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Ruling

Subject: Employee share plan

Question 1

Part A. Will the irretrievable cash contributions to the Trustee by the Company be assessable income of the Employee pursuant to section 44, via the application of Section 109C of the Income Tax Assessments Act 1936 (ITAA 1936)?

Part B. Will the irretrievable cash contributions to the Trustee by the Company be assessable income of the Employee pursuant to section 44, via the application of sections 109D and 318 of the ITAA 1936?

Answer

Part A. No.

Part B. No.

Question 2

Part A. Will the acquisition of a fixed interest in the Trust by the Employee in return for payment of market value consideration, give rise to any assessable income under section 6-5 of the ITAA 1997 for the employee?

Part B. Will the acquisition of a fixed interest in the Trust by the Employee in return for payment of market value consideration, give rise to any assessable income under section 15-2 of the ITAA 1997 for the employee?

Answer

Part A. No.

Part B. No.

Question 3

Will the first element of the CGT cost base of the fixed interest in the Trust by the Employee, in accordance with section 110-25 of the ITAA 1997, equal the amount paid for that fixed interest?

Answer

Yes

Question 4

Part A. Will capital gains tax (CGT) event E5 arise for the Employee at the time when the Employee become absolutely entitled to the Shares under section 104-75 of the ITAA 1997?

Part B. If the answer to Part A is yes, does CGT event E5 happen when the Shares are allocated to the Employee?

Answer

Part A. Yes

Part B. Yes

Question 5

Will the acquisition of a Share in return for payment of market value consideration be subject to Division 83A of the ITAA 1997 to the employee?

Answer

No.

Question 6

Will the proceeds received by the Employee in exchange for their Shares post vesting constitute assessable income under section 6-5 or 15-2 of the ITAA 1997?

Answer

No.

Question 7

To the extent that the proceeds received in exchange for the Shares post vesting do not constitute assessable income under section 6-5 or section 15-2 of the ITAA 1997 for the Employee:

Part A. Will the proceeds received by the employee in exchange for their Shares be taken into account in calculating their net capital gain under Division 102 of the ITAA 1997?

Part B. If the answer to Part A is yes, will the CGT discount provisions in Division 115 of the ITAA 1997 apply where the Shares were acquired at least 12 months before the CGT event?

Answer

Part A. Yes

Part B. Yes

Question 8

Where the employee receives distributions from the Trustee that represent franked dividends paid by the employer to the trustee, will they be entitled to a tax offset for the credits under section 207-40 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

The scheme the subject of this Ruling has been ascertained from the following documents:

§ Application for Private Ruling

§ Plan Rules

§ The Trust Deed of the Trust

§ Offer documents

§ The Loan Agreement

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 15-2 of the Income Tax Assessment Act 1997

Division 83A of the Income Tax Assessment Act 1997

Section 83A-10 of the Income Tax Assessment Act 1997

Section 83A-20 of the Income Tax Assessment Act 1997

Section 83A-25 of the Income Tax Assessment Act 1997

Section 110-25 of the Income Tax Assessment Act 1997

Section 104-75 of the Income Tax Assessment Act 1997

Section 207-40 of the Income Tax Assessment Act 1997

Section 207-45 of the Income Tax Assessment Act 1997

Section 207-50 of the Income Tax Assessment Act 1997

Section 207-55 of the Income Tax Assessment Act 1997

Section 207-145 of the Income Tax Assessment Act 1997

Section 207-150 of the Income Tax Assessment Act 1997

Section 44 of the Income Tax Assessment Act 1936

Division 7A of the Income Tax Assessment Act 1936

Division 13A of the Income Tax Assessment Act 1936

Section 109ZE of the Income Tax Assessment Act 1936

Subsection 139C(3) of the Income Tax Assessment Act 1936

Section 160APHD of the Income Tax Assessment Act 1936

Section 160APHE of the Income Tax Assessment Act 1936

Section 160APHL of the Income Tax Assessment Act 1936

Section 160APHM of the Income Tax Assessment Act 1936

Section 160APHO of the Income Tax Assessment Act 1936

Section 160APHU of the Income Tax Assessment Act 1936

Reasons for decision

Question 1

Division 7A of the ITAA 1936 was introduced to ensure that all advances, loans, and other credits (unless they come within specified exclusions) by private companies to shareholders (and their associates), are treated as assessable dividends to the extent that there are realised or unrealised profits in the company. In addition, debts owed by shareholders (or associates) which are forgiven by private companies are treated as dividends.

Subsection 44(1) of the ITAA 1936 requires that the assessable income of a resident shareholder in a company include dividends that are paid to the shareholder by the company out of profits derived by it from any source.

Subsection 109C(1) of the ITAA 1936 provides the following in respect to when a private company is taken to pay a dividend:

A private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

(a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or

(b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time.

Where sub-section 109C(1) applies, then section 109Z of the ITAA 1936 will apply as follows:

If a private company is taken under this Division to have paid a dividend to an entity, the dividend is taken for the purposes of this Act to be paid:

(a) to the entity as a shareholder in the private company; and

(b) out of the private company's profits.

In this case when we consider sub-section 109C(1) it does not apply for the following reasons:

(i) Payment not received by a Shareholder.

(ii) Payment not received by an associate of a shareholder.

Subsection 109C(1) of the ITAA 1936 does not apply. Similarly section 109D of the ITAA 1936 does not apply. Consequently section 109Z of the ITAA 1936 does not apply to make the payment a dividend.

Question 2

Subsection 6-5(1) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of 'ordinary income' in income tax legislation it is necessary to apply principles developed by the courts to the facts of a particular case.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (GP International Pipecoaters), the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts 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 recipient's purpose in engaging in the transaction, venture or business.

In this case, the Employee participant must use the funds he borrows from the Trust to acquire an interest in the Trust corresponding to his interest in the underlying shares.

Where the interest in the Trust is acquired by the Employee at market value, the actual interest in the Trust will not in itself give rise to profit or gain and so does not result in income according to ordinary concepts for the Employee.

Section 15-2 of the ITAA 1997 provides:

15-2(1) Your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you ….

Where the interest in the Trust is acquired by the Employee at market value, the actual interest in the Trust will not in itself give rise to profit or gain and so does not result in anything of the type that is covered by section 15-2 of the ITAA 1997 for the Employee.

Question 3

Each employee is absolutely entitled to the shares that are held on their behalf by the Trustee when the shares are vested. Any disposal of the shares will be treated as a disposal of the shares by the employees and not the Trust.

The cost base of a CGT asset is relevant in finding out if a capital gain has been made from a CGT event. The cost base of a CGT asset has five elements as set out in section 110-25 of the ITAA 1997.

The first element is the total of the money paid or required to be paid, in respect of acquiring the CGT asset and the market value of any other property given, or required to be given, in respect of acquiring the CGT asset as stated in section 110-25(2) of the ITAA 1997.

In this case the total amount of money paid or required to be paid is the amount of money that has been loaned to each employee to acquire the fixed interest in the trust. This amount will equal the amount paid for the fixed interest.

Question 4

Section 104-75 of the ITAA 1997 contains the rules dealing with CGT event E5. Subsection 104-75(1) of the ITAA 1997 states that 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(2) of the ITAA 1997 provides that the timing of the event is when the beneficiary becomes absolutely entitled to the asset, and under subsection 104-75(3) of the ITAA 1997 the trustee makes a capital gain if the market value of the asset (at the time of the event ) is more than its cost base.

It is necessary to determine if and when the employee becomes absolutely entitled to the shares to ascertain if and when CGT event E5 happens.

Draft Taxation Ruling TR 2004/D25 Income Tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 provides 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 a trust asset to call for the asset to be transferred to them as they so direct.

Paragraph 74 of TR 2004/D25 provides:

74. A vested interest is one that is bound to take effect in possession at some time and is not contingent upon an event occurring that may or may not take place. A beneficiary's interest in an asset is vested in possession if they the right to immediate possession or enjoyment of it.

Applying the above to the terms of the Trust Deed in this case, it is considered that the employee becomes absolutely entitled to the Shares as against the Trustee of the Trust, and CGT event E5 happens, when the shares are allocated to the employee.

Question 5

Subject to the exceptions in section 83A-20, a taxpayer who acquires an Employee Share Scheme (ESS) interest at a discount must include the discount in assessable income, in the income year that the taxpayer acquires the ESS interest as defined in section 83A-25 of the ITAA 1997.

As the Trustee is to pay full market value for the shares, then any interest that the Trustee acquires in the shares is not acquired at a discount, thus section 83A-25 of the ITAA 1997 will not apply.

Under section 83A-10(2) of the ITAA 1997:

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.

While the shares acquired by the employees of AIA are ESS as defined in the legislation, as the shares are acquired for market value consideration, no discount is provided on acquisition of the shares. Therefore section 83A-25 of the ITAA 1997 will not apply.

Question 6

Subsection 6-5(1) provides that an amount is included in assessable income if it is income according to ordinary concepts (ordinary income). However, as there is no definition of 'ordinary income' in income tax legislation it is necessary to apply principles developed by the courts to the facts of a particular case.

Whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (GP International Pipecoaters), the Full High Court stated:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts 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 recipient's purpose in engaging in the transaction, venture or business.

ATO Interpretative Decision ATO ID 2001/746 Income Tax Share and Securities Trading, provides the ATO View on the application of section 6-5 of the ITAA 1997 to the disposal of shares.

ATO ID 2001/746 provides that, unless the trading activities conducted by the taxpayer amounts to the carrying on of a business, any income from the disposal of shares is not assessable under 6-5 of the ITAA 1997 but any gain or loss may be subject to capital gains.

The Employee is not considered to be carrying on a business in respect to the shares acquired under this arrangement; as such the income derived is not assessable under section 6-5 of the ITAA 1997.

Section 15-2 of the ITAA 1997 provides:

15-2(1) Your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you ….

The disposal of shares acquired by the Employee is the realisation of capital assets and the disposal proceeds do not constitute allowances, gratuities, benefits, bonuses or premiums etc assessable under section 15-2 of the ITAA 1997.

Question 7

Part A

The CGT rules affect a taxpayer's income tax liability because assessable income includes a net capital gain for the income year. A taxpayer can only make a capital gain or loss if a CGT event happens. Where a CGT event happens in relation to the exchange of shares, the net capital gain is included in their assessable income in accordance with subsection 102-5(1) of the ITAA 1997.

Part B

Division 115 of the ITAA 1997 discusses discount capital gains. A discount capital gain remaining after the application of any capital losses and net capital losses from previous income years is reduced by the discount percentage when working out a net capital gain. A capital gain from a CGT asset is a discount capital gain only if the entity making the gain acquired the asset at least a year before the CGT event causing the gain and no choice has been made to include indexation in the cost base of the asset.

Where the employee has a CGT event happen in respect of shares held for at least twelve months the capital gain will be a discount capital gain under Division 115 of the ITAA 1997.

Question 8

By virtue of sections 207-145 and 207-150 of the ITAA 1997 as well as Taxation Determination TD 2007/11, it is clear that regard must be had to the rules in Division 1A of former Part IIIAA of the ITAA 1936 in determining whether a person is a qualified person and hence able to derive the benefit of franking credits attached to distribution made directly or indirectly to the entity.

Subject to the operation of section 207-150 of the ITAA 1997, section 207-45 of the ITAA 1997 provides that an entity to which a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year equal to its share of the franking credit on the distribution.

A franked distribution is taken to flow indirectly to a beneficiary of a trust for the purposes of section 207-45 where the three requirements of paragraphs 207-50(3)(a)-(c) are satisfied:

§ First, during that income year the distribution must be made or flow indirectly to the trustee of the trust;

§ Second, the beneficiary must have a share of the trust's net income for that income year in the relevant sense;

§ Third, the beneficiary's share of the distribution as identified in accordance with section 207-55 of the ITAA 1997 must be a positive amount.

Even where the indirect flow through rules are satisfied, a beneficiary of a trust to whom a franked distribution flows indirectly is only entitled to the tax offset under 207-45 of the ITAA 1997 if they are a qualified person for the purposes of Division 1A of Part IIIAA of the ITAA 1936 in relation to the distribution (refer paragraph 207-150(1)(a) of the ITAA 1997).

Division 1A contains special rules for determining whether the beneficiary of a trust is a qualified person in relation to a franked distribution that has indirectly flowed to them. The specific rules differ depending on whether the trust is a widely held trust or a trust other than a widely held trust.

Importantly, irrespective of whether or not a trust is a widely held trust as defined, a beneficiary of the trust cannot be a qualified person in relation to a franked distribution which has indirectly flowed to them through the trust unless the trustee of the trust is themselves a qualified person in relation to the distribution (subsection 160APHU(1) of the ITAA 1936). As such, the Employee cannot be a qualified person in relation to franked distributions flowing indirectly to them as beneficiary of the Trust unless the Trustee of the Trust is also a qualified person in relation to the distributions, that is the Trustee satisfies the holding period rules and, where relevant, related payment rules of section 160APHO of the ITAA 1936 in respect of the franked distributions.

The definition of widely held trust in section 160APHD of the ITAA 1936 has the effect of defining a trust to be a widely held trust at a particular time if one of the three criteria set out in the definition are met at that time. The Trust does not satisfy any of these criteria and accordingly the Trust is a trust other than a widely held trust for the purposes of Division 1A.

By reason of paragraph 160APHO(1)(a) and subparagraph 160APHO(2)(b)(i) of the ITAA 1936, where a taxpayer who holds an interest in shares (not being preference shares) on which a dividend has been paid, and neither the taxpayer nor the associate of the taxpayer has made, is under an obligation to make or is likely to make a related payment in respect to the dividend, the taxpayer will be a qualified person in respect of the dividend if, during the primary qualification period, they held their interest in the shares for a continuous period of not less than 45 days.

Under subsection 160APHG(3) of the ITAA 1936, the beneficiaries of a trust that is not a widely held trust are deemed to have acquired, held or disposed of an interest in shares when the trustee acquires, holds or disposes of those shares

The primary qualification period in relation to an interest in a share (not being a preference share) is defined in section 160APHD of the ITAA 1936 as the period beginning on the day after the day the taxpayer acquired their interest and ends on the 45^th day after the day on which the interest became ex-dividend. In relation to a beneficiary of a non-widely held trust, under subsection 160APHE(1) of the ITAA 1936 an interest in a share becomes ex-dividend on the day after the last day on which the acquisition by a person of the share will entitle the person to receive the dividend.

In accordance with subsection 160APHO(3) of the ITAA 1936, in calculating the number of days for which beneficiaries continuously held an interest in a share held by the Trust, any days on which beneficiaries had 'materially diminished' risks of loss or opportunities for gain in respect of the interest is to be excluded (although this exclusion is not taken to break the continuity of the period for which the interest was held).

Subsection 160APHM(2) provides that a taxpayer is taken to have "materially diminished" risks of loss or opportunities for gain on a particular day in respect of an interest held by the taxpayer in a share if their net position on that day in relation to the interest has less than 30% of those risks and opportunities. Subsection 160APHM(3) of the ITAA 1936 states that a taxpayer's net position for this purpose is worked out using the financial concept of delta.

Section 160APHL of the ITAA 1936 will apply as the shares will be acquired after 31 December 1997. Subsection 160APHL(7) of the ITAA 1936 attributes a delta of +1 to the interest in the shares held by a beneficiary of a non-widely held trust as determined under subsection 160APHL(5) of the ITAA 1936.

Unless there is a family trust election in place (or exceptions relating to deceased estates or employee share schemes are satisfied), subsection 160APHL(10) of the ITAA 1936 attributes additional positions to the beneficiary. It gives rise to a short position equal to the beneficiary's long position determined under subsection 160APHL(7) of the ITAA 1936 and a long position equal to so much of the taxpayer's interest in the trust holding as is a fixed interest.

Subsection 160APHL(10) of the ITAA 1936 states:

160APHL(10) Additional positions of the taxpayer.

If:

(a) the trust is not a family trust within the meaning of Schedule 2F; and

(b) the trust is not a trust for the purposes of this Act merely because of the reference to executors and administrators in paragraph (a) of the definition of of trustee in subsection 6(1); and

(c) the taxpayer's interest in the relevant share or the relevant shares is not an employee share scheme security;

the taxpayer has, in addition to any other long and short positions (including the positions that the taxpayer is taken to have under subsection (8)) in relation to the taxpayer's interest in the relevant share or relevant shares, a short position equal to the taxpayer's long position under subsection (7) and a long position equal to so much of the taxpayer's interest in the trust holding as is a fixed interest.

160APHL(11) of the ITAA 1936 states:

160APHL(11) A vested and indefeasible interest constitutes a fixed interest

For the purposes of subsection (10), the taxpayer's interest in the trust holding 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.

In the circumstances of this case, we have established that the employee is absolutely entitled to the Shares that are held by the Trustee on the employee's behalf when the shares are allocated to the employee (see question 4). On this basis it is considered that from the time of allocation of the Shares the employee has a fixed interest, being a vested and indefeasible interest, for the purposes of subsection 160APHL(10) of the ITAA 1936.

Consequently, the beneficiaries (including the Employee) will have a net long position with a delta of +1, under subsections 160APHL(7) and 160APHL(10) of the ITAA 1936, and therefore will be a qualified person in relation to the dividend paid on the shares.