Edited version of private advice

Authorisation Number: 1051823526895

Date of advice: 9 April 2021

Ruling

Subject: Employee share schemes - start-up concession

Question

For options granted between X YY 20ZZ and 30 June 20ZZ, will the Company be entitled to apply Method 1 (the net tangible assets method) set out in subsection 5(2) of the Income Tax Assessment (Methods for Valuing Unlisted Shares) Approval 2015 to determine the market value of an ordinary share under paragraph (b) of subsection 83A-33(5) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

X YY 20ZZ and 30 June 20ZZ

The scheme commences on:

X YY 20ZZ

Relevant facts and circumstances

The Company is an Australian proprietary company incorporated not more than 7 years before 30 June 20ZZ. The Company shares are not listed on a stock or securities exchange.

At all relevant times, the Company has been and continues to be, an Australia resident for Australian income tax purposes.

Capital structure

Before 30 June 20XX, the Company raised capital of A$X which is a "debt interest" for the purposes of Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997).

In June 20YY, the Company raised less than $10 million in equity, which are "equity interest" for the purposes of Division 974 of the ITAA 1997. At the same time, the Company converted approximately A$X million in shareholder loans (the Shareholder Loans) which are debt interests for the purposes of Division 974 of the ITAA 1997 that were drawn between June 20XX and W YY 20YY (inclusive), into shares issued in the capital of the Company, being equity interests for the purposes of Division 974 of the ITAA 1997 (the Converted Capital). The value of the Converted Capital is equal to the face value of the Shareholder Loans.

Employee Share Option Plan

To reward and incentivise employees, the Company established the Company Employee Option Plan (the Plan). The Plan is an employee share scheme for the purposes of Division 83A of the ITAA 1997.

Under the Plan, employees may be offered options to acquire shares in the Company. Options granted under the Plan are ESS interests for the purposes of Division 83A of the ITAA 1997.

Options granted under the Plan to which this Ruling applies will otherwise qualify for the start-up concession in section 83A-33 of the ITAA 1997 (i.e. they will meet the conditions in 83A-33(2) to (6) and section 83A-45 of the ITAA 1997).

The Company reasonably anticipates that there will not be a change of control of the company occurring within the period ending six months after the valuation time (the time of issue of the ESS interest).

The Company prepares, or will prepare, a financial report (within the meaning of the Corporations Act 2001), for the year in which the valuation time occurs, that complies with the accounting standards under the Corporations Act 2001.

Assumption

The Company will not raise further capital from X YY 20ZZ to 30 June 20ZZ or if it does, the amount of capital raised will not exceed the difference between A$10 million and the amount raised in June 20YY.

Reasons for Decision

Summary

For options granted under the Plan between X YY 20ZZ and 30 June 20ZZ, the conditions to apply Method 1 (the net tangible assets method) set out in section 4 and subsection 5(1) of the Income Tax Assessment (Methods for Valuing Unlisted Shares) Approval 2015 (ESS 2015/1) for the purposes of subsection 83A-33(5) of the ITAA 1997 will be satisfied. Therefore, Method 1 can be used to determine the market value of an ordinary share in the Company.

Detailed reasoning

ESS 2015/1 provides approved valuation methods for companies making an offer of ESS interests to eligible persons under an ESS which would otherwise qualify for the ESS start-up concession under section 83A-33 of the ITAA 1997. ESS 2015/1 sets out methods that will be accepted by the Commissioner as providing a safe-harbour assurance when working out the market value of ordinary shares in the company for the purposes of applying subsection 83A-33(5) of the ITAA 1997.

The methods set out in section 5 of ESS 2015/1 may be used only in working out the value of unlisted ordinary shares for the purposes of subsection 83A-33(5) as at the time when the relevant ESS interests are acquired (the valuation time): section 3 of ESS 2015/1.

Section 4 of ESS 2015/1 states that it applies to a company that:

•         issues ESS interests that are mentioned in 83A-33(1) of the ITAA 1997 (i.e. otherwise eligible for the ESS start-up concession); and

•         reasonably anticipates that there will not be a change of control of the company occurring within the period ending six months after the valuation time (the time of issue of the ESS interest).

•         In this instance:

•         Options granted under the Plan to which this Ruling applies will otherwise qualify for the start-up concession in section 83A-33 of the ITAA 1997 (i.e. they will meet the conditions in 83A-33(2) to (6) and section 83A-45 of the ITAA 1997).

•         The Company reasonably anticipates that there will not be a change of control of the company occurring within the period ending six months after the valuation time (the time of issue of the ESS interest).

Therefore, ESS 2015/1 applies to the Company.

Section 5 of ESS 2015/1 sets out the approved methods for valuing unlisted ordinary shares.

Subsection 5(1) sets out the conditions that must be satisfied by a company that wishes to use Method 1 for valuing unlisted ordinary shares as follows:

(1) For a company that:

(a) has not raised capital of more than $10 million during the period of 12 months immediately before the valuation time; and

(b) at the valuation time, either:

(i) has been incorporated for not more than 7 years; or

(ii) is a small business entity within the meaning of section 328-110 of the Income Tax Assessment Act 1997; and

(c) prepares, or will prepare, a financial report (within the meaning of the Corporations Act 2001), for the year in which the valuation time occurs, that complies with the accounting standards under the Corporations Act 2001;

the method set out in sub-clause (2) is an approved valuation method.

The $10 million capital raised threshold

For the purposes of the requirement in paragraph 5(1)(a) of ESS 2015/1 the relevant 12 month period is the period immediately before the valuation time being the time at which the ESS interest is issued. The ESS interests will be issued between X YY 20ZZ to 30 June 20ZZ. Therefore, the relevant period to consider will start at the earliest on X YY 20YY.

ESS 2015/1 does not define what constitutes the raising of capital for the purposes of the condition. Therefore, it is appropriate to consider the ordinary meaning of the terms.

In the Macquarie Dictionary [online] www.macquariedictionary.com.au:

'Raise' is relevantly defined as

-   17.to gather together; collect: to raise an army; raise funds.

'Capital' is relevantly defined as:

-   3. the wealth, whether in money or property, owned or employed in business by an individual, firm, etc.

-   4. an accumulated stock of such wealth.

-   5. any form of wealth employed or capable of being employed in the production of more wealth.

Paragraph 9 of ESS 2015/1 - Explanatory statement, states that the raising of capital under the requirement can be either debt or equity combined.

Therefore, the requirement is concerned with identifying the funds raised to employ in the business of the company sourced from either debt or equity. The conversion from one form of capital to another form, in the absence of the raising of further funds, would not constitute a raising of capital for the purpose of the requirement in paragraph 5(1)(a) of ESS 2015/1.

In this case, the Shareholder Loans have been converted into shares issued in the Company (share capital) on the basis of the face value of the Shareholder Loans. The relevant funds were raised by the Company in the period from June 20XX to W YY 20YY and not in the 12month period preceding the valuation time (the time when the ESS interests will be issued which will occur between X YY 20ZZ to 30 June 20ZZ).

The Company raised less than A$10 million in capital in the form of equity in June 20YY. Therefore, provided the company does not raise further capital from X YY 20ZZ to 30 June 20ZZ or if it does, the amount of capital raised does not exceed the difference between A$10 million and the amount raised in June 20YY, the requirement in paragraph 5(1)(a) of ESS 2015/1 will be satisfied.

The 7 year incorporation threshold

The Company was incorporated not more than 7 years before 30 June 20ZZ.

Therefore, at the time that that ESS interests are acquired (the valuation time), being the period from X YY 20ZZ to 30 June 20ZZ, the Company has not been incorporated for more than 7 years.

Therefore, the condition in subparagraph 5(1)(b)(i) of ESS 2015/1 is satisfied and there is no need to consider the condition in subparagraph 5(1)(b)(ii).

Preparation of financial reports that comply with the accounting standards

The Company prepares, or will prepare, a financial report (within the meaning of the Corporations Act 2001), for the year in which the valuation time occurs, that complies with the accounting standards under the Corporations Act 2001.

Therefore, the condition in paragraph 5(1)(c) of ESS 2015/1 is satisfied.

Conclusion

As the Company meets all of the conditions in section 4 and subsection 5(1) of ESS 2015/1, Method 1 (the NTA method) is an approved valuation method for determining the market value of an ordinary share in the Company for the purposes of subsection 83A-33(5) of the ITAA 1997.

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