Edited version of private advice

Authorisation Number: 1051817833098

Date of advice: 18 March 2021

Ruling

Subject: Employee share scheme discount and employment outside Australia

Question

Question: Is the employee share scheme (ESS) discount assessable to You to the extent it relates to your employment outside Australia?

Answer:

No.

This ruling applies for the following period:

2019-20 income year

The scheme commences on:

1 July 2015

Relevant facts and circumstances

You are in Australia on a temporary resident visa and falls under all categories to be classed as a temporary Australian resident for tax purposes.

You moved to Australia from another country arriving about five years ago.

You received shares in a foreign company that is the holding company of your employer.

Rights were granted when You were working in Australia for the Australian subsidiary.

Original rules and grants were written and confirmed while You lived and worked overseas and rights were granted each year after that.

You received the rights just after You had moved to Australia, and they had a deferred taxing point three and a half years later. Rights matured in the 2019-20 income year and were reported to the ATO as a discount from deferral scheme at Item 12F.

The letter notifying You of the grant outlined certain conditions and advised that the reference period would be three years beginning at the start of that calendar year.

The Stock Option Plan provided additional rules including vesting and forfeiture conditions.

Your employer has reported the ESS discount for the 2019-20 income year on the basis that the whole of it is assessable in Australia.

Assumption

For the purpose of this ruling, it is assumed that at least some portion of the ESS discount that is assessable in the 2019-20 income year relates to your employment outside Australia.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 6-1

Income Tax Assessment Act 1997 Section 83A-110

Income Tax Assessment Act 1997 Section 768-910

Reasons for decision

Summary

The ESS discount is not assessable to You to the extent it relates to your employment outside Australia.

Detailed reasoning

Section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) defines 'statutory income' as amounts included in your assessable income that are not ordinary income.

Division 83A of the ITAA 1997 contains a comprehensive regime for working out when the discount received in respect of rights to acquire shares is assessable and how much that amount is.

More specifically, subsection 83A-110(1) of the ITAA 1997 includes the ESS discount for deferral schemes in assessable income as at the deferred taxing point.

Then subsection 83A-110(2) of the ITAA 1997 makes the following statement:

Treat an amount included in your assessable income under subsection (1) as being from a source other than an Australian source to the extent that it relates to your employment outside Australia.

Your employer has determined that your rights were granted under an ESS that is a deferral scheme and that the deferred taxing point occurred during the 2019-20 income year.

ESS interests (including rights to acquire shares) are statutory income if they are assessable at the deferred taxing point. (See Abbott v Philbin [1961] AC 352 for the reasons why they are not ordinary income.)

You are a temporary resident for income tax purposes for the 2019-20 income year.

Subsection 768-910(1) of the ITAA 1997 defines statutory income (other than a net capital gain) that is from a source other than an Australian source as 'non-assessable non-exempt income' if you are a temporary resident when you derive it.

Subsection 6-15(3) of the ITAA 1997 states that amounts are not assessable income if they are non-assessable non-exempt income.

How to work out the Australian and foreign portions of the ESS discount

Division 83A was inserted into the ITAA 1997 by the Tax Laws Amendment (2009 Budget Measures No. 2) Act 2009. The Explanatory Memorandum stated:

1.354 Whether the discount on the ESS interest acquired under an employee share scheme relates to employment in Australia or outside Australia is a question of fact that needs to be determined on a case-by-case basis.

And:

1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development and Cooperation (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005.

The explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 states:

4.6 The OECD commentary on the articles of the model tax convention is relevant in interpreting Australia's tax treaties. The revised commentary treats the benefit accruing up to the exercise of a right as an employment benefit to which Article 15 (Income from Employment) of the model tax convention applies. The commentary recognises that the facts and circumstances of the particular case will determine the period of employment to which the right relates. The number of days worked in a treaty country during this employment period then determines the extent of that country's source taxing rights.

The OECD commentary on Article 15 (about employment) suggests the following principles as an aid to determining the employment period:

12.7 The first principle is that, as a general rule, an employee stock-option should not be considered to relate to any services rendered after the period of employment that is required as a condition for the employee to acquire the right to exercise that option. Thus, where a stock-option is granted to an employee on the condition that he provides employment services to the same employer (or an associated enterprise) for a period of three years, the employment benefit derived from that option should generally not be attributed to services performed after that three year period.

...

12.11 The second principle is that an employee stock-option should only be considered to relate to services rendered before the time when it is granted to the extent that such grant is intended to reward the provision of such services by the recipient for a specific period. This would be the case, for example, where the remuneration is demonstrably based on the employee's past performance during a certain period or is based on the employer's past financial results and is conditional on the employee having been employed by the employer or an associated enterprise during a certain period to which these financial results relate. Also, in some cases, there may be objective evidence demonstrating that during a period of past employment, there was a well-founded expectation among participants to an employee stock-option plan that a part of their remuneration for that period would be provided through the plan by having stock-options granted at a later date. This evidence might include, for example, the consistent practice of an employer over a number of years, as long as there was no indication that this practice might be discontinued. Depending on other factors, such evidence may be highly relevant for purposes of determining if and to what extent the stock-option relates to such a period of past employment.

...

12.13 Finally, there may be situations in which some factors may suggest that an employee stock-option is rewarding past services but other factors seem to indicate that it relates to future services. In cases of doubt, it should be recognised that employee stock-options are generally provided as an incentive to future performance or as a way to retain valuable employees. Thus, employee stock-options are primarily related to future services. However, all relevant facts and circumstances will need to be taken into account before such a determination can be made and there may be cases where it can be shown that a stock-option is related to combined specific periods of previous and future services (e.g. options are granted on the basis of the employee having achieved specific performance targets for the previous year, but they become exercisable only if the employee remains employed for another three years).

Ordinarily, the employment period (or earning period) will simply align with the vesting period - that is the period from the grant of the rights until they vest (can be exercised by the holder of the rights).

In this instance, your employer has nominated an alternate 'reference period' as the basis of the earning period. It is the three calendar years. However, the rights only vest and become exercisable some time after the end of the three year reference period. This additional period is also part of the earning period.

Therefore, the earning period will at least include the period from 1 January in the grant year to the vesting date.

There is insufficient information to determine whether any additional period can be added to the start of the reference period in accordance with the second principle.

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