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Authorisation Number: 1011751107246

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Ruling

Subject: Employee share trust

Question 1

Will the irretrievable cash contributions made by Company A to Company B as trustee of the Company A Employee Share Trust (EST) to fund the acquisition or subscription for Company A shares by the EST, in accordance with the Company A Employee Share Trust Deed entered into between Company A and Company B, be assessable income of the EST?

Answer

No.

Question 2

Will a capital gain or capital loss arise under section 104-75 (CGT event E5) of the Income Tax Assessment Act 1997 (ITAA 1997) for Company B as trustee of the EST at the time when an eligible employee becomes absolutely entitled to the fully paid ordinary shares in Company A?

Answer

No, if the participants acquire the shares for the same or less than the cost base of the shares in the hands of Company B.

Question 3

In respect of the shares acquired by or subscribed by Company B as trustee of the EST under the terms of the Company A Option Plan, will any capital gain or capital loss made by Company B as trustee of the EST under section 104-85 (CGT event E7) of the ITAA 1997 be disregarded when the trustee disposes of the shares in the EST to a participant?

Answer

Yes, if the participants acquire the shares for the same or less than the cost base of the shares in the hands of Company B.

This ruling applies for the following period:

Year ended 30 June 20XX

Relevant facts and circumstances

Company A is the head entity of an Australian consolidated group and is listed on the Australian Securities Exchange.

The remuneration of executives is evaluated against comparative positions in similar companies and industries, comprising of;

(a) fixed remuneration; and

(b) variable remuneration which consist of:

(i) short term incentives (annual bonus based on specified performance targets as agreed with executives); and

(ii) long-term incentives (Company A Option Plan).

Company B as trustee of the EST is an external trustee acting in an independent capacity on behalf of the beneficiaries of the EST.

Company B as trustee of the EST holds all shares pursuant to the Option Plan on capital account.

Option Plan

The rules will broadly operate to provide eligible employees with the opportunity to receive options over shares in Company A. In order to receive shares, the participant must satisfy both vesting criteria, as well as pre-determined criteria outlined in the plan rules. On the basis that these have been satisfied, following payment of the exercise price the participant will be entitled to shares in the company (one ordinary share for every option). The shares will be held in an EST on behalf of the participant subject to conditions as specified in the plan rules. At the time these conditions are satisfied, the participant will become eligible to withdraw the shares from the EST.

Under the Option Plan employees are invited to apply and participate in the Option Plan through the issue of a valid participation letter. A participation letter will outline the following:

(a) The number of options offered;

(b) The issue price (if any) for the grant of the option(s);

(c) The exercise price;

(d) Any vesting conditions;

(e) Expiry date of option(s); and

(f) Restrictions on dealing with the options and disposal restrictions on shares once granted.

Once the employee has received the participation letter, the employee may apply to be issued with options by executing the application attached to the participation letter within the specified time limit. At this time, the employee can also elect to have their shares subject to a disposal restriction period from the date of exercise of the option.

The issue price of an option is the price determined by the company from time to time and described in the relevant participation letter, and may be nil. The options will generally be issued to participants for nil consideration.

The exercise of each option may also be subject to a service-based vesting condition, performance-based vesting condition and share price vesting condition as set out in the participation letter. These vesting conditions must be satisfied (otherwise waived by the company) before an option vests and can be exercised by the participant.

Participants may choose to exercise vested options at any time prior to their expiry, subject to the share trading policy. Option expiry rules are contained in the Plan Rules.

Participants can choose to exercise their vested options by notifying Company A in writing and by paying the option exercise price. The exercise price of each option will be outlined in the participation letter.

At the time a participant successfully completes exercise of their options, the company must direct the Trustee to subscribe for, acquire or allocate to the participant one share for each option exercised and hold those shares in the EST on behalf of the participant.

The Plan Rules allows the company to provide funds to the Trustee in order to allow the Trustee to subscribe for and/or acquire shares to be held on behalf of the participants under this plan.

The Plan Rules ensures that all shares in the same class that are issued on the exercise of an option, will rank equally from the date of issue.

Participants may choose to fund the option exercise price with a loan from an external financier. The funding is provided by independent third party financiers. In this case, the participant may be required to lodge a withdrawal notice to transfer the legal title in the shares from the EST to a party nominated by the participant to enable the participant to grant a security interest over the shares.

A participant may submit a withdrawal notice to Company A and the Trustee in respect of some or all of the shares the EST holds on behalf of the participant. At this point, Company A must direct the Trustee to transfer legal title of the shares to the participant.

The withdrawal notice also allows the Trustee / Company A to sell the shares on behalf of the participant and provide the proceeds of sale less brokerage costs to the participant.

Employee Share Trust

The EST was established for the sole purpose of obtaining shares for the benefit of employees of Company A pursuant to the Company A Option Plan.

The EST will be funded by contributions from Company A (i.e. for the purchase of shares in accordance with the Company A Option Plan. In accordance with the intended operation of the Option Plan, contributions are likely to occur subsequent to the participant's valid request to exercise their options.

These funds will be used by the Trustee of the EST to acquire the shares in Company A either on-market or via a subscription for new shares in Company A, based on written instructions from Company A.

Shares acquired by the Trustee will be immediately allocated to the relevant participants and held on their behalf.

The structure of the EST and the Company A Option Plan are such that shares may be dealt with at any time after a restriction period lapses, in the following manner:

· shares allocated to each participant will generally be transferred into the name of the relevant participant (i.e. legal title) upon a withdrawal notice being made, lodged with and approved by the Board; or

· participants may engage an external financier to provide a margin loan to fund the exercise price. In this case, the shares may be immediately transferred from the EST to a Holder Identification Number in the name of the participant to enable the financier to obtain a security interest over the shares.

All shares will be allocated to participants.

The process of operating the ESS

Once an option has satisfied all vesting conditions (which vary) the option can be exercised at the discretion of the holder prior to expiry of the option. Options can only be exercised during 'trading windows' as detailed in the Company A securities trading policy.

Before the opening of a trading window, option holders will be advised of two dates during the trading window that they can exercise their options. Three days prior to the specified exercise dates option holders must have paid the exercise price to Company A and submitted their signed 'Exercise Notice' and 'Notice of Withdrawal of Shares from the Trust' (where required).

Once all payments and documentation is received on options being exercised, the information is collated to determine the number of shares that need to be acquired by the EST, either on market or through a new subscription, to satisfy the options being exercised. A decision is made by Company A as to whether the EST should acquire the shares on market or subscribe for new shares.

The day before Company A discharges its obligations to provide shares to a participant (following exercise of the option by a participant), Company A will make a cash contribution to the EST equal to the market value of the shares required to enable the EST to obtain the required shares along with formal instructions on the number of shares to acquire, how to acquire them and the participants to allocate the shares to.

If the EST is directed to acquire the shares on market it will do so, at the time, using the proceeds paid to it by Company A. The acquisition of shares on market will be facilitated by an external share broker. Once the shares have been acquired by the EST they are immediately allocated to the relevant participants.

If the shares are being acquired through a new subscription then on the exercise date the EST will subscribe for and pay subscription money to Company A. Company A will issue the shares subscribed for on the same day. Once the shares are issued to the EST they are immediately allocated to the relevant participants.

Currently there are no general restrictions on the transfer of shares held in the EST to participants. Participants may elect to have restrictions placed on their shares in the EST at the time they accept the options offered to them although this has not happened to date. Accordingly, participants can choose to transfer shares out of the EST and into their name or direct the trustee to dispose of the shares at any time by submitting a 'Notice of Withdrawal of Shares from the Trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 10-5.

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-20

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Section 104-85

Income Tax Assessment Act 1997 Section 130-85

Income Tax Assessment Act 1997 Section 130-90.

Income Tax Assessment Act 1997 Section 995-1

Income Tax (Transitional Provisions) Act 1997 Section 83A-5.

All legislative references in this Ruling are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Reasons for decision

Question 1

The irretrievable cash contributions made by Company A to Company B as trustee of the EST to fund the acquisition of Company A shares by the EST in accordance with the Company A Employee Share Trust Deed entered into between Company A and Company B will not be assessable income of the EST.

Detailed reasoning

The basic trust income assessing provisions are contained in Division 6 in Part III of the Income Tax Assessment Act 1936 (ITAA 1936). Subsection 95(1) of the ITAA 1936 defines net income of a trust as the total assessable income of the trust calculated as if the trustee were the resident taxpayer in respect of that income, less all allowable deductions.

Subsection 6-5(1) states: 'Your assessable income includes income according to ordinary concepts, which is also called ordinary income.'

Subsection 6-10(1) states: 'Your assessable income also includes some amounts that are not ordinary income.'

Subsection 6-10)2) states: 'Amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income, are called statutory income.'

'Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.'

An employee share trust is defined in subsection 130-85(4) as a trust whose sole activities are:

'(a) obtaining shares or rights in a company, and

(b) providing ESS interests that are beneficial interests in the above shares or rights, to employees or associates of the company or its subsidiaries, under the relevant employee share scheme, and

(c) other activities that are merely incidental to the above (such as payment of dividends and account keeping).'

An employee share scheme is defined in subsection 83A-10(1) 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.

A trust will satisfy the sole activities test for the purposes of subsection 130-85(4) and be an 'employee share trust' as defined in subsection 995-1(1), where the activities of the trustee of the trust are limited to managing an employee share plan and the general administration of the trust (ATO ID 2007/179 which applied to subsection 139C(5) of the ITAA 1936 but equally applies to the new provision).

The EST Deed was established on XX Month 20XX. The Recital of the EST Deed states that 'The Company wishes to establish an employee share trust for the sole purpose of obtaining Shares for the benefit of participants, including by subscribing for or acquiring, allocating, holding and delivering Shares under the Company A Option Plan, and other employee equity plans, for the benefit of participants.'

The company and the Trustee agree that the trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of section 130-85(4) of the ITAA 1997.

The Trustee is not permitted to offer, issue or acquire any share or any right to any share if to do so would contravene any applicable laws and is not obliged to offer, issue or acquire any share or any right to any share where compliance with any applicable laws would in the opinion of the Trustee or the company be unduly onerous or impractical.

The Trustee is not permitted to carry out activities that are not matters or things which are necessary or expedient to administer and maintain the trust and the trust assets or for the purpose of giving effect to, and carrying out, the trusts powers and discretions conferred on the Trustee by this Deed or the law.

The Trustee is not permitted to carry out activities which result in the participant being provided with additional benefits other than the benefits that arise from the relevant plan rules and/or relevant terms of participation.

The company must by notice in writing instruct the Trustee to subscribe for, purchase and/or allocate a number of shares specified in the notice, to be held by the Trustee as trust shares in respect of an identified participant or participants.

The terms and conditions set out in the EST Deed confirm that EST is an employee share trust as defined in subsection 130-85(4).

The EST Deed states: 'Subject to clause X, all funds received by the Trustee from the company or its related body corporate will constitute accretions to the corpus of the trust and will not be repaid to the company and no participant shall be entitled to receive such funds.'

The irretrievable contributions made by Company A to Company B are not particular kinds of assessable income contained in the list of provisions in section 10-5.

Accordingly, the irretrievable contributions made by Company A to Company B are used in accordance with the trust deed and plan rules for the sole purpose of and under the employee share scheme. The contributions constitute capital receipts to the EST, and are not assessable under section 6-5 (ordinary income) or 6-10 (statutory income) (ATO ID 2002/965).

The EST Deed states: 'The Trustee is not entitled to receive from the trust any fees, commission or remuneration in respect of its performance of its obligations as trustee of the trust. The company may pay to the Trustee from the company's own resources any fees, commissions or remuneration and reimburse any expenses incurred by the Trustee as the company and the Trustee may agree from time to time. The Trustee is entitled to retain for its own benefit any such remuneration or reimbursement.' Such receipts will be assessable income of the EST in contrast to the irretrievable contributions made to facilitate the acquisition of Company A shares.

Question 2

A capital gain or capital loss will not arise under section 104-75 (CGT event E5) for Company B as trustee of the Company A EST at the time when an eligible employee becomes absolutely entitled to the fully paid ordinary shares in Company A provided the participant does not acquire the beneficial interest in the share for more than its cost base in the hands of Company B at the time the CGT event happens.

Detailed reasoning

Section 130-90 operates to ensure that any capital gain or loss made by an employee share trust (EST) is disregarded if it arises as a result of a beneficiary of the trust becoming absolutely entitled to an employee share scheme share, or as a result of a disposal of an employee share scheme share or right to a beneficiary.

Subsection 130-90(1) states:

'Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

(b) the CGT event happens in relation to a *share; and

(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d) the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.'

Subsection 130-90(2) states:

'Subsection (1) does not apply if the beneficiary acquired the beneficial interest in the *share for more than its *cost base in the hands of the *employee share trust at the time the *CGT event happens.'

Company B is an employee share trust for the purposes of subsection 130-85(4).

Section 104-75 contains the rules dealing with CGT event E5. CGT event E5 happens if a beneficiary of a trust becomes absolutely entitled to an asset of the trust as against the trustee of the trust (subsection 104-75(1)).

In determining whether a beneficiary is absolutely entitled to the asset, any legal disability, e.g. if the beneficiary is under 18, is ignored. In Draft Taxation Ruling TR 2004/D25, the Commissioner stated his view that the core principle underlying the concept of absolute entitlement in the CGT rules is the ability of a beneficiary who has a vested and indefeasible interest in the entire trust asset to call for the asset to be transferred to them or as they so direct.

Subdivision 130-D treats an employee who acquires an ESS interest through an 'employee share trust' to be 'absolutely entitled' to the share or right to which the ESS interest relates from the time that they acquire the ESS interest (subsections 130-85(1) and (2)).

The EST Deed states that the Trustee declares and agrees that each participant is, subject to the relevant plan rules and relevant terms of participation:

(A) the beneficial owner of the trust shares held by the Trustee on their behalf; and

(B) absolutely entitled to all other benefits and privileges attached to, or resulting from holding, those trust shares.

The EST Deed states that each participant will be absolutely entitled to shares held by Company B as trustee of the EST from the time Company B as trustee of the EST acquires shares on their behalf as a result of the participant exercising their options. CGT event E5 will happen under the terms of the Option Plan at the time when the participant becomes entitled to the shares in Company A as against Company B as trustee of the EST (paragraph 130-90(1)(a)).

Subsection 995-1(1) defines a share to mean a share in the capital of a company. An ordinary share in Company A held by Company B as trustee of the EST and to which a participant is entitled upon exercise of an option is a share in the capital of Company A (a company) (paragraph 130-90(1)(b)).

A participant will have acquired a beneficial interest in a share in Company A by exercising an option granted under the 2002 Option Plan and/or the 2010 Option Plan (paragraph 130-90(1)(c).

Subsection 83A-20(1) of Subdivision 83A-B states:

This Subdivision applies to an *ESS interest if you acquire the interest under an *employee share plan at a discount.

The term 'employee share scheme' is defined in subsection 83A-10(2). Subsection 83A-10(2) states:

'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;….

in relation to the employees' employment.'

For the purposes of subsection 83A-10(2), section 995 defines the term 'scheme' as follows:

'scheme means:

(a) any *arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.'

The Option Plan defines trust to mean the 'Company A Employee Share Trust', being an employee share trust of that name established by the company for the sole purpose of subscribing for or acquiring, delivering, allocating and holding shares for the benefit of option holders who have exercised their options in accordance with clause Y and participants in other employee equity plans established by any group company.

The Recital of the Option Plan states that the company has established this plan to enable eligible persons to share in the ownership of the group in order to:

(i) promote the long-term success of the group;

(ii) provide a strategic, value based reward for eligible persons who make a key contribution to that success;

(iii) align eligible persons' interests with the interests of the company's shareholders; and

(iv) promote the retention of eligible persons.

The Option Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement/plan (scheme) under which an ESS interest i.e. a beneficial interest in an option to acquire a beneficial interest in a share of Company A, is provided to eligible participants in relation to their employment by Company A or its subsidiaries in accordance with the EST Deed. The options are acquired under the Option Plan at no cost.

Subdivision 83A-B will apply to options acquired under the Option Plan as pursuant to subsection 83A-20(1) the ESS interest (i.e. Rights issued under the Option Plan) will be acquired under an employee scheme at a discount (paragraph 130-90(1)(d)).

It should be noted however that whether a participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in subdivision 83A-B or subdivision 83A-C have been satisfied.

Accordingly, all the conditions in subsection 130-90(1) of the ITAA 1997 have been satisfied.

Provided the participant does not acquire the beneficial interest in the share for more than its cost base in the hands of the EST at the time that CGT event E5 happens, subsection 130-90(2) of the ITAA 1997 will also have been satisfied.

Under these circumstances, section 130-90 operates to disregard any capital gain or capital loss made by the Trustee on any share when a participant becomes absolutely entitled to that share.

Issue 3

In respect of the shares acquired by or subscribed by the Trustee of the EST under the terms of the Option Plan, any capital gain or capital loss made by the Company B as trustee of the EST under section 104-85 (CGT event E7) will be disregarded when the trustee disposes of the shares in the EST to a participant.

Detailed reasoning

As discussed in Issue 2, section 130-90 operates to ensure that any capital gain or loss made by an employee share trust is disregarded if it arises as a result of a beneficiary of the trust becoming absolutely entitled to an employee share scheme share, or as a result of a disposal of an employee share scheme share or right to a beneficiary.

Subsection 130-90(1) states:

'Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

(b) the CGT event happens in relation to a *share; and

(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d) the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.'

Subsection 130-90(2) states:

'Subsection (1) does not apply if the beneficiary acquired the beneficial interest in the *share for more than its *cost base in the hands of the *employee share trust at the time the *CGT event happens.'

As discussed in Issue 2, Company B as trustee of the EST is an employee share trust for the purposes of subsection 130-85(4).

Section 104-85 contains rules dealing with CGT event E7. CGT event E7 happens if the trustee of a trust 'disposes of' a CGT asset of the trust to a beneficiary so as to satisfy the beneficiary's interest, or part of an interest, in the capital of the trust (subsection 104-85(1)).

The time that CGT event E7 happens is when the asset is disposed of from the trustee to the beneficiary (subsection 104-85(2)).

The withdrawal of trust shares provisions are contained in clause X of the EST Deed, clause X states:

Withdrawal of Trust Shares

Subject to clause Y, at any time after a restriction period (if any) and subject to any administrative guidelines established by the company:

(a) if a participant gives to the Trustee, or is deemed by the relevant plan rules and/or relevant terms of participation to give to the Trustee, a withdrawal notice; and

(b) following any required approval of the withdrawal notice,

the Trustee must transfer the legal title in those trustee shares or sell those trust shares in accordance with the terms of the approved withdrawal notice and clause Y. Where the relevant plan rules provide for automatic withdrawal from the trust of trust shares held on behalf of a participant, then the Trustee must transfer the legal title in those trust shares in accordance with those relevant plan rules.

Upon transfer of the legal title in those trust shares in accordance with those relevant plan rules, CGT event E7 will occur at the time legal title in the shares is transferred to either the participant, or a third party as directed by the participant (paragraph 130-90(1)(a)).

A capital gain arises to the Trustee if the market value of the share at the time of disposal to the participant is more than the share's cost base (subsection 104-85(3)). A capital loss arises to the Trustee if the market value of the share at the time of disposal to the participant is less than the share's reduced cost base (subsection 104-85(3).

As discussed in Issue 2, paragraphs 130-90(1)(b) to (d) are satisfied, accordingly, all the conditions in subsection 130-90(1) of the ITAA 1997 have been satisfied.

Provided the participant does not acquire the beneficial interest in the share for more than its cost base in the hands of the EST at the time that CGT event E7 happens, subsection 130-90(2) of the ITAA 1997 will also have been satisfied.

Under these circumstances, section 130-90 operates to disregard a CGT event E7 capital gain or capital loss made by the Trustee.