Edited version of private advice

Authorisation Number: 1051815654971

Date of advice: 22 March 2021

Ruling

Subject: Employee share trust

Question 1

Will the irretrievable cash contributions by the Company to the Trustee to fund the acquisition of, or subscription for the Company's shares by the Share Trust (the Trust) be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a capital gain or capital loss that arises for the Trustee at the time when either CGT Event E5 or E7 happens in relation to the Company's shares held by the Trustee be disregarded under section 130-90 of ITAA 1997 if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee?

Answer

Yes

Relevant facts and circumstances

The Company is the head company of a tax consolidated group composed of itself and other wholly owned Australian resident subsidiaries.

The Company has ordinary shares (Shares) listed on the Australian Securities Exchange.

The Company has established a remuneration strategy that supports and drives the achievement of its business strategy which is designed to attract, retain, motivate and reward employees of the business.

In addition to wages and salaries, the Company offers its employees short term and long term incentives under a number of plans (the Plans).

The Plans allow the Board to offer incentives to employees in the form of grants of Rights as described in the Plan Rules and the Plan Deeds.

The Company imposes conditions, including performance-related conditions, on the right of a Participant to exercise any Rights granted.

The Company established a share trust (the Trust) as a sole purpose trust for the purpose of acquiring, delivering, allocating, and holding shares in connection with equity incentive plans established by the Company for the benefit of Participants in those plans.

The Trustee of the Trust is an independent third party.

The Trust is an entity that allows the Company to carry out its incentive arrangements by providing capital management flexibility and a means to acquire the Company's shares on-market or to subscribe for new shares in the Company. The Trust provides an arm's length vehicle through which Shares can be acquired and held on behalf of employees. This aspect allows the Company to satisfy the requirements of the Corporations Law 2001 relating to companies dealing in their own shares.

Broadly, the Trust operates as follows:

•         The Trust will be funded by contributions from the Company or a subsidiary member of the tax consolidated group (e.g., for the purchase of Shares in accordance with the plans), and

•         Irretrievable cash contributions are made regularly and progressively to the Trust in accordance with the rules of the Plans and the Trust Deed.

Reasons for decision

Legislative references in this Ruling are to provisions of the ITAA 1997.

Question 1

Detailed reasoning

Section 6-5

Under subsection 6-5(1), assessable income includes income according to ordinary concepts, which is called ordinary income.

The irretrievable contributions made by the Company to the Trustee under the terms of the Plans are to be used for the sole purpose of obtaining shares in the Company for the benefit of Participants and they will constitute accretions to the corpus of the Trust. Accordingly, the irretrievable cash contributions constitute capital receipts to the Trustee of the Trust.

The irretrievable cash contributions made by the Company to the Trustee will not be included in the Trustee's assessable income under section 6-5 as ordinary income because the contributions are of a capital nature. Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

Section 6-10

Under subsection 6-10(1), assessable income includes some amounts that are not ordinary income and these are included by provisions about assessable income listed under section 10-5. However, none of the provisions listed in section 10-5 is relevant in the present circumstances.

In ATO Interpretative Decision ATO ID 2002/965, Income Tax - Trustee not assessable on employer contributions made to it under the employee share scheme, the Commissioner has expressed the view that the funds provided to the trustee of an employee share scheme trust constitute capital receipts to the trustee, and are not assessable under sections 6-5 or 6-10.

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 if the market value of the asset, at the time of the event, is more than its cost base. The trustee makes a capital loss 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 will generally become absolutely entitled to the Shares, in accordance with the Rules, when the Shares are vested and the Company notifies the Participant that the restrictions in respect of the Shares have ceased or no longer apply. Upon the cessation of all the restrictions, the Participant has the right to request the Trustee to transfer the Shares into his or her name and deal with the Shares at his or her 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 the *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.

130-90(2) Subsection (1A) or (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 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'.

The Trust satisfies the definition of an 'employee share trust' in subsection 130-85(4) because:

•         the Trust acquires shares in a company, namely the Company

•         the Trust ensures that ESS interests as defined in subsection 83A-10(1) are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating those shares to the employees in accordance with the Trust Deed and the Plans

•         the Trust Deed provides that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of subsection 130-85(4).

Under the Plans, Participants acquire an ESS interest as defined in subsection 83A-10(1) as they acquire a beneficial interest in a right to acquire a beneficial interest in the share of the Company, and the Rights granted under the Plans are ESS interests to which subdivision 83A-B or 83A-C applies.

As such, any capital gain of loss that arises for the Trustee as a result of CGT event E5 happening is disregarded by virtue of section 130-90, provided a Participant does not acquire the beneficial interest in the Share for more than its cost base in the hands of the Trust at the time CGT Event E5 happens.

CGT Event E7

CGT event E7 happens if the trustee of the 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 cost 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, 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.

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