• The impact of this case on ATO policy is discussed in Decision Impact Statement: Taxpayer and Commissioner of Taxation (Published 22 December 2011).

CASE 9/2011

Members:
BJ McCabe SM

Tribunal:
Administrative Appeals Tribunal, Brisbane

MEDIA NEUTRAL CITATION: [2011] AATA 508

Decision date: 25 July 2011

---

Bernard J McCabe (Senior Member)

1. The taxpayer was a senior employee of a subsidiary of a multinational mining company. (I will refer to the multinational company in these reasons as "the company".) He participated in the company's employee incentive share scheme. Under that scheme, the taxpayer was given options to acquire the company's shares at a fixed price per share. On 16 September 2008, he exercised the option to acquire a number of the company's shares at the option price. The market price of the stock at the time was higher. The Commissioner says that the taxpayer received, in effect, a large discount by purchasing the shares under the scheme. The Commissioner says the amount of the discount should have been included in the taxpayer's assessable income for the 2008-2009 year of income. The taxpayer disagrees, and has asked the Tribunal to reconsider the matter.

Facts

2. The facts are not really in dispute. The taxpayer was allocated options to buy shares under the company's Long Term Incentive Plan, which was an employee share scheme. The scheme is described in correspondence included in exhibit one. The taxpayer also talked about it in his evidence at the hearing. The options were allocated free of charge in March 2005 although they could not be exercised for several years. It was a condition of the scheme that the options would not vest unless the company met performance targets. As it happens, the company did meet those targets and the taxpayer became entitled to exercise the options after March 2008: exhibit one at pp 34-38. This case arises out of his decision to exercise the options in the latter part of 2008. He said it was always his intention that the shares would be given to his wife. I have no reason to doubt that was so.

3. The taxpayer exercised the option to acquire 11,000 shares on 16 September 2008. The purchase price, inclusive of British taxes, was $238,568.84 assuming an exchange rate on that day of $A1=GBP 0.4397.

4. The shares were registered in the taxpayer's name in the company's share register on 27 October 2008. The Commissioner says the shares were subsequently transferred to the taxpayer's wife for no consideration on 28 October 2008. By that time, the value of the shares had declined relative to the market price on 16 September. Indeed, by late October, the shares had fallen below the strike price under the option - the strike price being the price the employee paid to acquire the shares when exercising the option. In that sense, the taxpayer had sustained a loss. The taxpayer said his wife had paid around $4,000 into their joint account on 14 October 2008 as consideration for the shares.

The Contentions Of The Parties

5. The Commissioner says the shares were effectively acquired at a discount. The discount is the difference between the market price of the share and the strike price of the option. (I will say more about the way in which the discount is calculated shortly.) The Commissioner says the legislation requires that the amount of the discount be included in the taxpayer's assessable income unless certain exceptions are made out. The Commissioner says the exceptions do not apply here.

6. Dr Schulte, the counsel for the Commissioner, explained that the legislation assumes share options and rights given to an employee in these circumstances are really part of the taxpayer's remuneration, and should therefore be treated as income. He referred me to
Donaldson v Federal Commissioner of Taxation (1974) 23 FLR 1 to illustrate the background to the provisions. In that case, Bowen CJ in Eq explained (at 19):

"… such benefits are to be regarded as being in the nature of a bonus or an addition to salary and are of an income nature where they are conferred in relation to the employment or services rendered."

7. Division 13A of the Income Tax Assessment Act 1936 ("ITAA36") contains the relevant legislation for the purposes of the 2008-2009 year of income. The key provision is s 139B which says at sub-section (1):

"If a taxpayer has acquired a share or right under an employee share scheme, the assessable income of the taxpayer includes the discount given in relation to the share or right."

8. Section 139C(1) says a share or right is acquired under an employee share scheme:

"… if the share or right is acquired by the taxpayer in respect of, or for or in relation directly or indirectly to, any employment of the taxpayer or an associate of the taxpayer."

9. I am satisfied the acquisition of shares in this case in 2008 was linked to the employment of the taxpayer. The acquisition occurred under the terms of the Long Term Incentive Plan, after all. The Commissioner says in those circumstances the amount of the discount must be included in the taxpayer's assessable income pursuant to s 139B(1). But in what year?

10. Section 139B(2) says the value of the discount is included in the taxpayer's assessable income in the year of income in which the share is acquired - unless the share is a qualifying share within the meaning of s 139CD. In that alternative event, s 139B(3) says the discount is included in the assessable income of the tax year in which the cessation time occurs unless an election is made pursuant to s 139E. I note there is no evidence that an election was made in accordance with s 139E in this case.

11. There does not appear to be any doubt that the shares in question here satisfy the definition of qualifying share in s 139CD. The cessation time is determined having regard to s 139CA. The cessation time in this case is the date on which the shares were acquired (ie 16 September, or perhaps - depending on one's view of the question - 27 October 2009) because (a) there was no restriction preventing the taxpayer from disposing of the shares and (b) the scheme under which the shares were acquired does not provide for the shares to be forfeited.

12. I have already described in general terms how the discount is calculated. The specific rule which governs the calculation of the discount in this case is found in s 139CC(4). It deals with the acquisition of shares which are covered by s 139B(3) that are not disposed of in an arms' length transaction within 30 days of the acquisition. In this case, the shares were disposed of to the taxpayer's spouse more than a month after the right was exercised. Even if it is argued the shares were not acquired by the taxpayer until they were registered in his name on 27 October, the disposition of the shares to his wife the following day did not occur at arms' length. In those circumstances, the amount of the discount is the market value of the share at the cessation time reduced by:

• "(b) the amount of any consideration paid or given by the taxpayer as consideration for the acquisition of the share or right; and
• (c) for a right that has been exercised - the amount of any consideration paid or given by the taxpayer to exercise the right."

13. The market value of the share is determined in accordance with s 139FA(1). Given the shares in question were traded on the London Stock Exchange, the market value of the share in this case is equal to "the weighted average of the prices at which those shares … were traded on that stock market during the one week period up to and including that day …". The expression weighted average is not defined: the Commissioner says it is determined by dividing the total value of shares traded on the market during the period in question by the volume of shares traded. That seems fair enough. Using the exchange data from the company's website, the Commissioner calculated the weighted average share price for the period in question was 22.5374 pounds sterling. Using an exchange rate of 0.4397 (the exchange rate on 16 September 2008), that means a weighted average share price of $A51.2563. Given the exercise price of the options was $A21.6861 (being 9.5354 pounds-sterling at an exchange rate of 0.4397), the discount per share was $A29.5702. Given there were 11,000 shares acquired, the total amount of the discount was $A325,272.20. (I note a slightly less favourable outcome is achieved from the taxpayer's viewpoint if one performs the calculations set out above using data supplied by Bloomberg from the London Stock Exchange. The Commissioner has used data set out on the company's website. I accept it is appropriate to do that.)

14. I also accept that it is appropriate to perform the exchange rate calculation once the weighted average share price has been calculated in pounds-sterling. It is not necessary to translate the daily share prices that form part of that calculation into Australian dollars before determining the weighted average share price. I think that follows from the scheme of the legislation which focuses on the weighted average share price, not the share price on individual days. The foreign currency calculation required by the legislation (in s 960-50 of the Income Tax Assessment Act 1997, most obviously) is only required at that point at which the weighted average share price has been determined.

15. The end result of all this is that the amount of the discount must be included in the taxpayer's assessable income for the year ended 30 June 2009. The legislation does not contemplate there being a capital loss or gain in these circumstances. The logic of Donaldson's case prevails.

Penalties

16. The Commissioner determined the taxpayer was liable to a penalty imposed at the rate of 25% under Division 284 of Schedule 1 Taxation Administration Act 1953 in light of a false or misleading statement that was the product of a want of reasonable care by the taxpayer. The taxpayer prepared his assessment himself. He is experienced in financial matters as a result of his occupation and experience. Given the amount of money involved, he should have obtained advice. The legislation is complex, although I think the outcome is clear (and different to that contended for by the taxpayer). I agree there was a want of reasonable care. I have been given no other reason to doubt that the penalty was correctly imposed.

Conclusion

17. The objection decision under review is varied so that the amount of the discount to be included in the taxpayer's assessable income pursuant to s 139B of the Income Tax Assessment Act 1936 is reduced from $332,266 to $325,272. The decision is otherwise affirmed.