Edited version of private advice

Authorisation Number: 1052023777424

Date of advice: 18 August 2023

Ruling

Subject: CGT - employee share schemes

Question 1

Is the Company X Employee Share Plan 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 CGT event E5 happen at the time when the employees become absolutely entitled to Shares held by the Trustee of the Trust?

Answer

Yes.

Question 3

If CGT event E5 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E5 happening be disregarded under section 130-90 of the 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.

Question 4

Will CGT event E7 happen in respect of Shares held by the Trustee of the Trust?

Answer

No - the scheme does not include any facts that gives rise to CGT event E7 happening.

Question 5

If CGT event E7 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the 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

Not necessary to rule.

This ruling applies for the following periods:

Income tax years ended 30 June 20XX to 30 June 20XX

Relevant facts and circumstances

This private ruling is based on the facts stated in the description of the scheme that is set out below, including the following documents, or relevant parts of them, which are to be read with the description:

Company A

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

The Company is the head company of the income tax consolidated group (TCG) and it also has a number of wholly-owned foreign subsidiaries (collectively referred to herein as Group Companies).

Any reference to the Group or Company A Group includes Company A, members of the TCG and any wholly-owned incorporated bodies who are a corporation as defined in the Corporations Act 2001.

The Company develops and sells products worldwide. Neither the Company, nor any Group Company is involved predominantly in the business of acquiring, selling or holding share securities of other investments.

Company A Long Term Incentive Plan (the Plan)

The Plan forms a part of the Company's global remuneration framework.

The Plan is designed to attract, retain, motivate and reward high performance individuals with the key skills required by the Company and its related bodies corporate to undertake their daily activities and to align the interests of these persons with the interests of the Company and its shareholders.

The Company A Long Term Incentive Plan Rules (Rules) are used to stipulate the terms under which the various Awards are made to the Participants.

The Board may determine that an employee is eligible to participate in the Plan. The Board will then issue an invitation to the employee to participate in the Plan. The employee can then choose whether to accept the invitation.

Under the Plan a person can be provided with any one (or any number) of the following:

                      i.        Options;

                     ii.        Performance Rights;

                    iii.        Shares.

The meaning of these terms are set out in Rule XX of the Plan. The terms are defined as follows:

-       Option means an option granted under this Plan to subscribe for, acquire and/or be allocated (as determined by the Board in its sole and absolute discretion) one Plan Share subject to the satisfaction of any Vesting Conditions and/or Performance Hurdles, and payment of the relevant Exercise Price (if any).

-       Performance rights means an entitlement of a Participant granted under this Plan to subscribe for, acquire and/or be allocated (as determined by the Board in its sole and absolute discretion) one Plan Share subject to the satisfaction of any Vesting Conditions and/or Performance Hurdles. For the avoidance of doubt, a Performance Right has a nil Exercise Price.

-       Share means a fully paid ordinary share in the capital of the Company.

Collectively (and individually) these are referred to as Awards granted under the Plan and operate in relation to ordinary shares (Shares) in the Company.

The Company A Employee Share Plan Trust (Trust) will be used to provide Shares to satisfy the Award.

Awards under the Plan are made to Eligible Employees. Eligible Employee is defined in Rule XX as:

(a)  Any Director or Employee who is declared by the Board in its sole and absolute discretion to be eligible to receive grants of Awards under the Plan; or

(b)  Any other natural person providing services to the Group and who is declared by the Board in its sole and absolute discretion to be eligible to receive grants of Awards under the Plan.

The Company administers the Plan on behalf of its subsidiaries. It provides administrative services to Group Companies and monitors contributions made by Group Companies on behalf of their employees. The Company undertakes these activities for other Group Companies to assist in the efficient running of its global enterprise.

In relation to foreign employees who receive an Award, the Company has a transfer pricing policy under which the Company charges the Group Company a fee for the provision of services relating to the Plan.

The Company administers the Plan through the Trust. The Trust issues the Shares to the Eligible Employees including foreign employees of Group Companies.

The Company invoices the Group Company for the amount of the contribution made to the Trust in relation to the eligible employee's award plus a mark-up. The mark-up represents an amount to compensate the Company for managing the Plan. The Company then receives the funds from the Group Company. The funds are transferred; there is no set-off of obligations between the Company and the Group Company.

Where the Awards are issued subject to performance hurdles, the Participant cannot exercise the Award until the conditions are met (Rule XX). Performance Hurdles are defined in Rule XX as any ongoing minimum performance requirements (as specified in the Invitation Letter and determined by the Board in its sole and absolute discretion) that are to apply to Awards granted to a Participant.

Where a Participant receives an Option, the Board retains a discretion to determine an exercise price (if any) (Rule XX).

The Expiry Date in respect of Options and Performance Rights is detailed in the Invitation made to a Participant. Rule XX sets out the circumstances in which Options or Performance Rights may lapse.

The Company envisages that it will have implementation and ongoing administration costs with respect to the Plan.

The Trust

Company A established the Trust with XX Custodians as the initial trustee (Trustee).

The Trust was not in existence at the time the Plan was established, however, Rule X of the Plan allows for the creation of a Trust to assist in the administration of the Plan.

The earlier employee share plans established by the Company did not have provision for a Trust to administer the Plans in the respective Plan Rules. For this reason, any interests issued under the earlier Plans will not be satisfied via the Trust.

The Trust has been established for the sole purpose of obtaining Shares for the benefit of Participants under the Plan, and for any future equity incentive plans that the Company may adopt (Company A Employee Share Plan Trust Deed (Trust Deed) Recital X).

The Trust may acquire Shares in advance of allocating those Shares to Participants and these may be held by the Trust on an unallocated basis or as Plan Shares on behalf of a Participant at any particular time (Trust Deed Recital X).

Once the Trust is funded, the Company will arrange for the Trustee of the Trust to subscribe for newly issued Shares or to purchase Shares from existing shareholders so that the Shares can be provided to Participants on grant of Shares or on exercise of the Options or Rights in accordance with the Plan (Clause XX Trust Deed).

The Trust Deed

The Trustee is to deal with any Shares held in the Trust as set out in the Trust Deed and the Rules.

The Trustee has been granted powers in respect of the Trust to the maximum extent permitted by law, including but not limited to the powers set out in Clause XX of the Trust Deed.

Clause XX of the Trust Deed then clarifies these powers. It provides that the Company and the Trustee agree 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) of the Tax Act.

The Company is required to make cash contributions to the Trust for the price of the Shares (Clauses X, X, X of the Trust Deed).

The contributions by the Company or any Group Company to the corpus of the Trust shall be an irrevocable contribution to the Trust and will not be repaid to the Company (Clause X of the Trust Deed).

Neither the Company nor any member of the Group (including the Trustee) are entitled to obtain any beneficial interest in the Trust Assets (Clause X and X of the Trust Deed).

Upon exercise of Options or Performance Rights by Participants, Shares are issued to the Trustee. The Shares may continue to be held by the Trustee post exercise on behalf of the Participant or they may be delivered by the Trustee to the Participant upon their request and approval by the Company (Clause X, Clause X and Clause X of the Trust Deed).

Reasons for decision

All legislative references in this Ruling are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Question 1

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).

The Company X Employee Share Plan Trust (Trust) obtains Company X shares to satisfy the obligations of the Shares, Options and Performance Rights according to the Company X Long Term Incentive Plan (the Plan) to Participants who are employees of Company X. 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 Company X. 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 TD 2019/13 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 X Employee Share Plan 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 Clause X, and the other clauses 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.

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

Question 2

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.[1]

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.[2]

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.[3]

Pursuant to the Trust Deed, a Participant is the beneficial owner of and absolutely entitled to their Allocated Shares. Allocated Shares is defined as a Trust Share that is credited to the Trust Share Account of a Participant. Once credited, the Participant (i.e. the beneficiary) will become absolutely entitled to the Allocated Shares (i.e. a CGT asset of the Trust) as against the Trustee. Accordingly, pursuant to subsection 104-75(1), CGT event E5 happens.

Question 3

If CGT event E5 happens, any capital gain or loss that the Trustee makes is disregarded if section 130-90 of the ITAA 1997 applies. Section 130-90 provides as follows:

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

(a)  immediately before the event happens, an *ESS interest is a *CGT asset of the trust; and

(b)  either of the following subparagraphs applies:

(i)            the event is CGT event E5, and the event happens because a beneficiary, of the trust becomes absolutely entitled to the ESS interest as against the trustee;

(ii)           the event is CGT event E7, and the event happens because the trustee *disposes of the ESS interest to a beneficiary of the trust; and

(c)   Subdivision 83A-B or 83A-C (about employee share schemes) applies to the ESS interest.

(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.

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

Subsection 130-85(4) of the ITAA 1997 defines an employee share trust 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) of the ITAA 1997 as either a beneficial interest in a share in the company, or a beneficial interest in a right to acquire a beneficial interest in a share in the company. Shares that are purchased by the Trustee to satisfy its obligation under the Plan, and subsequently allocated to Company X's Participants pursuant to the Plan, are ESS interests for the purposes of section 83A-10(1) of the ITAA 1997.

An 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997 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 employee's employment.

Company X's Plan constitutes an 'employee share scheme' because it is a scheme under which ESS interests in Company X are provided to the employees of Company X in relation to their employment with Company X.

Therefore, paragraphs 130-85(4)(a) and (b) of the definition of an employee share trust are satisfied because:

(a)  The Trust acquires shares in a company, namely Company X; and

(b)  The Trust ensures that ESS interests as defined in subsection 83A-10(1) are provided under an employee share scheme by allocating those shares to the employees of Company X in accordance with the Trust Deed and the Plan.

Paragraph 130-85(4)(c) of the definition of an employee share trust provides that a trustee can engage in activities that are merely incidental to those described in paragraphs 130-85(4)(a) and (b) of the ITAA 1997. The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13: Income tax: what is an 'employee share trust'? (TD 2019/13).

However, 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 document does not, of itself, mean that the trustee has breached the requirements to be an employee share trust. In examining whether the requirements of subsection 130-85(4) are met, it is necessary to examine the actual activities that the trustee has undertaken.[4]

The Trust Deed contains only powers and/or duties that are merely incidental, as required by subsection 130-85(4)(c) of the ITAA 1997. Therefore, the Trust established pursuant to the Trust Deed satisfies the definition of an employee share trust in subsection 130-85(4) of the ITAA 1997.

As the rights granted under the Plans will be acquired by the employees at a discount, they are ESS interests to which subdivision 83A-B of the ITAA 1997 applies.

As such, a capital gain or capital loss that arises for the Trustee of the Trust established pursuant to the Trust Deed at the time when CGT Event E5 happens in relation to Company X shares held by the Trustee will be disregarded under section 130-90 of the 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.

Question 4

Under section 104-85, 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. The timing of the event is when the disposal occurs.[5]

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.[6]

However, in relation to this scheme, CGT event E7 does not occur. This is because the scheme does not include any facts that gives rise to CGT event E7 happening.

Question 5

As per the answer in Question 4 above, CGT event E7 does not arise. Therefore, it is not necessary to consider whether a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the 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.

[1] Subsection 104-75(2).

[2] Subsection 104-75(3).

[3] Paragraph 41 of TR 2004/D25.

[4] Paragraph 6 of TD 2019/13.

[5] Subsection 104-85(2).

[6] Subsection 104-85(3).

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