Edited version of private advice

Authorisation Number: 5010058017533

Date of advice: 29 July 2019

Ruling

Subject: Contributions to employee share trust of an employee share scheme

Question 1

Will Public Company obtain an income tax deduction, pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), in respect of the irretrievable cash contributions made by it to the Trustee of the Employee Share Trust (EST) to fund the subscription for (or the acquisition on-market &/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 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 by the EST pursuant to the Plan, deductible to Public 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

If the Trustee of the EST satisfies the relevant Plan obligations by subscribing for new shares in Public Company, will the subscription proceeds be included in the assessable income of Public Company under section 6-5 or 20-20 of the ITAA 1997 or trigger a capital gains tax (CGT) event under Division 104 of the ITAA 1997?

Answer

No

Question 4

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 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 of Public Company's shares?

Answer

No

Question 5

Is the provision of performance rights (Rights) and/or shares by Public Company to employees of Australian subsidiary Company (Aus Sub Company) 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

This ruling applies for the following periods for Questions 1 - 4

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 5

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.

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 implemented 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 (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), 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

Subsection 8-1(1) is the general deduction provision. Broadly, it provides an entitlement to a deduction from your assessable income for 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 for the purposes of this scheme 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 contributions to the EST by Public Company are irretrievable and non-refundable. The contributions made to the Trustee by Public Company are irretrievable and non-refundable to Public Company according to the Deed as:

- The Deed provides that the Trustee must acquire shares in Public Company for the purposes of Public Company satisfying its obligation to Participants.

- The Deed requires that Public Company provide sufficient funds to the Trustee to enable it to comply with the Deed and ensures that those funds cannot be returned to the Public Company Group (except as payment for shares issued to the Trustee).

- The Deed states that on termination of the EST, the Trustee must not pay any balance of capital or income of the EST that no Participant is entitled, to a company in the Public Company Group.

Thus, the contributions made by Public Company to the Trustee of the EST 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 contributions to the EST and the gaining or producing of assessable income, or that the contributions are 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 Commissioner considers that the cash contributions made by Public Company to the Trustee of the EST under the scheme are either incurred in the gaining or producing of assessable income or necessarily incurred in carrying on Public Company's business for the purpose of producing its assessable income (See, Heather v PE Consulting Group Limited (1973) 1 All ER 8 (1973) 48 TC 293 (Heather)).

The Deed and Rules indicate that Public Company makes the contributions to the EST solely to enable the Trustee to acquire Public Company's shares for Participants in accordance with the Plan in order to remunerate and retain the employees of the Public Company Group. Accordingly, it is considered that there is sufficient nexus between the outgoings (irretrievable contributions made by Public Company to the EST) and the derivation of Public Company's assessable income.

Capital or revenue

A company will be entitled to a general deduction for irretrievable contributions made to the trustee of its employee share scheme under section 8-1 provided it is not capital, or capital in nature.

In Spotlight Stores Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 745 and Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 58 ATR 210 it was determined that payments by an employer company to an employee share trust established for the purpose of providing incentive payments to employees were on revenue account and were not capital or of a capital nature.

The contributions made by Public Company to the Trustee of the EST are regular and recurring.

The contributions made by Public Company to the EST are ultimately and in substance applied for the benefit of remunerating employees in connection with the derivation of assessable income by Public Company. The primary advantage sought by Public Company in making contributions to the EST under the Plan is the resultant incentivizing of Aus Sub Company employees to perform effectively and contribute to the assessable income derived by Public Company (through dividends from Aus Sub Company) as well as the income received by Public Company from recharging the relevant expenditure to 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 Public Company by way of contributions to the Trustee to carry on its business 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 contributions made by Public Company to the Trustee are private or domestic in nature, or are incurred in gaining or producing exempt income or non-assessable non-exempt income, or are 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 Public Company makes irretrievable contributions to the Trustee of the EST to fund the acquisition of shares according to the Deed and Rules, those contributions will be allowable deductions to Public Company under section 8-1.

Question 2

The deduction for the irretrievable cash contributions under section 8-1 would generally be allowable in the income year in which Public 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 the EST and the acquisition of Employee Share Scheme (ESS) interests (directly or indirectly) by employees under the ESS (in relation to the employee's employment), and the contributions are made before the acquisition of the ESS interests.

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 Performance Rights (Rights) granted to employees will be ESS interests as these are rights to acquire a beneficial interest in a share in Public Company. The Plan is an ESS for the purposes of Division 83A as it is an arrangement under which an ESS interest is provided to an employee in relation to their employment in Aus Sub Company (a subsidiary of Public Company) according to the Deed.

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 of the Plan. All of these components must be carried out so that the ESS can operate as intended.

However, if any amount of money is 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, the excess payment would be incurred before the employee acquires the relevant Rights under the scheme. In such a case, section 83A-210 will apply and the excess payment will only be deductible to Public Company in the year of income when the relevant Rights are subsequently granted to the employees. This is consistent with the ATO view expressed in ATO Interpretative Decision ATOID 2010/103 Income Tax - Employee share scheme: timing of deduction for money provided to the trustee of an employee share trust.

Section 83A-210 will not apply where Public Company makes irretrievable contributions to the Trustee of the EST to fund the acquisition of Public Company shares where the contribution is made after the acquisition of the relevant ESS interests.

In such a situation, the irretrievable contributions by Public Company to the Trustee of the EST will be deductible under section 8-1 in the income year in which the irretrievable contributions are made where relevant ESS interests are ultimately satisfied with Public Company shares.

Question 3

Section 6-5 provides that a taxpayer's assessable income includes income according to ordinary concepts, which is called ordinary income. To the extent that a taxpayer is an Australian resident, the assessable income of the taxpayer includes ordinary income derived directly or indirectly from all sources.

The expression "income according to ordinary concepts" is not defined for the purposes of the income tax legislation, however there is a substantial body of case law which has developed and elaborated on the expression and which has established certain factors which may assist in determining whether a receipt should be characterised as income according to ordinary concepts.

In G. P. International Pipecoaters Proprietary Limited v The Commissioner of Taxation of the Commonwealth of Australia (1990) 170 CLR 124, the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. The Full Court stated at page 138 that:

To determine whether a receipt is of an income or of a capital character, various factors may be relevant. Sometimes, the character of the receipt will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt, sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipients purpose in engaging in the transaction, venture or business.

Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

In an ESS, where the trustee subscribes to the company for an issue of shares and pays the full subscription price for the shares, the company receives a contribution of share capital from the trustee.

The receipt of subscription proceeds from the Trustee takes the character of share capital and accordingly is capital in nature. This view is supported by the reasoning in ATO Interpretative Decision ATOID 2010/155 Income Tax - Employee Share Scheme: assessability to an employer of the option exercise price paid by an employee.

Accordingly, when Public Company receives subscription proceeds from the Trustee of the EST where the Trustee has subscribed for new shares in Public Company to satisfy obligations to Participants, those subscription proceeds received by Public Company are capital receipts. That is, they will not be on revenue account and will not be ordinary income in the hands of Public Company under section 6-5.

Section 20-20

Subsection 20-20(2) states that an amount that you have received as recoupment of a loss or outgoing is an assessable recoupment if:

- You receive the amount by way of insurance or indemnity; and

- You can deduct an amount for the loss or outgoing for the current year or a previous income year.

A recoupment includes "any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described and a grant in respect of the loss or outgoing" (see, section 20-25).

Public Company will receive an amount for the subscription of shares by the Trustee of the EST. There is no insurance contract involved and the amount is not received by way of insurance.

Further, the amount is not an indemnity because the receipt does not arise under a statutory or contractual right of indemnity and the receipt is not in the nature of compensation.

It follows that the subscriptions received do not constitute an assessable recoupment under subsection 20-20(2).

Assessable Recoupment - Other Recoupment (i.e. not by way of insurance of indemnity)

Subsection 20-20(3) provides that an amount a taxpayer receives as recoupment of a loss or outgoing, otherwise than by way of insurance or indemnity, is an assessable recoupment if such a loss or outgoing is deductible in the current or a prior income year because of a provision listed in the table in section 20-30.

The receipt by Public Company is in return for issuing shares to the Trustee of the EST, not as a recoupment of previously deducted expenditure under section 8-1 regarding bad debts or rates or taxes that could be subject to section 20-30.

Therefore, the subscription proceeds will not be assessable recoupment under section 20-20.

Capital Gains Tax

Under subsection 102-5(1) a taxpayer must include any net capital gain for the income year in its assessable income. In turn, section 102-20 provides that "You can make a capital gain or capital loss if, and only if, a CGT event happens...".

As the transaction is the payment of subscription proceeds by the Trustee of the EST to Public Company, the possible CGT Events are CGT Event D1 (Creating a contractual or other rights) and/or CGT event H2 (Receipt for event relating to a CGT asset).

However, where a company issues or allots shares, paragraph 104-35(5)(c) provides that CGT Event D1 does not happen if "a company issues or allots equity interests or non-equity shares in the company". The Public Company shares in question will constitute "equity interests", (see, subsection 974-75(1)).

CGT Event H2 happens if an act, transaction or event occurs in relation to a CGT asset that the taxpayer owns and which does not result in an adjustment to the asset's cost base or reduced cost base (see, subsection 104-155(1)).

In relation to CGT event H2, paragraph 104-155(5)(c) provides that CGT Event H2 does not happen where a company issues or allots equity interests or non-equity shares in the company.

When Public Company issues shares to the Trustee of the EST, neither CGT event D1 nor CGT Event H2 will happen.

Accordingly, a CGT event under Division 104 does not arise when the Trustee of the EST subscribes for shares in Public Company.

Question 4

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 must be 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).

Scheme

Scheme is defined in subsection 177A(1) of the ITAA 1936 very broadly, as follows:

(a) Any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) Any scheme, plan, proposal, action, course of action or course of conduct.

The establishment of the EST and its funding to acquire shares and the allocation of those shares to employees will be a scheme under subsection 177A(1) of the ITAA 1936.

Tax Benefit

In order to apply Part IVA of the ITAA 1936 to the scheme, the Commissioner must identify a tax benefit in relation to the scheme.

Relevantly, subsection 177C(1) of the ITAA 1936 provides that:

Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

(a) an amount not being included in the assessable income of the taxpayer of a year of income where the amount would have been included, or might reasonably be expected to be included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out;

As stated in Commissioner of Taxation v Hart (2004) 55 ATR 712 (Hart) in assessing whether a tax benefit arises, a comparison must be made between the scheme in question and an alternative postulate or counterfactual. That is, an assessment must be made of what would have happened, or what might reasonably be expected to happen, if the EST had not been established. The counterfactual also forms the background against which the objective ascertainment of the purpose of a person occurs in accordance with section 177D of the ITAA 1936.

Since the decision in Hart there have been recent amendments to Part IVA of the ITAA 1936, in particular, the introduction of section 177CB of the ITAA 1936, which is designed to limit the scope of alternative postulates to one that has the same objective as the scheme identified and results in the same commercial outcome. These changes are effectively designed to restrict the consideration of tax consequences in determining an alternative postulate.

In considering the alternative postulate, subsection 177CB(2) of the ITAA 1936 states:

A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme).

Further, subsection 177CB(3) of the ITAA 1936 provides:

A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme.

In the present case, Public Company receives an income tax deduction as a result of contributions made to the Trustee to facilitate the implementation of the Plan under an arm's length arrangement. In order to determine the tax benefit that would be derived from the scheme, it is necessary to compare this scheme to an alternative postulate having regard to the considerations noted in section 177CB of the ITAA 1936, above.

If the scheme were not entered into (i.e. contributions were not paid to the EST to purchase shares on market or subscribe for new shares) but rather Public Company purchased shares directly on market on behalf of the relevant employees, then Public Company should still receive a deduction for the purchase price of the shares.

If the scheme were not entered into (i.e. contributions were not paid to the EST to purchase shares on market or subscribe for new shares) but rather Public Company issued new shares directly to the relevant employees then Public Company may not receive a deduction in respect of new shares issued to the employees.

It is noted, therefore, that Public Company/Aus Sub Company could have either chosen to simply buy shares from existing shareholders or alternatively remunerate employees via an entirely different method (e.g. cash bonuses). While the alternative remuneration would entitle Public Company Group to a deduction, issuing shares directly to the employees would not. Therefore, by using an EST, a tax benefit is created through the deduction Public Company will claim under section 8-1 for the irretrievable cash contributions it makes to the Trustee of the EST.

Accordingly, it is arguable that a deduction would have been available to Public Company, whether or not the scheme had been entered into.

Under the scheme commercial benefits and outcomes arise for Public Company. This analysis proceeds on the assumption that there is a potential tax benefit arising from the scheme.

Sole or Dominant Purpose

The Commissioner is only permitted to disallow a tax benefit in connection with a scheme if the Commissioner considers that the sole or dominant purpose for entering into the scheme was to enable a taxpayer to obtain a tax benefit.

Consistent with the decision in Hart, when drawing a conclusion about purpose from the eight matters identified in section 177D of the ITAA 1936 the Commissioner is required to consider what other possibilities existed (i.e. in what other way could the taxpayer have achieved their stated commercial objectives).

In applying Part IVA of the ITAA 1936, the courts have tended to consider which step or steps produce the "tax benefit" and then consider how the step is explained. If the step or steps could only be explained by the tax benefits delivered, then the courts have historically concluded that Part IVA of the ITAA 1936 applies to deny any tax benefit. This is apparent from the High Court decisions in Hart, Commissioner of Taxation v Spotless Services Ltd (1996) 34 ATR 183 and Consolidated Press Holdings v FCT (2001) 47 ATR 229.

Conversely, if the step which produces the tax benefit can principally be explained by reference to non-tax consequences, the courts have generally held that Part IVA of the ITAA 1936 does not apply. This is evident from the Federal Court decisions in Eastern Nitrogen Ltd v FCT (2001) 46 ATR 474 and FCT v Metal Manufacturers Ltd (2001) 46 ATR 497. Similarly, if it can be demonstrated that the steps which produce the tax benefit are commercially necessary, in the sense that the commercial outcomes could not have been achieved without those steps, then prima facie Part IVA of the ITAA 1936 should not apply.

Furthermore, the explanatory memorandum to the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 provides:

1.98 The amendments make it clear that in determining whether a postulate is a reasonable alternative to the entering into or carrying out of the scheme, particular regard must be had to the 'substance of the scheme' and to 'any result or consequence for the taxpayer that would be achieved by the scheme' (tax results aside). [Schedule 1, item 5, paragraph 177CB(4)(a)]

1.99 These matters are ones to which regard must also be had under section 177D in determining whether it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit.

1.100 Particular regard must be given to the specified matters: they are not intended to be an exhaustive list of the matters to which regard may be had.

1.101 Particular attention is directed to the specified matters in order to ensure that postulates identified under the reconstruction limbs of the subsection 177C(1) paragraphs are reasonable substitutes for the scheme.

1.102 A tax advantage cannot meaningfully be linked to a scheme by comparing the tax consequences of the scheme to the tax consequences that would have flowed if the parties had chosen to pursue some other objective. To provide a meaningful comparison, the tax consequences of the scheme should be compared with the tax consequences of an alternative that is reasonably capable of achieving for the taxpayer substantially the same non-tax results and consequences as those achieved by the scheme.

Paragraphs 177D(2)(a) - (h) of the ITAA 1936

(a) The manner in which the scheme was entered into or carried out

In the present case, even though a tax benefit may arise, the EST and the contributions made to the EST do not represent a blatant, contrived or artificial arrangement, but are explicable by reference to ordinary business dealing. In particular:

- ESTs are common commercial vehicles which have been used by taxpayers for many years. Their usage is widespread amongst private and public companies in Australia and overseas.

- Their use has been sanctioned by the tax law in various areas for many years (see, for example, the exemption from the Fringe Benefits Tax Assessment Act 1986 (FBTAA) in paragraph 136(1)(ha) of the FBTAA and the timing of tax deductions in section 83A-210 of the ITAA 1997).

- All dealings between the parties are conducted according to rules set out in the Plan and the Deed which are a standard set of rules with arm's-length terms and are consistent with the way that ESSs operate in practice.

- The use of a trust has a range of commercial uses in addition to being a vehicle for the delivery of shares to employees. Those commercial benefits are identified in the scheme.

Whilst the funding of the EST and how the EST uses such funds will be directed by the Board of Public Company, this is common practice in relation to employee share trusts. Further, the directions that the Board gives to the Trustee (e.g. whether to subscribe for shares in Public Company or buy shares from existing shareholders) will be made for commercial purposes. For example, there may be a desire by Public Company to prevent shareholding dilution (supporting a decision to purchase shares from existing shareholders).

The establishment of the EST is explicable by reference to a number of commercial reasons and ordinary business arrangements.

However, the EST provides benefits to the operation of the scheme that would not be available if the shares were provided directly by Public Company to the employees of Aus Sub Company.

(b) The form and substance of the scheme;

There is no discrepancy between the form of the scheme and its economic and commercial substance. The integration of the EST with the Plan is designed to remunerate and incentivise employees to align their interests with those of shareholders for which the Plan was designed. It is not uncommon for public companies to remunerate their employees, particularly senior management, in the form of equity. In particular, the form and substance align such that irretrievable contributions are made to the EST which cannot be refunded to Public Company. Those funds will be used to obtain shares that are held on behalf of employees for the purpose of rewarding and retaining senior management.

There is nothing in this factor to suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit.

(c) The time at which the scheme was entered into and the length of the period during which the scheme was carried out;

The contributions will be made progressively over future years in accordance with the terms of the Plan. Furthermore, the length of the scheme is not intended to be for a short period. The scheme is intended to remain in place indefinitely provided the commercial benefits outweigh the respective costs of administration.

Accordingly, the timing and duration of the scheme does not suggest that the EST was established for the sole or dominant purpose of obtaining a tax benefit.

(d) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

The impact under the tax law of funding the EST with cash is that Public Company will be entitled to a tax deduction for irretrievable contributions made to the EST by Public Company. As noted above, an entity in the Public Company Group would also have been entitled to a tax deduction if it had remunerated employees via other methods (e.g. cash bonuses). However, if Public Company had issued shares directly to employees of Aus Sub Company, the cost of issuing share would not be deductible. It is noted that the contributions reflect a genuine non-capital outgoing by Public Company to achieve a business outcome. Therefore, the results of the scheme do not suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit.

(e) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

The Plan is also likely to result in improved performance of employees which will in turn improve the Public Company Group's operating performance and Public Company's return through increased dividends from Aus Sub Company. This is the intended outcome of the Plan through establishing incentive arrangements which attract, reward and retain key employees. Profitability is also likely to improve given embedded performance targets. This outcome points to the commercial outcomes as opposed to any dominant tax purpose in the scheme. The fact that there may be a cash outlay to satisfy the obligations under the Plan is reflective of the cost of remunerating/incentivising employees.

While it is arguable that the quantum of the deductions is higher with an EST as part of the scheme than would be the case if the company provided shares to employees directly, there is nothing artificial or contrived about Public Company's expenditure.

(f) Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

The EST receives funds from Public Company (forming the corpus of the EST) which enables it to acquire shares for the employees either on or off market or by way of new subscription. The Trustee must deal with the funds in accordance with the terms of the Deed.

In relation to the relevant Participants, their financial position will change as a result of participating in the scheme. There is nothing artificial or contrived in the scheme to suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit.

(g) Any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out;

This factor is not relevant in the present case.

(h) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (f).

In the present case the relevant parties are Public Company, the Trustee of the EST, Aus Sub Company and the eligible employees who participate in the Plan (Participants). The eligible employees as a group are generally at arm's-length from Public Company, Aus Sub Company and the Trustee. Moreover, their relationship is governed by the Rules and the Deed which are at arm's-length.

There is nothing in this factor to suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit.

Conclusion

On balance, a consideration of all the factors referred to in subsection 177D(2) of the ITAA 1936 leads to the conclusion that the sole or dominant purpose of the parties to the scheme is not to obtain a tax benefit. Rather the sole or dominant purpose is to provide remuneration to employees of the Public Company Group who participate in the scheme in a form that promotes the Public Company Group's business objectives, rather than to obtain a tax benefit.

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 5

A company's liability to fringe benefits tax (FBT) arises under section 66 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer for the relevant year of tax. 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 an associate of an 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 ESS. 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 ESS (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 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.

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