Edited version of private advice

Authorisation Number: 2935012092797

Date of advice: 30 July 2019

Ruling

Subject: Employee share trust

Question 1

Will Aus Sub Company obtain an income tax deduction, pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), in respect of the payment to Public Company of a recharge amount (Recharge Amount) equal to the amount of irretrievable cash contributions made by Public Company to the Trustee of the Employee Share Trust (EST) to fund the subscription for or acquisition on-market and/or off-market of Public Company's shares by the EST pursuant to the Public Company Long Term Incentive Plan (Plan)?

Answer

Yes

Question 2

Are the Recharge Amounts payable to Public Company in respect of cash contributions made by Public Company to the Trustee of the EST to fund the subscription for or acquisition on-market and/or off-market of Public Company's shares by the EST pursuant to the Plan, deductible to Aus Sub Company at the time determined by section 83A-210 of the ITAA 1997 if the contributions are made before the acquisition of the relevant ESS interests?

Answer

Yes

Question 3

Will the Commissioner seek to make a determination under section 177F that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to deny, in part or in full, any deduction claimed by Aus Sub Company in respect of the Recharge Amounts payable to Public Company?

Answer

No

Question 4

Is the provision of performance rights (Rights) and/or shares in Public Company by Aus Sub Company to its employees pursuant to the Plan a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No

Question 5

Will the Recharge Amounts payable to Public Company in respect of the irretrievable cash contributions made by Public Company to the Trustee of the EST to fund the subscription for or acquisition on-market and/or off-market of Public Company's shares, be treated as a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No

Question 6

Will the Commissioner seek to make a determination that section 67 of the FBTAA applies to increase the aggregate fringe benefits amount of Aus Sub Company by the amount of tax benefit gained from Recharge Amounts payable by Aus Sub Company in respect of the irretrievable cash contributions made by Public Company to the Trustee of the EST to fund the subscription for or acquisition on-market and/or off-market of Public Company's shares?

Answer

No

This ruling applies for the following periods for Questions 1 - 3

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

This ruling applies for the following periods for Questions 4 - 6

Year ending 31 March 2020 (FBT)

Year ending 31 March 2021 (FBT)

Year ending 31 March 2022 (FBT)

Year ending 31 March 2023 (FBT)

Relevant facts and circumstances

A public company (Public Company)is listed on the Australian Securities Exchange (ASX). The Public Company Group comprises legal entities around the world (Public Company Group). Public Company has an Australian subsidiary (Aus Sub Company), which conducts the business operations in Australia. Aus Sub Company employs all Australian resident employees of the Public Company Group. Public Company and Aus Sub Company are not members of a tax consolidated group.

The business of the Public Company Group is the refining and sale of XYZ.

A large part of the Public Company Group's success can be attributed to its ability to motivate its staff and maintain longevity of employment, particularly amongst senior management. As a result, the Public Company Group needs to continue to provide incentives to ensure they attract the right people, especially at the senior management level, and retain high caliber staff to ensure the future success of the group.

The Public Company Group's remuneration policy is designed to align the economic interests of senior management and other employees with those of Public Company's shareholders. This is done by providing an opportunity for employees to earn significant rewards by potentially acquiring an equity interest in Public Company, thus motivating the creation of shareholder value.

Public Company has the Public Company Long Term Incentive Plan (Plan) to provide Eligible Persons the opportunity to become Plan Participants and receive rights to fully paid shares in Public Company (Rights) as an incentive.

The Rights issued by Public Company to a Participant will be issued at a discount.

Public Company has decided to establish an Employee Share Trust (EST), which was settled via a Deed on 3 April 2019 (Deed) to facilitate the provision of shares in Public Company under the Plan to certain Australian employees of the Public Company Group (Participants).

It is proposed that current Participants and new employees will be eligible to participate in the Plan administered by the EST.

The establishment of the EST will accommodate capital management flexibility for Public Company in that the EST can use the contributions from Public Company to either acquire shares in Public Company from existing shareholders, or, alternatively, subscribe for new shares in Public Company. It also allows for a streamlined approach to the administration of the Plan.

Any time there is a grant of Rights pursuant to the Plan, the grant will be subject to the rules of the Plan (Rules).

While it will be Public Company making the contributions to the Trustee of the EST, these costs will be recharged to Aus Sub Company (as employer of the relevant individuals) (Recharge Amounts). Therefore, it will be Aus Sub Company (as employer of the relevant individual) who will ultimately bear these costs.

The costs incurred by Public Company are recharged to Aus Sub Company (the Recharge Amounts generate assessable income of Public Company pursuant to subsection 6-5(1) of the ITAA 1997), these costs are incurred by Aus Sub Company (a 100% subsidiary of Public Company) to generate increased profit via enhanced employee performance, thereby generating additional dividend income to Public Company.

The Plan broadly operates as follow:

- The Board may from time to time, in its absolute discretion, nominate any eligible person for participation in the Plan (Participant) and determine the number of Rights to be offered to that Participant.

- The Invitation to participate in the Plan may be made by the Board at any time, in any form and on any conditions or subject to any restrictions as the Board decides.

- The Invitation will specify certain information, including a description and the number of Rights offered and the amount (if any payable by the Participant for the rights or shares to which the rights relate), as well as the terms (including any conditions and restrictions) and the time by which and the manner in which the Invitation is to be accepted.

- The conditions and restrictions may include time vesting (period of time before the Participant is entitled to exercise the rights and have shares provided), performance vesting (performance conditions to be satisfied before the Participant is entitled to exercise the Rights and have shares provided), forfeiture conditions (circumstances where the Participant will forfeit the rights or any interest in, or right to receive shares) and any other condition that the Board may determine.

- After the acceptance of an Invitation by a Participant, Public Company will allocate the number of Rights specified in the Invitation to the Participant and notify them of the date that the Rights were allocated to them (Grant Date).

- The total number of shares which may be offered to a Participant under the scheme will not at any time exceed 5% of the Public Company's total issued shares.

- An invitation must specify the Performance Conditions that apply to the Rights, which may include the testing period (period which performance conditions are assessed), performance measure (standard which performance conditions are measured against), assessment and expiry period.

- The Participant may exercise the Right by giving notice to Public Company (which notice must specify the number of Rights provided to the Participant and how to be exercised).

- Public Company must as soon as practicable after receipt of the notice, arrange for the Participant to be provided with the number of Shares which corresponds to the number of Rights that have been exercised.

- Rights will automatically lapse if Performance Conditions are not satisfied and the period of that Performance Period has expired.

- A Right may not be transferred and lapses immediately on the purported transfer, unless the Board approves the transfer.

- If the Participant ceases to be an eligible Person, then they will have six months to exercise the vested Right and be provided with a Share.

- Shares acquired upon the exercise of Rights under the Plan will rank equally with all existing Shares in all respects from the date of acquisition.

The scheme (resulting from the operation of the Plan and the Deed) is an Employee Share Scheme (ESS) for the purposes of Division 83A. Under the scheme the ESS interests are acquired at a discount.

The relevant clauses of the Deed and the Plan rules are set out in the ruling.

Reasons for decision

Unless otherwise indicated, all legislative references are to the Income Tax Assessment Act 1997.

Question 1

Public Company will recharge expenditure (Recharge Amount) related to the irretrievable contributions which it makes to the Trustee of the Eployee Share Trust (EST) to Aus Sub Company, given all of Public Company's Australian employees are engaged through Aus Sub Company.

Subsection 8-1(1) is a general deduction provision. Broadly, it provides an entitlement to a deduction from your assessable income any loss or outgoing to the extent that:

·         It is incurred in gaining or producing your assessable income; or

·         It is necessarily incurred in carrying on a business for the purposes of gaining or producing your assessable income.

There are a number of exclusions in subsection 8-1(2) relevant to the operation of subsection 8-1(1). The relevant exclusion in the present circumstances is that a loss or outgoing is non-deductible to the extent that it is capital or of a capital nature.

Subsection 8-1(1) - the positive limbs

Losses or outgoings

For a loss or outgoing to be incurred under subsection 8-1(1), it must be established that the Recharge Amount payable by Aus Sub Company to Public Company is irretrievable and non-refundable. The Recharge Amount paid by Aus Sub Company to Public Company is irretrievable and non-refundable to Aus Sub Company as the Deed ensures that any funding provided by Public Company to the Trustee cannot be returned to the Public Company Group, which includes Aus Sub Company.

Thus, the Recharge Amounts payable by Aus Sub Company to Public Company will be losses or outgoing that are irretrievable for the purposes of subsection 8-1(1).

Sufficient nexus

Subsection 8-1(1) requires that there is a sufficient nexus between the Recharge Amount paid to Public Company and the gaining or producing of assessable income, or that the Recharge Amount is necessarily incurred in carrying on a business for that purpose.

An expense will have the relevant nexus to a business when it is 'desirable or appropriate in the pursuit of the business ends of the business' (see, Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 55-58).

The Recharge Amounts are considered to be incurred either in gaining or producing assessable income or necessarily incurred in carrying on Aus Sub Company's business for the purpose of producing its assessable income because:

- The recharge amount payable by Aus Sub Company is in respect of irretrievable contributions made by Public Company to the EST in relation to Rights which have been offered to particular employees of Aus Sub Company; and

- The benefits provided to employees under the Plan intend to attract, reward and retain high-quality employees and align their interests with those of shareholders which is ultimately designed to improve Aus Sub Company's operating performance and therefore its assessable income. The payments made by Aus Sub Company are incurred to facilitate the achievement of the objectives as set out in the Plan.

Capital or of a capital nature

Aus Sub Company will be entitled to a general deduction for the Recharge Amounts made to Public Company (in respect of the irretrievable contributions Public Company makes to the Trustee of the EST) under section 8-1 provided it is not capital, or capital in nature (see, subsection 8-1(2)).

The contributions made by Aus Sub Company to Public Company are regular and recurring.

The contributions made by Aus Sub Company to Public Company are ultimately and in substance applied for the benefit of remunerating employees in connection with the derivation of assessable income by Aus Sub Company. The primary advantage sought by Aus Sub Company is the incentivizing of Aus Sub Company employees to perform effectively and contribute to the assessable income of Aus Sub Company.

The combined operation of subsections 8-1(1) and 8-1(2) may require apportionment of a loss or outgoing into deductible and non-deductible components, where a single loss or outgoing is incurred for more than one purpose or on items of a differing nature. In this case, the outgoings incurred by Aus Sub Company by way of Recharge Amounts to Public Company are either not capital in nature or any capital component is sufficiently small or trifling such that the Commissioner would not seek to apportion the deduction.

Private or domestic in nature and other negative limbs

Nothing in the facts suggests that the Recharge Amount paid by Aus Sub Company to Public Company is private or domestic in nature, or is incurred in gaining or producing exempt income or non-assessable non-exempt income, or is otherwise prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936.

Conclusion

Subject to the operation of section 83A-210 (discussed in question 2 - below), when Aus Sub Company pays a Recharge Amount to Public Company, those payments will be allowable deductions to Public Company under section 8-1.

Question 2

The deduction of Recharge Amounts by Aus Sub Company under section 8-1 would generally be allowable in the income year in which Aus Sub Company incurred the outgoing but, under certain circumstances, the timing of the deduction is specifically determined under section 83A-210.

Section 83A-210 provides that:

If:

(a) at a particular time, you provide another entity with money or other property:

(i) under an arrangement; and

(ii) for the purpose of enabling an individual (the ultimate beneficiary) to acquire, directly or indirectly, an ESS interest under an employee share scheme in relation to the ultimate beneficiary's employment (including past or prospective employment); and

(b) that particular time occurs before the time (the acquisition time) the ultimate beneficiary acquires the ESS interest;

then, for the purpose of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time.

Section 83A-210 will only apply if there is a relevant connection between the cash provided to Public Company and the acquisition of ESS interests (directly or indirectly) by Aus Sub Company's employees under the Plan, in relation to the employee's employment.

The meaning of "ESS interest" and "employee share scheme" are defined in section 83A-10:

(1) An ESS interest, in a company, is a beneficial interest in:

(a) a share in the company; or

(b) right to acquire a beneficial interest in a share in the company.

(2) 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) of:

(a) the company; or

(b) subsidiaries of the company;

in relation to the employees' employment.

Under the Plan, the Rights granted to Participants will be an ESS interest as these are rights to acquire a beneficial interest in a share in Public Company. The Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest is granted to an employee in relation to their employment in Aus Sub Company.

The granting of the beneficial interests in the Rights, the contributions made to the Trustee of the EST under the arrangement, the acquisition of shares by the Trustee of the EST and the allocation of those shares to Participants are all interrelated components. All of these components must be carried out so that the scheme can operate as intended.

As one of those components, the Recharge Amount payable by Aus Sub Company to Public Company in respect of the contributions to the Trustee of the EST necessarily allows the scheme to proceed. Consequently, the Recharge Amount is considered to be for the purpose of enabling the Participants, indirectly via the Plan, to acquire the Rights.

Recharge Amounts used by the Trustee of the EST to purchase excess shares intended to meet a future obligation arising from a future grant of Rights under the Plan would be incurred before the Participant acquires the Right under the employee share scheme. Section 83A-210 will apply and the excess payment will only be deductible to Aus Sub Company in the year of income when the relevant Rights are subsequently granted to the Participants.

Any recharge amounts paid by Aus Sub Company to fund the acquisition of shares from Rights already granted, will be deductible to Aus Sub Company when the obligation to pay the Recharge Amount to Public Company is incurred.

Question 3

Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936.

Before the Commissioner can exercise his discretion to make a determination under section 177F of the ITAA 1936, three requirements must be met:

1.    There is a scheme (within the meaning of section 177A of the ITAA 1936);

2.    A tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out; and

3.    Having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose).

On the basis of an analysis of the three requirements, the Commissioner will not seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Public Company for the irretrievable contributions made by Public Company to the Trustee of the EST to fund the subscription for or acquisition of Public Company shares by the EST.

Question 4

A company's liability to fringe benefits tax (FBT) arises under section 66 of the FBTAA which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer of a year. The fringe benefits taxable amount is calculated under the FBTAA by reference to the taxable value of each fringe benefit provided.

No amount will be subject to FBT unless a fringe benefit is provided.

Subsection 136(1) of the FBTAA defines a fringe benefit to include a benefit provided to an employee by their employer or an associate of their employer 'in respect of' the employment of the employee.

The provision of rights

Certain benefits however are excluded from being a 'fringe benefit' by virtue of paragraphs (f) to (s) of the 'fringe benefit' definition in subsection 136(1) of the FBTAA.

Paragraph (h) of the definition of 'fringe benefit' relevantly states that a fringe benefit does not include:

(h) a benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83A-B or 83A-C of that Act applies.

The Commissioner accepts that the Plan is an employee share scheme. The Rights provided under the Plan are ESS interests and Division 83A-C applies to those ESS interests.

Accordingly, the provision of Rights pursuant to the Plan will not be subject to FBT on the basis that they are acquired by employees under an employee share scheme (to which Subdivision 83A-B or 83A-C will apply) and are excluded from being a fringe benefit by virtue of paragraph (h) of the definition of fringe benefit in subsection 136(1) of the FBTAA.

The provision of Public Company shares

As mentioned above, in general terms, 'fringe benefit' is defined in subsection 136(1) of the FBTAA 1986 includes a benefit provided to an employee by an associate of an employer 'in respect of' the employment of the employee. The meaning of the phrase 'in respect of' was considered by the Full Federal Court in J & G Knowles & Associates Pty Ltd v. Federal Commissioner of Taxation (2000) 96 FCR 402; 2000 ATC 4151; (2000) 44 ATR 22. Heerey, Merkel and Finkelstein JJ at page 410 stated:

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment.

The situation is similar to that which existed in Federal Commissioner of Taxation v. McArdle 89 ATC 4051; (1988) 19 ATR 1901 where an employee was granted valuable rights in respect of his employment which he subsequently surrendered in return for a lump sum payment. Davies, Gummow and Lee JJ noted that what had occurred under the surrender agreement was not the granting of a valuable benefit, but the exploitation of rights received from the employer in previous years.

When an employee of Aus Sub Company accepts Rights to participate in the Plan, they obtain a right to acquire a beneficial interest in a share. This right constitutes an ESS interest.

When this right is subsequently exercised, any benefit received would be in respect of the exercise of the Right, and not in respect of employment (ATO Interpretative Decision ATO ID 2010/219 Fringe Benefits Tax- Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme).

Therefore, the benefit that arises to an employee upon vesting of the performance right under the Plan (that is, the provision of a share) will not give rise to a fringe benefit as a benefit has not been provided in respect of the employment of the employee.

Question 5

Paragraph (ha) of the definition of 'fringe benefit' in section 136(1) of the FBTAA states that a fringe benefit does not include:

(ha) a benefit constituted by the acquisition of money or property by an employee share trust (within the meaning of the Income Tax Assessment Act 1997); or

The definition of employee share trust is contained in section 130-85(4):

(4) An employee share trust, for 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 right to acquire a beneficial interest in an employer share is an ESS interest within the meaning of subsection 83A-10(1).

An employee share scheme is defined in subsection 83A-10(2) 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 employees' employment.

The scheme is an employee share scheme within the meaning of subsection 83A-10(2) because it is a scheme under which rights to acquire beneficial interests in shares in the company are provided to employees in relation to the employee's employment.

Under the Plan, Public Company has also established the EST to acquire shares in the Company and to allocate those shares to Participants. Therefore, paragraphs 130-85(4)(a) and (b) are satisfied because:

- The EST's sole activities are to obtain shares in Public Company; and

- The operation of the EST ensures that the ESS interests, being the right to beneficial interests in those shares, are provided under an employee share scheme, to the employees in accordance with the Deed and Rules of the Plan.

Undertaking the above activities will require that the Trustee undertake incidental activities that are a function of managing the plans and administering the trusts (see, paragraph 130-85(4)(c)).

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 merely incidental.

The Trustee of the EST will administer the EST in accordance with the terms of the Deed (in particular, clause 5.17 of the Deed which specifically provides that the EST will be managed and administered so that it satisfies the definition of an employee share trust under subsection 130-85(4)). Therefore, the activities of the Trustee of the EST will be within the scope of activities outlined in section 130-85(4) and the trust will be an employee share trust.

As such, paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA should exclude the contributions to the Trustee of the EST from being a fringe benefit. Payments of the Recharge Amounts by Aus Sub Company to Public Company to facilitate the payment to the EST are not considered to be a fringe benefit.

Accordingly, Aus Sub Company will not be required to pay FBT in respect of the Recharge Amounts which it pays to Public Company, nor the amount of the irretrievable cash contributions which Public Company makes to the Trustee of the EST to fund the acquisition of Public Company shares in accordance with the Deed.

Question 6

As mentioned in the answer to question 3, PS LA 2005/24 has been written to assist those who are contemplating the application of Part IVA or other general anti-avoidance rules to an arrangement, including in a private ruling. It succinctly explains the operation of section 67 of the FBTAA. Notably, paragraphs 145 - 148 provide as follows:

145.      Section 67 is the general anti-avoidance provision in the FBTAA. The operation of section 67 is comparable to Part IVA, in that the section requires the identification of an arrangement and a tax benefit, includes a sole or dominant purpose test and is activated by the making of a determination by the Commissioner. The definition of 'arrangement' in subsection 136(1) of the FBTAA is virtually identical to the definition of 'scheme' in section 177A of Part IVA.

146.      Subsection 67(1) of the FBTAA is satisfied where a person or one of the persons who entered into or carried out an arrangement or part of an arrangement under which a benefit is or was provided to a person, did so for the sole or dominant purpose of enabling an eligible employer or the eligible employer and another employer(s) to obtain a tax benefit.

147.      An objective review of the transaction and the surrounding circumstances should be undertaken in determining a person's sole or dominant purpose in carrying out the arrangement or part of the arrangement. Section 67 differs from paragraph 177D(b) in Part IVA in that it does not explicitly list the factors that should be taken into account in determining a person's sole or dominant purpose.

148.       Subsection 67(2) of the FBTAA provides that a tax benefit arises in respect of a year of tax in connection with an arrangement if under the arrangement:

                                  (i)        a benefit is provided to a person

                                 (ii)          an amount is not included in the aggregate fringe benefits amount of the employer; and

                                (iii)          that amount would have been included or could reasonably be expected to have been included in the aggregate fringe benefits amount, if the arrangement had not been entered into.

The Commissioner would only seek to make a determination under section 67 of the FBTAA if the arrangement resulted in the payment of less fringe benefits tax than would be payable but for entering into the arrangement. The point is made effectively in Miscellaneous Taxation Ruling MT 2021 Fringe Benefits Tax-Response to questions by major rural organisation under the heading "Appendix, Question 18" where, on the application of section 67 of the FBTAA, the Commissioner states:

...As mentioned in the explanatory memorandum to the FBT law, section 67 may only apply where there is an arrangement under which a benefit is provided to a person and the fringe benefits taxable amount in respect of that benefit is either nil or less than it would have been but for the arrangement...

Further, paragraph 151 of Practice Statement 2005/24 states:

151.   The approach outlined in this practice statement (refer to paragraphs 69 to 113) to the counterfactual and the sole or dominant purpose test in Part IVA is relevant and should be taken into account by Tax officers who are considering the application of section 67 of the FBTAA.

In the present case, the payment of the Recharge Amounts by Aus Sub Company to Public Company, the benefits provided to the Trustee by way of irretrievable contributions to the EST and to Participants by way of the provision of Rights and shares under the Plan is excluded from the definition of a fringe benefit for the reasons given above in questions 4 and 5.

As these benefits have been excluded from the definition of a fringe benefit, no fringe benefits arises and no fringe benefits tax (FBT)will be payable under the Plan, the FBT liability is not any less than it would have been but for the arrangement.

Accordingly, the Commissioner will not seek to make a determination that section 67 of the FBTAA applies to include an amount in the aggregate fringe benefits amount of Aus Sub Company in relation to a tax benefit obtained under the scheme from payment of the Recharge Amounts from Aus Sub Company to Public Company or the irretrievable contributions made by Aus Sub Company to the Trustee of the EST to fund the acquisition of Public Company shares under this scheme.

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