Edited version of private ruling

Authorisation Number: 1011403002878

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Ruling

Subject: Employee Share Scheme

Relevant facts

The taxpayer company (the taxpayer) established an Employee Share Trust (EST) to facilitate the provision of its shares to its Australian employees.

As the scheme was established after 1 July 2009 it will be considered under Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997).

The trustee of the EST will be an entity unrelated to the taxpayer and one that does not form part of its tax consolidated group.

Shares in the trustee will be held by entities such that the trustee is controlled by the taxpayer's shareholders.

The taxpayer applied for a private ruling on how the taxation law applies to its employee share schemes.

The taxpayer operates an Australian-based business.

The taxpayer has implemented employee share schemes.

The employee share schemes broadly operate as follows:

§ To motivate achievement and promote longevity of employment

§ Invitation to apply for options is at the employer's discretion

§ Options are granted for no consideration

§ Options granted are able to be exercised, subject to a vesting period

§ Options exercised are convertible to one share

§ There is an exercise price for each option

§ Options are personal to the employees and cannot be sold, transferred, encumbered or disposed of by the employee

§ The last date of the vesting period is referred to as 'the closing date' and options granted expire 2 years from this date

§ After the closing date, an employee may sell any exercisable options to the company or other shareholders, only

§ The company can also redeem options or shares at any time

§ Shares issued on exercise of options carry the same rights to the capital and dividends of the taxpayer as other ordinary shares

§ Through exercise of the option, employees agree to be bound by the terms of the taxpayer's constitution and shareholders agreement

§ At the time of the ruling application options were outstanding

§ Unexercised options, will be amended and incorporated in the EST

§ If an option holder ceases to be an employee, their options lapse

§ Administration of the scheme is vested in the board

§ On exercise of options, the trustee of the EST will acquire the shares on behalf of each employee, through acquisition from existing shareholders, via a new share issue or by an allocation of shares already acquired

§ The receipt of the subscription price will be accounted for as an addition to the share capital of the taxpayer, in its books and records

§ While such shares are held on trust in the EST on behalf of the employees, the employees will be entitled to dividend and voting rights

§ Employees are absolutely entitled to the shares as against the Trustee from when the shares are allocated to them

§ By written notice, employees can apply for legal title to the shares held in the EST to be transferred to them or their nominee or to be sold on their behalf with a remittance of the sale proceeds (less any brokerage costs).

The application states that the EST is intended to operate in accordance with the trust deed, as a sole purpose trust to acquire shares for participants in share schemes and accordingly hold the shares in trust for eligible employees.

The trust deed states, that the trust will be managed and administered so that it satisfies the sole activities test for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936) and that it will be an 'employee share trust' as defined in subsection 995-1(1) of the ITAA 1997.

The EST will be funded by contributions from the taxpayer for the purchase of the shares under the share schemes.

Shares acquired by the EST will be allocated to employees who will become absolutely entitled to them.

The structure of the EST and the rules of each employee share plan are such that shares allocated to each employee will generally be transferred into the name of the relevant employee (or their nominee) on receipt of a withdrawal request.

The trustee will be permitted to sell shares on behalf of an employee where the relevant rules permit.

The trustee may not exercise any voting rights, participate in rights issues or hold any bonus shares in relation to unallocated trust shares.

§ Capital management flexibility

§ An arm's length vehicle for acquiring and holding its shares

§ A streamlined approach to the administration of the share schemes

§ Allowing for shares to be acquired and warehoused by the EST

§ Better visibility of management's share transactions

§ A means to give effect to disposal restrictions after vesting

§ It allows for the recycling of shares

§ A single entity for the administration of the share schemes; and

§ A flexible arrangement for long-term incentive schemes.

Question 1

Will the taxpayer company (the taxpayer) obtain an income tax deduction, pursuant to section 8-1 of the ITAA 1997, in respect of the irretrievable cash contributions made by it or any of the subsidiary members of its tax consolidated group to the Trustee of the EST, where such funding is in accordance with the purpose, terms and conditions of its equity plans?

Detailed reasoning

Section 8-1 of the ITAA 1997, insofar as it is relevant, states:

8-1(1)

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

8-1(2)

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature;

In Pridecraft Pty Ltd v. FC of T; FC of T v. Spotlight Stores Pty Ltd FCAFC 339; 2005 ATC 4001; 58 ATR 209, the Court held that payments by an employer company to a trust established for the purpose of providing incentive payments to employees were on revenue account and not capital or of a capital nature. This is consistent with the opinion expressed in ATO Interpretative Decision ATO ID 2002/1074 Income Tax - deductability - irretrievable employer contributions paid to the Trustee of its employee share scheme to acquire a share or right under the employee share scheme: that a company will be entitled to a deduction under section 8-1 of the ITAA 1997 for irretrievable contributions made to the trustee of its employee share scheme.

The stated purpose of the taxpayer in establishing and funding its employee share plans is to motivate achievement and promote longevity of employment and to reward senior management and key executives for achieving earnings targets set by the Board. The taxpayer has advised that the company will make irretrievable cash contributions to the EST to provide eligible employees with shares. Therefore, the irretrievable contributions it makes to the EST under the rules of the plans are directed to enhancing the profitability of the group's business and producing assessable income.

Accordingly, the irretrievable contributions the taxpayer makes to the EST to acquire shares, whether by on-market purchase or subscription, are allowable deductions.

Question 2

Will the taxpayer obtain income tax deductions, pursuant to sections 8-1 or 25-5 of the ITAA 1997, in respect of costs incurred in relation to the implementation and on-going administration of the EST?

Summary

Essentially, the same reasons apply to these costs as in Question 1 above. Costs incurred in relation to the implementation and ongoing administration of the EST are part of the ordinary recurrent costs to the company of remunerating its employees and are, therefore, deductible under section 8-1 of the ITAA 1997. This decision accords with the ATO view expressed in ATO Interpretative Decision ATO ID 2002/961 Income Tax: employer costs for the purpose of administering its employee share scheme are deductible.

However, it is noted that, unlike the irretrievable contributions made to the EST to acquire shares, these payments do not form part of the corpus of the EST, but are assessable income of the Trustee.

Question 3

Will the timing of deductions for irretrievable cash contributions made by the taxpayer to the trustee for the acquisition of ESS interests before the acquisition time, be determined by section 83A-210 of the ITAA 1997?

Detailed reasoning

As discussed in Question 1, above, the irretrievable contributions the taxpayer makes to the EST to acquire shares are allowable deductions, pursuant to section 8-1 of the ITAA 1997. Under the taxpayer's scheme options will be granted which, subject to certain conditions, will be exercisable for shares. These options are ESS interests in a company, as defined in subsection 83A-10(1) of the ITAA 1997.

With effect from 1 July 2009, section 83A-210 of the ITAA 1997 determines the timing of a deduction for contributions, as follows:

If:


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


(i) under an arrangement; and


(ii) for the purposes 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 purposes 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 of the ITAA 1997 will only apply if there is a relevant connection between the money provided to the Trustee, and the acquisition of ESS interests (directly or indirectly) by the taxpayer under the employee share plans, in relation to the employee's employment.

An ESS interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

Under the taxpayer's employee share plans an option granted to an employee will be an ESS interest as it is a right to acquire a beneficial interest in a share in the company. This ESS interest is granted under an employee share scheme in relation to the employee's employment. The share acquired by the Trustee to satisfy such an option is granted under the employee share scheme to an employee, in relation to the employee's employment.

The granting of the beneficial interests in the options, the provision of the money to the Trustee under the arrangement, the acquisition and holding of the shares by the Trustee and the allocation of shares to the participating employees are all interrelated components of the taxpayer's employee share plans. All the components of the schemes must be carried out so that the schemes can operate as intended.

As one of those components, the provision of money to the Trustee necessarily allows the schemes to proceed. Consequently, the provision of money to the Trustee to acquire the taxpayer's shares is considered to be for the purpose of enabling the participating employees, indirectly as part of the employee share plans, to acquire the options. If that money is provided before the options are acquired then section 83A-210 of the ITAA 1997 will apply. However, section 83A-210 of the ITAA 1997 will not apply to a deduction for the purchase of shares to satisfy the obligation arising from options already granted, and that deduction is accordingly allowable to the taxpayer in the year in which the money was paid to the Trustee, under section 8-1 of the ITAA 1997.

However, if any amount of money is used by the Trustee to purchase excess shares intended to meet a future obligation arising from a future grant of options, the excess payment occurs before the employees acquire the relevant options (ESS interests) under the scheme. Section 83A-210 of the ITAA 1997 will apply in that case and the excess payment will only be deductible to the taxpayer in the year of income when the relevant options are subsequently granted to the employees.

Question 4

If the EST satisfies the relevant equity plan obligations by subscribing for new shares in the taxpayer company, will the subscription proceeds be included in the assessable income of the 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?

Detailed reasoning

Section 6-5 Income according to ordinary concepts (ordinary income)

If you are an Australian resident, your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).

Income according to ordinary concepts is not defined in the ITAA 1997. However, there is a substantial body of case law which discusses factors that indicate whether an amount has the character of income according to ordinary concepts.

Dixon J in Sun Newspapers Limited and Associated Newspapers Limited v. Federal Commissioner of Taxation (1938) 61 CLR 337; 5 ATD 23; 1 AITR 403 (Sun Newspapers) outlined three matters to be considered in determining whether a payment is on capital or revenue account, including:

§ the character of the advantage sought by the payment

§ the way it is to be used or enjoyed; and

§ the means adopted to obtain it.

The character of the advantage sought by the payment

As stated previously in this ruling, the stated purpose of the taxpayer in establishing and funding its employee share plans is to motivate achievement and promote longevity of employment by rewarding senior management and key executives for achieving performance criteria set by the Board. A general aim of the taxpayer's employee share schemes it to enhance the profitability of the group's business. Therefore the character of the advantage sought is one of reward and retention of the human resources of the business as a contribution to its long term success, which distinguishes it as capital in nature.

The way it is to be used or enjoyed

As stated in the application the receipt of the subscription price will be accounted for as an addition its share capital in its books and records. While this treatment of the subscription price is not decisive in itself, it is indicative of the taxpayer's treatment of the receipt and consistent with accounting principles.

The means adopted to obtain it

The payment is a premium or outlay to secure a share(s) in the company as a means to structure the business to secure and enhance its long-term profitability, which when considered with the two preceding matters - the character of the advantage sought and the way it is to be used - makes a persuasive case for the subscriptions for the shares to be distinguished as being on capital account.

Section 20-20 Assessable recoupments

Division 20 of the ITAA 1997 deals with amounts included to reverse the effect of past deductions and section 20-20 of the ITAA 1997 with assessable recoupments, which are described (at section 20-10 of the ITAA 1997) as 'an amount you receive by way of insurance, indemnity or other recoupment'.

The subscriptions received by the taxpayer from the EST are for shares and are integral to the arrangement whereby the acquisition and holding of the shares by the Trustee and the allocation of shares to the participating employees are all interrelated components of the taxpayer's employee share plans. The character of the subscriptions paid to the taxpayer for shares is not one of 'insurance, indemnity or other recoupment'.

Also, the table at section 20-30 of the ITAA 1997 showing the deductions for which recoupments are assessable does not include provision for subscriptions for funding an EST to acquire shares for employees.

Division 104 CGT events

Given that a capital gain or capital loss is made only if a CGT event happens, the initial step is to ascertain whether such an event has occurred. Also, given that the transaction is the payment of subscriptions by the EST to the taxpayer for shares, the possible events are:

§ D1 Creating contractual or other rights; or

§ H2 Receipt for event relating to a CGT asset.

Event D1 applies in preference to event H2

Subsection 104-35(1) states that CGT event D1 'happens if you create a contractual right or other legal or equitable right in another entity'. However the legal or equitable right has actually been created at the time of the issuance of the options, not upon the payment of the subscription proceeds to the taxpayer. Therefore no legal or equitable right is created and hence event D1 does not happen.

Also, paragraph (c) of subsection 104-35(5) states event D1 does not happen where a company issues or allots equity interests in the company, which is the case with the taxpayer's transactions under consideration.

As event DI is excluded, H2 is to be considered

Event H2 happens if an act, transaction or event occurs to a CGT asset owned by the taxpayer and the occurrence does not result in an adjustment to the cost base or reduced cost base (section 104-155(1)).

Again, consideration of the subscriptions received by the taxpayer from the EST establishes that they are for shares and are integral to the arrangement whereby the acquisition and holding of the shares by the Trustee and the allocation of shares to the participating employees are all interrelated components of the taxpayer's employee share plans. As part of the taxpayer's employee share plans, contractual rights of employees are exercised on their behalf to acquire shares in the taxpayer, rather than an act, transaction or event relating to a CGT asset owned by the taxpayer.

Also, paragraph (c) of subsection 104-155(5) states event H2 does not happen where a company issues or allots equity interests in the company, which is applicable to the payment of subscription proceeds to the taxpayer.

In summary, if the EST satisfies the relevant obligations of the taxpayer's employee share plans by subscribing for new shares in the taxpayer, the subscription proceeds will not be included in the assessable income of the taxpayer under sections 6-5 or 20-20 of the ITAA 1997, or trigger a CGT event under Division 104 of the ITAA 1997?

Question 5

Will the Commissioner make a determination that Part IVA of the ITAA 1936 applies to any aspect of the arrangement(s) described in Section 2.0 of the application to deny, in part or in full, any deduction claimed by the taxpayer in respect of the irretrievable cash contributions made by it or any of its subsidiary members to the trustee of the EST to fund the subscription for or acquisition of its shares from existing shareholders by the EST?

Summary

Provided that the scheme as implemented is materially identical to the taxpayer's scheme described in this ruling, it is considered that Part IVA of the ITAA 1936 would not apply.

Question 6

Is Fringe Benefits Tax (FBT) payable by the taxpayer for the provision of options to its employees under its equity plans?

Detailed reasoning

The taxpayer's trust deed states that the trust will be managed and administered so that it will be an 'employee share trust' as defined in subsection 995-1(1) of the ITAA 1997, which is the meaning given by subsection 130-85(4) of the ITAA 1997, as follows:

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

83A-10(1)  

An ESS interest, in a company, is a beneficial interest in:


(a) a *share in the company; or


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

83A-10(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.

As the taxpayer's trust deed states, the EST will meet the legislative requirements of an employee share trust and provide ESS interests in the company as part of an employee share scheme. In its application the taxpayer has stated that its schemes will invite employees to apply for options which when exercised, subject to certain conditions, will be convertible to shares. It would appear, therefore, that the options are ESS interests as they provide 'a right to acquire a beneficial interest in a share in the company' (paragraph (b) of subsection 83-10(1) of the ITAA 1997).

Furthermore, the taxpayer's application states that its schemes established on 2 December 2009 are to facilitate the provision of shares to its Australian employees 'to motivate achievement and promote longevity of employment' and thus the equity plans meet the criteria of an employee share scheme, namely: a scheme; provision of ESS interests in a company; to employees of the company; in relation to their employment.

Certain benefits are excluded from being fringe benefits within the meaning of the Fringe Benefits Tax Assessment Act 1986 (FBTAA). Paragraph (h) of subsection 136(1) FBTAA excludes from the definition of 'fringe benefit':

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 the Act applies.

As the taxpayer's employees will acquire performance rights and options in accordance with its equity plans in respect of their employment, these rights and options are therefore acquired under an employee share scheme. The granting of these rights and options to the taxpayer's employees, under its equity plans will not be subject to FBT because they are specifically excluded from the definition of fringe benefit.

Question 7

Is FBT payable by the taxpayer for its payment of irretrievable cash contributions to the Trustee to fund the acquisition of its shares from existing shareholders?

Detailed reasoning

Subsection 136(1) of the FBTAA defines a 'fringe benefit', in relation to an employee as a benefit in respect of the employment of the employee, but paragraphs (h) and (ha) of subsection 136(1) of the FBTAA excludes from the definition of 'fringe benefit':

(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; or

(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

An unpublished ATO ID considered in coming to a decision on this matter states that a trust will satisfy the sole activities test where the activities of the trustee of the trust are limited to managing an employee share plan and the activities merely incidental to the administration of the trust (paragraphs (a), (b) and (c) of subsection 130-85(4) of the ITAA 1997).

As the sole activities of the trustee of the EST are related to acquiring shares or rights to acquire shares in the taxpayer company for employees, the exclusions in paragraphs (h) and (ha) of subsection 136(1) of the FBTAA will apply. Therefore, the contributions will be excluded from the definition of fringe benefit in subsection 136(1) of the FBTAA.

Question 8

Will the Commissioner seek to apply section 67 of the FBTAA to the taxpayer's payment of irretrievable contributions to the trustee?

Summary

Provided that the scheme as implemented is materially identical to the taxpayer's scheme described in this ruling, it is considered that section 67 of the FBTAA would not apply.