Edited version of private advice

Authorisation Number: 1052030333150

Date of advice: 29 September 2022

Ruling

Subject: Employee share trust

Question 1

Will the irretrievable cash contributions made by Company A (or any other Participating Company) to the Trustee of the Trust to fund the subscription for, or acquisition on-market of Shares by the Trust be assessable income of the Trust under section 6-5 or section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a capital gain or capital loss made by the Trust as a result of CGT event E5 happening in respect of Shares held by the Trust and allocated pursuant to the Company A Employee Share Plan (Plan) be disregarded under section 130-90 if the Participants acquire the Shares for the same or less than cost base of the Shares in the hands of the Trustee?

Answer

Yes.

Question 3

Will dividends and other income received by the Trust in respect of Unallocated Shares held by the Trustee:

(a)  be included in the calculation of the net income of the Trust under section 95 of the Income Tax Assessment Act 1936 (ITAA 1936), and

(b)  be assessed to the Trust under section 99A of the ITAA 1936?

Answer

Yes.

Question 4

Will the Trust be entitled to a tax offset for the franking credits attached to the franked dividend on the Unallocated Shares under Subdivision 207-B?

Answer

Yes.

Relevant facts and circumstances

Company A is a wholly-owned subsidiary of Company B, a newly established listed public company which operates in the XYZ industry. Immediately prior to its listing, Company B formed part of the Company C global group until it was demerged.

As part of Company A's existing strategy to attract, incentivise and retain employees in Company A and other Participating Companies, Company A has established the Plan.

To assist with the effectiveness, structure and administration of the Plan, the Trust was established in 20XX.

The Plan is currently the only plan facilitated through the Trust.

While the Plan allows both Australian resident employees and non-resident employees to participate, it is not intended that any non-resident or resident associates of Company A outside of the Company A tax consolidated group or their respective employees will participate in the Plan. As such, the scope of this ruling is restricted to irretrievable cash contributions made by members of the Company A tax consolidated group. Any associated Australian tax implications for the Trust in respect of non-resident employee participants or resident employee participants of associates of Company A outside of the Company A tax consolidated group is not within the scope of this ruling.

Employee Share Plan Rules

The Plan is designed to provide the opportunity for Participants to acquire Shares through sacrificing a portion of their Remuneration, thus:

a)     allowing the Participants the opportunity to become shareholders and share in the success of the Company B

b)     aligning the interests of the Participants with those of the shareholders of Company B, and

c)     allowing the Participants the opportunity to acquire Shares in a tax-effective manner.

The Plan is operated in accordance with the Trust Deed and the Plan Rules.

Under the Plan, Participants can choose to participate in one of two schemes:

a)     Scheme A - under which the Participant will sacrifice pre-tax salary to acquire Shares with a value up to A$1,000, or

b)     Scheme B - under which the Participant will sacrifice pre-tax salary to acquire Shares with a value between A$1,000 and A$5,000.

In relation to Scheme A, shares are subject to disposal restrictions from the date the shares are acquired until the earlier of:

a)     the end of the period of 3 years (or such earlier time as the Commissioner allows under section 83A45(5(a)) of the ITAA 1997) commencing at the time the Participant acquires the Share, and

b)     the time when the Participant ceases to be employed by a Participating Company.

In relation to Scheme B, each Participant can nominate a disposal restrictions period. The restriction period is the period from the acquisition date until the earlier of:

a)     the date the Participant ceases to be employed by a Participating Company; or

b)     the end of the Restriction Period (either 3, 5 or 7 years after the end of the Plan Year) nominated by a Participant on the online acceptance.

During the restriction period, Participants may not dispose of or grant a security interest over, any Shares allocated to them as part of the Plan.

The Plan states that Subdivision 83A-C of the ITAA 1997 applies to Scheme B.

Employee Share Plan Trust

The Trust has been established to facilitate the acquisition, holding and allocation of Shares to Participants in accordance with employee equity plans that Company A operates from time to time (including the Plan).

For tax purposes, the Trust does not form part of the Company A tax consolidated group. Company A (or any other Associated Body Corporates or members of the Company B economic group) cannot be a beneficiary of the Trust.

The reasons for using the Trust include:

a)    the Trust is a vehicle that will enable Shares to be held for purposes of the Plan

b)    the Trust will facilitate the acquisition of Shares either on-market or by the issue of new Shares by Company B

c)    the Trust provides a vehicle for acquiring and holding Shares, either by way of a new issue or acquiring on-market, i.e. providing flexibility relating to capital management

d)    the Trust will be an efficient structure for giving effect to sales restrictions. As the Trustee of the Trust is the legal owner, Participants will have no ability to deal in the Shares until the applicable restriction period has ended

e)    the Trust provides the flexibility to acquire and hold Shares that will be allocated to employees under the Plan, and

f)     the Trust will maintain independent records and accounts for the Participants.

Obligations of the Trustee

The sole activity of the Trustee will be acquiring Shares for the purpose of providing them to Participants under the Plan and the administration of the Trust.

In the Trust Deed, the activities of the Trustee include:

•         entering into and executing contracts and agreements

•         acquiring, transferring or disposing of Shares and applying the proceeds of sale on the terms of the Trust Deed and Plan Rules

•         receiving and applying distributions in relation to Shares on the terms of the Trust Deed

•         opening and operating bank accounts to retain, on current or deposit account at any bank, any money it considers proper

•         taking and acting on the advice or opinion of any legal practitioner or other professional person

•         with the consent of Company A, transferring all or part of any Trust Property to a new or existing trust that exists for the benefit of Participants

•         paying taxes and undertaking activities that involve record-keeping and administrative actions necessary to operate the Trust

•         receiving dividends in respect of Unallocated Shares and interest from bank accounts and using those funds to:

o   acquire additional Shares for the purposes of the Plan Rules

o   pay interest on loans provided to the Trust for the acquisition of Shares for the purposes of the Plan, where the interest payable does not exceed arm's length commercial rates or pay necessary and incidental costs of administering the Trust

•         generally doing all acts the Trustee deems necessary or expedient to carry out the powers and discretions on the terms of the Trust Deed.

Company A 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 ITAA 1997.

Allocation of Shares

Company A will instruct the Trustee to subscribe for, purchase or allocate a number of Shares specified in the notice.

The Trustee will in accordance with instructions received and pursuant to the Trust Deed acquire, deliver and allocate Shares to Participants provided that the Trustee receives sufficient payment from Company A or another Participating Company to subscribe for or purchase Shares and/or has sufficient Unallocated Shares available in the Trust.

The Participating Company must make irretrievable cash contributions to the Trustee as required.

Contributions to the Trust

All funds received by the Trustee from the relevant Participating Company in the form of irretrievable cash contributions will constitute accretions to the corpus of the Trust and no Participant will be entitled to receive a distribution of or from such funds.

The funds will not be returned or repayable to Company A (the cash contributions by Company A to the Trustee will be irretrievable regardless of whether the Trustee uses the funds to acquire the Shares on market or subscribe for new Shares).

Company A is not a beneficiary under the Trust Deed and any funds it contributes to the Trust other than specifically in the form of a loan, cannot be refunded, repaid or returned to Company A.

Company A will have no interest in the Shares held by the Trustee.

Relevant legislative provisions

Income Tax Assessment Act 1936

Income Tax Assessment Act 1997

Reasons for decision

Question 1

Detailed reasoning

The total assessable income of a trust estate is calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1) of the ITAA 1936).

The assessable income of a taxpayer includes income under ordinary concepts (section 6-5) or statutory income (section 6-10).

None of the provisions listed in section 10-5 (list of provisions about assessable income that is not ordinary income) are relevant in the present circumstances. The irretrievable cash contributions made by Company A to the Trustee will therefore not be included in the assessable income of the Trustee under section 6-10.

The cash contributions made by Company A are irretrievable and non-refundable to it in accordance with the Trust Deed. The funds provided to the Trustee are used in accordance with the Trust Deed and the Plan Rules for the sole purpose of the employee share scheme. Therefore, the cash contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10. (ATO Interpretative Decision ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme).

Question 2

Detailed reasoning

Under section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens.

CGT Event E5

Under section 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 a beneficiary becomes absolutely entitled to the asset according to subsection 10475(2).

If CGT event E5 happens, the trustee may make a capital gain or loss if the market value of the asset, at the time of the event, is more than its cost base or less than the asset's reduced cost base respectively.

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 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.

In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies. A Participant will become absolutely entitled to the Shares in accordance with the Plan when those Shares have vested, been exercised (if applicable) and 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 their name and deal with the Shares at their 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 a Trustee makes from CGT event E5 is disregarded if section 130-90 applies.

Shares held to satisfy the future exercise of rights: subsection 130-90(1)

Subsection 130-90(1) applies to disregard any capital gain or loss made by an employee share trust if all of the following apply:

•         the CGT event is CGT event E5 or E7 (paragraph 130-90(1)(a))

•         the CGT event happens in relation to a share (paragraph 130-90(1)(b))

•         the beneficiary had acquired a beneficial interest in the share by exercising a right (paragraph 13090(1)(c))

•         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 (paragraph 130-90(1)(d)).

Employee share trust

In examining whether the requirements of an employee share trust in subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that are relevant. To qualify as an employee share trust, a trustee's activities must be limited to:

•         obtaining shares or rights in a company (paragraph 130-85(4)(a))

•         ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the ESS to employees, or to associates of employees, of the company or a subsidiary of the company (paragraph 130-85(4)(b)

•         other activities that are merely incidental to the activities mentioned in paragraphs 130-85(4)(a) and (b) (paragraph 130-85(c)).

The Trust Deed provides:

Without limitation, 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 section 130-85(4) of the Tax Act.

Paragraph 130-85(4)(a) is satisfied because the purpose of the Trust is to acquire, hold and transfer shares in a company, namely Company B (Recital A of the Trust Deed).

Paragraph 130-85(4)(b) is satisfied because:

•         the Trust has been established to acquire Shares and to allocate those Shares to Participants to satisfy Shares acquired by Participants under the Plan which subsequently vest (with each Share constituting an ESS interest as defined in subsection 83A-10(1))

•         the Plan is an ESS within the meaning of subsection 83A-10(2) as it is a scheme under which rights to acquire Shares are provided to employees, or associates of employees in relation to the employees' employment.

In respect of paragraph 130-85(4)(c), the phrase 'merely incidental' takes its ordinary meaning, with further guidance drawn from the context and purpose of the legislation in which it appears. 'Merely incidental' is not defined in the legislation and has not been judicially considered in the context of subsection 130-85(4). The Macquarie Dictionary defines 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'.

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'?

Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental.

In the present case, the objects of the Trust are for the sole purpose of undertaking activities that are in line with the definition of an employee share trust under section 130-85(4), including paragraph 130-85(4)(c) as the other activities undertaken by the Trustee are merely incidental to managing the Plan.

Paragraph 130-90(1)(a)

CGT event E5 will apply under the terms of the Plan when the Participant becomes absolutely entitled to the Shares as against the Trustee. Therefore, paragraph 130-90(1)(a) will be satisfied.

Paragraph 130-90(1)(b)

Subsection 995-1(1) defines a share to mean a share in the capital of a company. A Share held by the Trustee and to which a Participant is entitled upon the vesting (or exercise if applicable) of a Share is a share in the capital of a company. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a Share by the vesting of a Share granted under the Plan.

Paragraph 130-90(1)(d)

Subsection 83A-20(1) is the key condition that an ESS interest must meet for Subdivision 83A-B or 83A-C to apply. Subsection 83A-20(1) states:

This Subdivision applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

As stated above, each Share constitutes an 'ESS interest' as defined in subsection 83A-10(1), and the Plan is an ESS within the meaning of subsection 83A-10(2).

The Shares purchased under the Scheme A and Scheme B are acquired at a discount as they are part of a salary sacrificing arrangement in return for a reduction in salary that would not have otherwise happened (paragraph 83A-105(4)(a)).

Therefore, Subdivision 83A-B or 83A-C applies to Shares granted under the Plan.

Accordingly, all the conditions in subsection 130-90(1) have been satisfied.

Subsection 130-90(2)

Subsection 130-90(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 (subsection 130-90(2)). 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 that CGT event E5 happens, subsection 130-90(1) will apply to disregard any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening.

Question 3

Detailed reasoning

The net income of the trust is defined in section 95 of the ITAA 1936 to mean the total assessable income of the trust estate calculated under Division 6 of the ITAA 1936 as if the Trustee were a taxpayer in respect of that income, less all allowable deductions.

Under subsection 44(1), the assessable income of a resident shareholder includes dividends that are paid to the shareholder by a company out of profits derived by it from any source.

Therefore, dividends and other income received by the Trustee on Unallocated Shares are required to be included in calculating the net income of the Trust as defined under subsection 95(1).

Subsection 97(1) determines the assessable, exempt, and non-assessable non-exempt income of a beneficiary who is not under any legal disability and who is presently entitled to a share of the income of the trust estate.

When no beneficiary is presently entitled to the income of a trust estate, the net income of the estate will be taxed in the hands of the trustee under either section 99 or 99A. Section 99A will apply unless excluded in accordance with subsection 99A(2).

Where no part of the net income of a resident trust estate is included in the assessable income of a beneficiary of the estate, the trustee is assessed and liable to pay tax on the net income (as defined in subsection 95(1) and pursuant to subsection 99A(4)).

Accordingly, the Trustee will be assessed under section 99A on that part of the net income of the trust estate which relates to Unallocated Shares to the extent the net income is not included in the assessable income of a Participant.

Question 4

Detailed reasoning

Division 207 deals with the effect of receiving franked distributions.

Subsection 207-5(3) provides that if a franked distribution is made to a member that is a trustee of a trust, an amount equal to the franking credit on the distribution is included in the member's assessable income.

Subsection 207-5(4) provides that a tax offset in relation to an above distribution is only available to an entity if the distribution flows indirectly to it and does not flow indirectly through it to another entity. The tax offset is equal to its share of the franking credit on the distribution.

Subdivision 207-B deals with the effect of receiving a franked distribution through certain partnerships and trusts.

Section 207-25 provides that Subdivision 207-B deals with an entity that receives a benefit of a franked distribution where the distribution is made to a partnership or the trustee of a trust, and the benefit is received either directly or through interposed partnerships or trusts.

The distribution is regarded as flowing indirectly to the entity under this Subdivision.

On the basis of a notional amount of the entity's share of the distributions, the entity may be entitled to have an amount included in its assessable income and/or a tax offset under this Subdivision.

Under subsection 207-35(1), the assessable income of the trust for an income year includes the amount of the franking credit on a distribution if the following conditions are met:

•         a franked distribution is made in an income year to an entity that is a trustee of a trust (paragraph 207-35(1)(a))

•         the entity is not a corporate tax entity (paragraph 207-35(1)(b))

•         in the case of a trustee of a trust, the trust is not a complying superannuation entity (paragraph 20735(1)(c)).

Subsection 207-50(4) relevantly provides that a franked distribution will be taken to flow indirectly to the trustee of a trust if all the following apply:

•         the distribution is made to the trustee

•         the trustee is liable to be assessed on all or part of the trust's net income for that year under section 99A of the ITAA 1936 (subparagraph 207-50(4)(b)(ii))

•         the trustee's share of the distribution under section 207-55 is a positive amount, whether or not the trustee actually receives any of that share.

Consequently, where the Trustee receives a franked distribution in respect of an Unallocated Share, an amount equal to the franking credit attached to the distribution will be included in the assessable income of the Trustee.

Tax offset

Section 207-45 relevantly states that an entity to whom a distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution if it is the trustee of a trust that is liable to be assessed on a share of, or all or a part of, the trust's net income under section 99A of the ITAA 1936 for that income year.

The Trustee will be liable to be assessed under section 99A of the ITAA 1936 in relation to dividends on Unallocated Shares.

However, where a franked dividend is paid to an entity, subsection 207-145(1) denies a gross-up and tax offset where that entity is not a qualified person for the purposes of Division 1A of the former Part IIIAA of the ITAA 1936.

Qualified person

Former section 160APHO relevantly states:

(1)           A taxpayer who has held shares or an interest in shares on which a dividend has been paid is a qualified person in relation to the dividend if:

(a)           where neither the taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the primary qualification period in relation to the dividend; or

(b)           where the taxpayer or an associate of a taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the secondary qualification period in relation to the dividend.

(2)           A taxpayer who has held shares or an interest in shares on which a dividend has been paid satisfies this subsection in relation to a qualification period in relation to the shares or interest if, during the period:

(a)           where the taxpayer held the shares - the taxpayer held the shares for a continuous period (not counting the day on which the taxpayer acquired the shares or, if the taxpayer has disposed of the shares, the day on which the disposal occurred) of not less than:

(i)             if the shares are not preference shares - 45 days ...

(b)           where the taxpayer held the interest in the shares-the taxpayer held the interest for a continuous period (not counting the day on which the taxpayer acquired the interest or, if the taxpayer has disposed of the interest, the day on which the disposal occurred) of not less than:

(i)             if the shares are not preference shares - 45 days ...

Former section 160APHD defines:

primary qualification period, in relation to a taxpayer in relation to shares or an interest in shares, means the period beginning on the day after the day on which the taxpayer acquired the shares or interest and ending:

(a) if the shares are not preference shares - on the 45th day after the day on which the shares or interest became ex dividend ...

secondary qualification period, in relation to a taxpayer in relation to shares or an interest in shares, means:

(a) if the shares are not preference shares - the period beginning on the 45th day before, and ending on the 45th day after, the day on which the shares or interest became ex dividend...

The term 'related payment' is defined in former section 160APHN to relevantly mean:

(2) The taxpayer or associate is taken, for the purposes of this Division, to have made, to be under an obligation to make, or to be likely to make, a related payment in respect of the dividend or distribution if, under an arrangement, the taxpayer or associate has done, is under an obligation to do, or may reasonably be expected to do, as the case may be, anything having the effect of passing the benefit of the dividend or distribution to one or more other persons.

Where the Trustee does not make a related payment in respect of the dividend paid on the Shares, the Trustee will be a qualified person in respect of the dividend if the Trustee held the Shares at risk for a continuous period of not less than 45 days (excluding the day the Shares were acquired and if the Shares have been disposed of, the day the disposal occurred) during the period beginning on the day after the day on which the Trustee acquired the Shares and ending on the 45^th day after the day on which the Shares became ex dividend (primary qualified period).

However, where the Trustee makes a related payment in respect of the dividend on the Shares, the Trustee will be a qualified person in respect of the dividend if the Trustee held the Shares at risk for a continuous period of not less than 45 days (excluding the day the Shares were acquired and if the Shares have been disposed of, the day the disposal occurred) during the period beginning on the day after the day on which the Trustee acquired the Shares and ending on the 45^th day after the day on which the Shares became ex dividend (secondary qualified period).

A share, in respect of which a dividend is paid, becomes ex dividend on the day after the last day on which the acquisition by a person of the share will entitle that person to receive the dividend.

Refundable tax offsets

Subsection 67-25(1) states:

Tax offsets available under Division 207 (which sets out the effects of receiving a franked distribution) or Subdivision 210-H (which sets out the effects of receiving a distribution franked with a venture capital credit) are subject to the refundable tax offset rules, unless otherwise stated in this section.

Subsection 67-25(1B) provides that the tax offset is only subject to the refundable tax offset rules if the trustee entitled to the tax offset is not liable to be assessed under section 98 or 99A.

As franked distributions flow indirectly to the Trustee of the Trust, the Trustee is entitled to a franking tax offset under section 207-45. However, the Trustee is assessed on the distributions received in respect of Unallocated Shares under section 99A. Therefore, the tax offsets available to the Trustee are limited to the amount of tax payable and any excess franking tax offset is not refundable.

Conclusion

Where a franked distribution is paid in respect of Unallocated Shares, the Trustee will include an amount equal to the franking credit on the distribution in its assessable income under section 207-35.

In this case, provided that the Trustee does not make a related payment in relation to the dividend paid on Unallocated Shares and holds the Unallocated Shares for a continuous period of not less than 45 days during the period beginning the day after the Trustee acquires the Unallocated Shares and ending on the 45^th day after the Unallocated Shares become ex dividend, then the Trustee will be a qualified person in respect of the distribution and be entitled to the benefit of the franking credits attached to franked distributions on Unallocated Shares to the extent of tax payable. Any excess franking tax offset is not refundable pursuant to section 67-25.

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