole purpose of the Deed. The Trust Deed provides:

•         Recital A. The Company has established the XYZ Group Share Plans ("Plan") pursuant to the Rules under which certain Employees may be granted the opportunity to acquire Shares in the Company.

•         Recital B. The Company wishes to establish a trust for the sole purpose of subscribing for, acquiring and holding Shares for the benefit of Participants under the Plan, previous plans, and successor plans, to be known as the XYZ Employee Share Trust.

•         Clause 1.1 Purpose. The Plan operates with the sole purpose of providing Participants with an opportunity to acquire beneficial ownership of Shares in the Company.

•         Clause 5.3. On and from the commencement of the Plan, subject to Clause 5.4, the Company or any Associated Company may pay to the Plan Trustee contributions to fund the subscription or acquisition of Shares for the purposes of the Plan as determined by the Board from time to time.

•         Clause 5.4. The Plan Trustee must use such contributions to acquire Shares in the ordinary course of trading on the ASX or by off-market purchase or subscribe for new Shares issued by the Company, as directed from time to time by the Board and may do so either prior to or on or after the Exercise Date applicable to Plan Shares. Under no circumstances may the Plan Trustee repay to the Company or any Associated Company any amount received as contributions for the subscription or acquisition of Shares.

•         Clause 5.9. The Plan Trustee must not hold fractions of Shares. Any Shares remaining after the allocation of whole Shares to a Participant may be retained by the Plan Trustee pending future allocation when Plan Shares are exercised and are to be settled in Shares. If the Plan Trustee sells Shares then under no circumstances may the Plan Trustee pay these proceeds of sale or other remaining funds to the Company or any Associated Company.

•         Clause 5.17. The Company has no proprietary right or interest, charge or lien in the shares acquired by the Trustee under this Deed, or income generated from those Shares, and the Company cannot acquire a beneficial interest in the assets of the Trust, including upon termination of the Trust.

•         Clause 13.3. Where the Plan and Trust is terminated the balance of the capital of the Trust (if any) to which no Participant is entitled in accordance with (a) above must be applied by the Plan Trustee at the direction of the Board, in whole or in part for the benefit of one or more of the following as the Trustee considers appropriate:

a)    a provident, benefit, superannuation or retirement fund established and maintained by the Company or any associate of the Company

b)    in any other manner that would not result in the Trust ceasing to be an employee share trust within the meaning of subsection 130-85(4) of the Tax Act.

•         Clause 13.4. For the avoidance of doubt, on termination of the Trust, no amount can be paid to the benefit of the Company.

•         Clause 19.7. The powers conferred on the Plan Trustee by Law or under this Deed may only be exercised for the purposes of the Trust and the plan.

The Trust will be an employee share trust under subsection 130-85(4) of the ITAA 1997. Notwithstanding this, to continue to qualify as an employee share trust the contemporaneous activities of the Trustee must be limited to those activities described in paragraphs 130-85(4)(a), (b) and (c).

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