Edited version of private advice

Authorisation Number: 1052118139689

Date of advice: 9 June 2023

Ruling

Subject: Commissioner's discretion - employee share scheme

Question

Will the Commissioner exercise his discretion under paragraph 83A-45(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the minimum holding period for ESS interests acquired under the Employee Share Option Plan to end on the date of completion of the proposed share sale?

Answer

Yes.

This ruling applies for the following period:

Income year ending 30 June 2023

Relevant facts and circumstances

1.    The Company was incorporated on in 20AA, is governed by a constitution and is a private Australian company.

2.    A Shareholder Agreement was entered into in 20CC between the Company and its shareholders.

3.    In 20DD the Company commenced the Employee Share Option Plan (ESOP). Options (each an ESS interest in the Company under subsection 83A-10(1) of the ITAA 1997) were granted to non-shareholder individuals (Optionholders) for no consideration. Each Option granted had an exercise price and exercise date greater than 3 years from the date of grant.

4.    The conditions for the start ups concession under section 83A-33 of the ITAA 1997 are satisfied as:

•         the Company was an Australian company at the time the Options were acquired;

•         no equity interests in the Company (or any subsidiary of the Company, holding company of the Company or subsidiary of a holding company of the Company) are or have been listed for quotation in the official list of an approved stock exchange;

•         the Company was incorporated within 10 years of the end of the most recent income year before Options were acquired (nor was any subsidiary of the Company, holding company of the Company or subsidiary of a holding company of the Company incorporated more than 10 years prior to the end of the most recent income year before Options were acquired);

•         the Company had an aggregate group turnover of less than $50 million in the most recent income year before the income year in which Options were acquired; and

•         the amount that must be paid to exercise the Options is greater than or equal to the market value of an ordinary share in the Company when the Options were acquired.

ESOP rules

5.    According to the ESOP rules, the ESOP is managed by the Company's Board who have discretion with respect to:

•         which employees, consultants or directors (Eligible Persons) may participate in the ESOP; and

•         the terms and conditions of any offer made to those Eligible Persons, including the number of Options, purchase price, and the vesting, disposal and forfeiture restrictions applying to those Options.

6.    Options issued to Optionholders in the ESOP only vest while the Optionholder is employed with, provides consultancy services to, or acts as a director of, the Company. However the Options cease to vest during any unpaid leave of absence.

7.    All Optionholders were employees (not contractors) at the time of accepting the Offer and subject to a 48 month vesting period noted in the Offer.

8.    The ESOP provides rules regarding the disposal of the Options and states the following:

•         An Offer may specify further restrictions on the Disposal of any Option without limiting rule 5.2 of the ESOP (rule 5.1).

•         Subject to rule 5.4 of the ESOP, a legal or beneficial interest in an Option may be disposed of:

o   by transferring the Option to a nominee or trustee of the Optionholder;

o   by transferring the Option to an Optionholder's deceased estate;

o   by transfer consented to by the Board; or

o   by sale or transfer otherwise permitted or required by the ESOP Rules (rule 5.2).

•         Unless otherwise consented to by the Board and notwithstanding any other provision in the ESOP or an Offer, but subject to rule 5.4 of the ESOP, a legal or a beneficial interest in an Option may not be disposed of until after:

o   where a Listing occurs, the earlier of the date that is 180 days following the Listing and the expiration of any underwriter imposed lock-up in connection with the Listing; and

o   where an Exit Event other than a Listing occurs, the occurrence of that Exit Event (rule 5.3).

•         Unless an Optionholder disposes of an Option or an Option Share under an arrangement which meets the requirements in section 83A-130 of the ITAA 1997, a legal or a beneficial interest in an Option or an Option Share may not be disposed of until the earlier of:

o   3 years after the issue of the Option or such earlier time as the Commissioner allows in accordance with subsection 83A-45(5) of the ITAA 1997; and

o   where the Optionholder becomes a Leaver (i.e. ceases to be employed or contracted by a Company Group Member) (rule 5.4).

9.    An Exit Event referred to in rule 5.3 of the ESOP is a Listing, a Business Sale and a Share Sale (rule 1.1(p) of the ESOP). A 'Share Sale' means the sale by Shareholders (in one transaction or a series of connected transactions) to a third party purchaser of all of the issued Shares provided that no sale or transfer undertaken to effect a corporate reorganisation of any of the Company Group will constitute a Share Sale (rule 1.1(jj) of the ESOP).

10.  Rule 6.2 of the ESOP provides that, despite anything in the ESOP Rules and unless the Board determines otherwise, where there is a Shareholder Agreement in place no Optionholder may receive any Option Shares (i.e. ordinary shares in the capital of the company issued as a result of the exercise by an Optionholder of its Options) upon exercise of Options unless they become bound by the terms of the Shareholder Agreement or are already a party to the Shareholder Agreement.

11.  Rule 7 of the ESOP provides the procedure on an Exit Event. Where the terms of rule 7 conflict with the terms of the Shareholder Agreement, the Shareholder Agreement shall prevail. Rule 7.4 provides the procedure in connection with an Exit Event including Drag-along rights. On or prior to the Exit Event (and in connection with an Exit Event) the Board must (if requested to do so by the Majority Shareholders, referred to as the Dragging Shareholders) issue an irrevocable Drag-along Notice to the Company and each Optionholder (referred to as the Dragged Holder) stating that the Dragged Holders are required to sell all of their Option Shares.

12.  Rules 7.4(d) and (e) of the ESOP state:

(d) If the Dragging Shareholders serve a Drag-along Notice, then subject to rule 5.4 a Dragged Holder must as part of the sale of the Sale Shares to the Third Party Buyer, sell all of its Option Shares to the Third Party Buyer on terms which comply with rules (f) and (g) and each Optionholder is deemed to appoint the directors of the Company as its attorney for this purpose (and for the avoidance of doubt, the provisions of the power of attorney contained in an acceptance of offer signed by the Optionholder or their Eligible Person (as applicable) apply for the purposes of this rule).

(e) If the Dragged Holder is prevented from Disposing of their Option Shares under rule 5.4 then this rule (excluding this rule(e)) will not apply to the Dragged Holder in respect of those Option Shares.

Proposed sale

13.  The Company has agreed to the sale of all of its shares to an unrelated third party (the Acquirer) to the Company and its Shareholders (the Proposed Sale). The Proposed Sale will constitute an Exit Event under the ESOP, was negotiated and will be completed on an arm's length basis.

14.  The Shareholders of the Company, or a sufficient number of them, have agreed to the Proposed Sale so as to enliven the 'Drag-along' provisions under the Shareholder Agreement. It is proposed that in accordance with the power under the ESOP, the Company's Board will:

•         accelerate the vesting of unvested Options;

•         require the exercise of all Options prior to the Proposed Sale such that the Optionholders will become Shareholders in the Company; and

•         participate alongside all other Shareholders in the Company in the Proposed Sale in their capacity as such.

15.  Prior to the Proposed Sale:

•         the Company's Board has never exercised its discretion to allow for the disposal of an Option or Option Share within the 3 year holding period imposed under rule 5.4 of the ESOP; and

•         there was no disposal of Options or Option Shares as a result of a previous Exit Event.

16.  There were no offers, intentions, or negotiations in relation to any takeover or similar transaction at any time prior to when the Acquirer approached the Company with a view to acquiring all of its shares. The Acquirer's approach to the Company happened after the issue of all Options under the ESOP.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 83A-10(1)

Income Tax Assessment Act 1997 section 83A-25

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 section 83A-35

Income Tax Assessment Act 1997 section 83A-45

Income Tax Assessment Act 1997 subsection 83A-45(4)

Income Tax Assessment Act 1997 subsection 83A-45(5)

Income Tax Assessment Act 1997 paragraph 83A-45(5)(a)

Income Tax Assessment Act 1997 subparagraph 83A-45(5)(a)(i)

Income Tax Assessment Act 1997 subparagraph 83A-45(5)(a)(ii)

Income Tax Assessment Act 1997 section 83A-130

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Section 83A-25 provides that your assessable income for an income year in which an ESS interest is acquired includes the discount given in relation to the interest. Sections 83A-33 (start ups) and 83A-35 (other cases) provide for a reduction of the amount of the discount included in your assessable income provided, among other things, the further conditions in section 83A-45 are satisfied.

One of the conditions in section 83A-45 is the minimum holding period condition under subsection 83A-45(4) which requires the employee share scheme to be operated with a minimum holding period for the acquirer of an ESS interest during which the acquirer is not permitted to dispose of the ESS interest. Subsection 83A-45(5) provides the minimum holding period is 3 years or such earlier time that the Commissioner allows:

Minimum holding period

(4) This subsection applies to an ESS interest you acquire under an employee share scheme if, at all times during the interest's minimum holding period, the scheme is operated so that every acquirer of an ESS interest (the scheme interest) under the scheme is not permitted to dispose of:

(a) the scheme interest; or

(b) a beneficial interest in a share acquired as a result of the scheme interest;

during the scheme interest's minimum holding period.

(5) An ESS interest's minimum holding period is the period starting when the interest is acquired under the employee share scheme and ending at the earlier of:

(a) 3 years later, or such earlier time as the Commissioner allows if the Commissioner is satisfied that:

(i) the operators of the scheme intended for subsection (4) to apply to the interest during the 3 years after the acquisition of the interest; and

(ii) at the earlier time that the Commissioner allows, all membership interests in the relevant company were disposed of under a particular scheme; and

(b) when the acquirer of the interest ceases being employed by the relevant employer.

Disposals

Rule 5 of the ESOP contains the rules for disposals of a legal or beneficial interest in an Option or Option Share. Unless the Optionholder becomes a Leaver sooner, rule 5.4 of the ESOP contains an overriding restriction on any disposal in the first 3 years which reflects the minimum holding period provided for in paragraph 83A-45(5)(a), unless the Commissioner allows an earlier time by exercising his discretion. Rule 5.4 is designed to ensure the ESOP rules comply with the requirements in subsections 83A-45(4) and (5).

Rule 5.3 of the ESOP provides that a legal or beneficial interest in an Option may not be disposed of before an Exit Event (including the occurrence of a Share Sale).

The remaining ESOP Rules (in rule 5.2) provide for permitted disposals of a legal or beneficial interest in an Option and are expressed to be subject to the overriding restriction on disposal in rule 5.4 so that permitted disposals of an Option will also need to comply with the minimum holding period condition of 3 years unless the Commissioner's discretion has been exercised.

Options cannot be disposed of until an Exit Event other than by the permitted disposals, which are subject to the overriding restriction on disposal in rule 5.4 to ensure satisfaction of the minimum holding period condition in subsections 83A-45(4) and (5). The disposal of Option Shares is also subject to rule 5.4 and similarly ensures that the disposal of shares on an Exit Event will comply with the minimum holding period of 3 years unless the Commissioner's discretion has been exercised.

The rules in rule 7 of the ESOP provide for the procedure in connection with an Exit Event and include the procedure if the Majority Shareholders of the Company want to sell their shares prior to the Exit Event.

Rule 7.4(a) of the ESOP states that on request by the Majority Shareholders the Board must, on or prior to the Exit Event, issue a Drag-along Notice to the Company and to each Dragged Holder to sell all of its Option Shares. In the case of a Share Sale, the Option Shares are to be sold to either a third party buyer or a New Holding Entity.

The requirement of a Dragged Holder to sell all of its Option Shares under rule 7.4 of the ESOP is also expressed to be subject to overriding restriction on disposal in rule 5.4 (rule 7.4(e)).

If the Dragged Holder receives a Drag-Along Notice but has not satisfied the minimum holding period condition of 3 years or received the Commissioner's discretion to reduce the period, then the rules in rule 7 of the ESOP for the Drag-along Notice will not apply. The Dragged Holder will retain the Option Shares for the duration of the 3-year minimum holding period to satisfy subsection 83A-45(4).

The rules in the ESOP providing for disposal of an Option or Option Share are subject to the overriding restriction on any disposal contained in rule 5.4 which is expressed to ensure the ESOP rules comply with the requirements in subsection 83A-45(4).

Shareholder Agreement

Rule 6 of the ESOP contains the rules which apply to the issue of ordinary shares in respect of the exercise of outstanding Options. Where there is a Shareholder Agreement in place in respect of the Company, the rule provides that no Optionholder may receive Option Shares upon the exercise of Options unless they are party to the Shareholder Agreement or otherwise become bound by the terms of the Shareholder Agreement.

Where the procedures in the ESOP regarding an Exit Event (rule 7) conflict with the Shareholder Agreement, the Shareholder Agreement shall prevail. The Shareholder Agreement sets out Drag along procedures (at clause 17) and does not conflict with the overriding restriction in rule 5.4 of the ESOP or rule 7.4(e) of the ESOP.

Conclusion

There was no disposal or transfer of Options or Option Shares acquired under the ESOP prior to the date of the Proposed Sale.

The rules in the ESOP which permit disposal of the Options or Option Shares are expressed to be subject to rule 5.4 which provides an overriding restriction on disposal and is expressed to ensure the ESOP Rules comply with the minimum holding period requirement of 3 years in subsections 83A-45(4) and (5).

The Commissioner is therefore satisfied that the ESOP Rules prevented Optionholders disposing of Options acquired until the earlier of the 3-year anniversary of the date the Options were granted or the day after the date they ceased to be employed by the Company. The ESOP Rules did not provide for an exemption from or non-compliance with this rule and there is no evidence to suggest that the Company (or its Board), as operators of the ESOP, did not intend for every Optionholder under the ESOP to be restricted from disposing their Options for that minimum holding period.

Further, all Options were acquired by the Optionholders under the ESOP prior to the Company having been approached by the Acquirer and having entered into any negotiation with the Acquirer regarding the Acquirer's acquisition of all the Company's issued capital under the Proposed Sale.

Accordingly, the Commissioner is satisfied that the requirements of subparagraphs 83A-45(5)(a)(i) and (ii) are met to the extent Share Options are/were disposed of during their original minimum holding period of 3 years, and will allow the minimum holding period to end at the earlier time of the date of the Proposed Sale.

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