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Ruling

Subject: Employee Share Scheme

Question 1

To the extent that the dividends assessable to the employee constitute franked distributions for the purposes of Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997), will the employee be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997?

Answer

No. To the extent that the dividends assessable to Mr Mitchell constitute franked distributions for the purposes of Subdivision 207B of the ITAA 1997, Mr Mitchell will not be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997 due to the operation of paragraph 207-150(1)(a) of the ITAA 1997.

Question 2

In the event that the Commissioner's response to Question 1 is in the negative, will the Commissioner determine that the interest in the Allocated Shares will be taken to be vested and indefeasible in accordance with former section 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No. The Commissioner will not determine that the interest in the Allocated Shares will be taken to be vested and indefeasible in accordance with former section 160APHL(14) of the ITAA 1936.

Relevant facts and circumstances

The employer has established a plan for the purpose of providing a long term equity incentive structure to deliver equity based benefits to key employees of the employer. An employee is seeking to determine the distributions or offsets they may be entitled to under this plan.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95A

Income Tax Assessment Act 1997 Section 130-85

Income Tax Assessment Act 1997 Section 207-45

Income Tax Assessment Act 1997 Section 207-50

Income Tax Assessment Act 1997 Section 207-150

Reasons for decision

Pursuant to subsection 207-50(3) of the ITAA 1997, a franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

· the distribution is made to the trustee of the trust, or flows indirectly to the trustee from another trust distribution;

· the beneficiary has a share of the trust net income for that year; and

· the beneficiary's share of the franked distribution is positive.

Therefore, if a franked distribution is made to the trustee of the trust and the employee receives a share of the trust net income for that income year, a franked distribution is taken to flow indirectly to the employee.

Entities to whom a franked distribution flows indirectly in an income year may be entitled to a tax offset for that income year, equal to the amount of their share of the franking credits attached to the distribution as provided under section 207-45 of the ITAA 1997, subject to the operation of subsection 207-150(1) of the ITAA 1997.

Qualified person

Where a franked distribution flows indirectly to an entity in an income year, paragraph 207-150(1)(a) of the ITAA 1997 will deny the tax offset otherwise provided under section 207-45 of the ITAA 1997 if the taxpayer is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936).

Broadly, to be a qualified person in relation to a distribution, a taxpayer as a beneficiary of a trust must satisfy the holding period rule under either former section 160APHO or former section 160APHP of the ITAA 1936. To satisfy the holding period rule in a non-widely held scenario, the interest in the ordinary shares to which a distribution relates must be held at risk for a period of at least 45 days for the purposes of former section 160APHO. Further, in determining whether the holding period requirements are satisfied for the prescribed minimum period, no account is taken of any days on which the taxpayer has materially diminished risks of loss and opportunities for gain in respect of the shares as prescribed under former subsection 160APHP(2) of the ITAA 1936.

A taxpayer is taken to have materially diminished risks of loss and opportunities for gain with respect to shares if their net position results in them having less than 30 per cent of the risks and opportunities relating to the shares, as provided by former subsection 160APHM(2) of the ITAA 1936. A taxpayers net position is defined at former subsection 160APHJ(5) of the ITAA 1936 and is worked out using the financial concept known as delta (subsection 160APHM(3) of the ITAA 1936). Broadly, to have a net position equal to 30 per cent of the risks and opportunities with respect to a share requires a delta of +0.3.

As the employee will be a beneficiary of the trust, former section 160APHL of the ITAA 1936 is the relevant provision to determine his interest in the shares held by the trust for the purposes of former Division 1A of the ITAA 1936. It is considered likely that not more than 20 persons will have interests that entitle them to more than 75% of the beneficial interests in the income and capital of the trust. As such, the trust will be considered a 'closely held fixed trust' as that term is defined in former section 160APHD of the ITAA 1936. As the trust will be excluded from the definition of 'widely held trust' in former section 160APHD of the ITAA, it will be treated as an 'other than a widely held trust' scenario for the purposes of former Division 1A of the ITAA 1936. In this context, it should be noted that the term 'widely held trust' is defined in former section 160APHD of the ITAA 1936 as a trust that is neither a 'closely held fixed trust' nor a 'non-fixed trust' (as those terms are themselves defined in former section 160APHD of the ITAA 1936). For the purposes of former section 160APHL of the ITAA 1936, if a trust is not a widely held trust it is treated as 'other than a widely held trust', which will be referred to as the non-widely held scenario in this ruling.

The non-widely held scenario

Under the non-widely held scenario, it is necessary to examine the nature of the interest a beneficiary has in the shares that comprise the trust holding in which the beneficiary has an indirect interest. This is determined by the operation of former subsections 160APHL(1), (3) and (5) of the ITAA 1936 by reference to the beneficiary's proportionate share of the dividend income derived by the trust. In the current circumstances, the employee's interest in the trust holding is the allocated shares referable to his share units. In this instance, it will be the employee's interest in the specific shares held by the trustee for his benefit that will be tested for the purposes of former Division 1A of the ITAA 1936.

The next step is to allocate a 'position' to the interest pursuant to former section 160APHL of the ITAA 1936. Accordingly, former subsection 160APHL(7) of the ITAA 1936 operates to attribute a delta of +1 to the interest in the shares held by a beneficiary of a non-widely held trust. Therefore, the employee will have a long position with a delta of +1 in relation to any shares held by the Trust under this provision.

However, as a family trust election has not been and will not be made and the trust arrangement does not give rise to an employee share scheme security, former subsection 160APHL(10) of the ITAA 1936 may attribute additional positions to the employee. These additional positions are:

· a short position equal to his long position, as determined under former subsection 160APHL(7) of the ITAA 1936; and

· a long position equal to so much of the employee's interest in the trust holding that is a fixed interest.

Accordingly, as the employee has a long position with a delta of +1 in relation to the shares under former subsection 160APHL(7) of the ITAA 1936, he will have a corresponding short position with a delta of -1 under former subsection 160APHL(10) of the ITAA 1936.

Under former subsection 160APHL(10) of the ITAA 1936, an additional long position will arise in relation to so much of the employee's interest in the trust holding as is a fixed interest. Former subsection 160APHL(11) of the ITAA 1936 states that a beneficiaries interest in a trust is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding. For these purposes, the trust holding is the allocated shares held by the trustee and which has paid the trust a dividend (see former subsections 160APHL(1) and (3) of the ITAA 1936). The interest being tested under former subsection 160APHL(11) of the ITAA 1936 is the actual interest held by the employee in the allocated shares referable to the share units that form the employee's proportionate interest in the trust holding.

Vested and indefeasible interest

A vested interest

A person has a vested right in something if he, she or it has a present right relating to it. A vested interest is one that is bound to take effect in possession at some point in time. It may either be immediate, where it is described as "vested in possession" and refers to a present right of present enjoyment; or it may not, where it is described as "vested in interest" and refers to a present right of future enjoyment.

The conjunction of "vested and indefeasible" shows that the right must be absolute. A vested interest is to be contrasted with a contingent interest. The latter may never take effect in possession if the contingency is not met. A contingent right is antithetical to an absolute right.

Vested and indefeasible

A vested interest is indefeasible where it is not able to be lost. It is defeasible where it can be brought to an end, and indefeasible where it cannot.

It is defeasible, for instance, where it is subject to a condition subsequent. For example, a future occurrence may lead to the divestment of a person's vested entitlement. The circumstances by which this may occur include the happening of an event, or the exercise of a power.

A beneficiary's interest in particular assets of the trust will not be vested and indefeasible if:

(a) that is the effect of the trust deed;

(b) the assets are disposed of by the trustee in the course of administration of the trust prior to the vesting day;

(c) the person's status as a beneficiary as at the vesting date is subject to a condition precedent (i.e. a contingency).

Where a beneficiary's vested interest is able to be divested by the exercise of a power by the trustee (or any other person), the interest is defeasible.

The specific phrase "vested and indefeasible" is also used elsewhere in the ITAA 1936 to describe the interest of a beneficiary of a trust to the trust income: see s 95A(2) of the ITAA 1936.

The trust deed & other circumstances - s 160APHL(11)

The above principles apply when examining the trust deed here.

Application of the principles leads to the conclusion that the employee does not have a "vested and indefeasible" interest in so much of the corpus of the trust as is comprised by the trust holding. It follows that:

1. former section 160APHL(10) of the ITAA 1936 does not operate to deem the employee to have an additional long position in respect of his interest in the trust holding;

2. in turn, the net position of the applicant in relation to his interest (at all times has) a delta of zero (thus a delta of less than +0.3).

Relevant circumstances demonstrating the employee's lack of a vested and indefeasible interest include the following:

Restrictions on disposal

As per the handbook, there will be restrictions on the ability of the employee achieving satisfaction of the stipulated date contained in the deed.

Trustee's exercise of powers

Certain of the trustee's powers exercisable in relation to the trust property show that the applicant does not have a vested and indefeasible interest in any shares held by the trustee.

Deemed defeasibility under s 160APHL(12)

Former subsection 160APHL(12) deems a relevant interest to be defeasible where such interest may be redeemed under the trust instrument for less than its value, or its value may be materially reduced by the issue of further units.

Cancellation entitlements

Redemption of any interest the applicant has in shares held by the Trustee may occur for less than its value under the provisions in the Trust deed.

Conclusion on the question of "fixed interest"

It follows from the above that the employee does not have a vested and indefeasible interest in any allocated shares held by the trustee in respect of share units issued to him, and thus does not have a fixed interest in shares held by the trustee.

Accordingly, notwithstanding the employee's units are not subject to vesting conditions, his interest in the trust holding represented by the allocated shares is defeasible and as such, the interest will not be a fixed interest under former subsection 160APHL(11) of the ITAA 1936.

Former Subsection 160APHL(14) discretion

Subsection 160APHL(14) provides the Commissioner with a discretion to determine that an interest should be treated as being vested and indefeasible in circumstances where that interest in the corpus of the trust as is comprised by the trust holding would not otherwise be vested or indefeasible, where regard is had to the factors in sub-paragraph 160APHL(14)(c)(i) to (iv).

Having regard to the overall arrangement as provided in the trust deed, it would seem that the intent would be for defeasance to take place on a regular basis. In broad terms, it would seem that the trust deed has been constructed to take into account future contingencies such as employee's leaving prior to achieving certain stipulated date requirements, and to provide an intended outcome in those circumstances which defeats the departing employee's interest in any allocated shares. Given the deed has special provision for these circumstances, it must be considered likely that such contingencies will occur in the future. In conjunction with the other elements of defeasibility, these factors would mitigate against the Commissioner exercising his discretion in former subsection 160APHL(14) in these circumstances.

Conclusion

The employee will have a long position with a delta of +1 under former subsection 160APHL(7) of the ITAA 1936 and a short position with a delta of -1 under former subsection 160APHL(10) of the ITAA 1936, resulting in a net position of zero in relation to the shares held by the trust. The employee will not have an additional long position under former subsection 160APHL(10) and will consequently have materially diminished risks of loss or opportunities for gain in relation to the shares.

As a result, the employee will not be able to satisfy the holding period rule of former section 160APHP of the ITAA 1936 and will not be capable of being considered a qualified person in relation to the distribution on the shares for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. Accordingly, pursuant to the operation of subsection 207-150(1) of the ITAA 1997, the employee will not be entitled to tax offsets equal to his share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997.