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Ruling

Subject: Employee Share Scheme

Question 1

Will the taxpayer obtain an income tax deduction pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of:

· the irretrievable contribution made by the taxpayer to the Trustee of the Trust to fund the subscription for shares by the Trust?

· costs incurred in relation to the implementation and on-going administration of the Trust?

Answer

Yes

Question 2

Will the irretrievable contribution made by the taxpayer to the Trustee of the Trust, to fund the subscription of shares by the Trust, be deductible to the taxpayer at a time determined by section 83A-210 of the ITAA 1997?

Answer

Yes

Question 3

Will the subscription proceeds received from the Trustee upon the subscription for new shares in the taxpayer, be included in the assessable income of the taxpayer under sections 6-5 or 20-20 of the ITAA 1997 or trigger a capital gains tax (CGT) event under Division 104 of the ITAA 1997?

Answer

No

Question 4

Will the Commissioner seek to make a determination that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to deny, in part or full, any deduction claimed by the taxpayer in respect of the irretrievable contributions made by the taxpayer to the Trustee of the Trust?

Answer

No

This ruling applies for the following periods:

Period 1 July 2011 to 31 December 2011

Year ending 31 December 2012

Year ending 31 December 2013

Year ending 31 December 2014

Year ending 31 December 2015

Year ending 31 December 2016

Year ending 31 December 2017

Year ending 31 December 2018

The scheme commences on:

1 July 2011

Relevant facts and circumstances

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

· Application for private ruling

· Plan rules

· Trust deed of the Trust

· Shareholders agreement

· Offer documents

· Loan agreement

· Constitution

· Management agreement

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 8-1

Income Tax Assessment Act 1997 - section 83A-210

Income Tax Assessment Act 1997 - section 6-5

Income Tax Assessment Act 1997 - section 20-20

Income Tax Assessment Act 1997 - subsection 102-5(1)

Income Tax Assessment Act 1997 - section 104-35

Income Tax Assessment Act 1997 - section 102-25

Income Tax Assessment Act 1997 - section 104-155

Income Tax Assessment Act 1936 - section 177A

Income Tax Assessment Act 1936 - section 177C

Income Tax Assessment Act 1936 - section 177D

Income Tax Assessment Act 1936 - section 177F

Reasons for decision

Question 1

Summary

Yes, the irretrievable contributions made to the Trustee to acquire shares are allowable deductions.

Yes, the costs incurred in relation to the implementation and ongoing administration of the Trust are allowable deductions.

Detailed reasoning

Irretrievable cash contributions

Subsection 8-1(1) of the ITAA 1997 is a general deduction provision. It provides:

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

· it is incurred in gaining or producing your assessable income; or

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

Subsection 8-1(2) of the ITAA 1997, where relevant, provides:

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

· it is a loss or outgoing of capital, or of a capital nature…

The contributions made by the taxpayer to the Trustee of the Trust to fund the subscription for shares by the Trust are irretrievable and non-refundable under the Trust Deed.

On this basis, it is considered that the irretrievable contributions made by the taxpayer are losses or outgoings for the purpose of subsection 8-1(1) of the ITAA 1997.

The irretrievable cash contributions are incurred to improve the taxpayer's operating performance and to motivate and retain valued employees of its subsidiaries. Therefore, the irretrievable contributions made to the Trustee under the Plan are directed to enhancing the profitability of the taxpayer's business and producing assessable income.

That the contributions are incurred to enhance the taxpayer's ability to derive assessable income is evidenced by the selection of eligible employees being made from those office-holders or managers being in roles directly linked to Australian income.

In considering the application of paragraph 8-1(2)(a) of the ITAA 1997, in Pridecraft Pty Ltd v. FC of T [2004] FCAFC 339; 2005 ATC 4001; 58 ATR 210; and FC of T v. Spotlight Stores Pty Ltd [2004] FCA 650; 2004 ATC 4674; 55 ATR 745, payments by employer companies 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 that a company will be entitled to a deduction under section 8-1 of the ITAA 1997 for non-refundable cash contributions made to the trustee of its employee share scheme.

Recurring irretrievable contributions to the Trust will be required to be made by the taxpayer if and when the management committee agrees to provide an additional allocation of shares under the plan, pursuant to the Trust Deed.

Accordingly, the irretrievable contributions made to the Trustee to acquire Shares are revenue in nature and are allowable deductions under section 8-1 of the ITAA 1997.

Implementation and on-going administration

As discussed above, you can deduct an amount under section 8-1 of the ITAA 1997 if the expense is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

In respect of costs in administering an employee share trust, ATO Interpretative Decision ATO ID 2002/961 provides that costs incurred in implementing and administering an employee share scheme will be deductible under section 8-1 of the ITAA 1997 as they are part of the ordinary employee remuneration costs.

The taxpayer will incur various costs in relation to the implementation and on-going administration of the Trust. These expenses form part of the ordinary employee remuneration costs.

The costs are revenue and not capital in nature on the basis that they are regular and recurrent employment expenses. Accordingly the costs are deductible under section 8-1 of the ITAA 1997 in the year they are incurred.

Question 2

Summary

Yes, the contribution will be deductible at a time determined by section 83A-210 of ITAA 1997.

Detailed reasoning

The provision of money to the Trustee of the Trust by the taxpayer for the purpose of remunerating employees of its subsidiaries under the plan is an outgoing in carrying on its business and is deductible under section 8-1 of the ITAA 1997, as discussed at Question 1.

The deduction under section 8-1 of the ITAA 1997 would generally be allowable in the income year in which the taxpayer incurred the outgoing, however under certain circumstances, the timing of the deduction is specifically determined under section 83A-210 of the ITAA 1997.

Section 83A-210 of the ITAA 1997 provides that, if:

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

under an *arrangement; and

for the purpose 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 purpose 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.

As the contributions by the taxpayer will be used by the Trustee to purchase shares for future allocation to employees, section 83A-210 of the ITAA 1997 will apply and the payments will only be deductible in the year of income when the relevant ESS interests are subsequently granted to the employees.

Question 3

Summary

Where the Trustee subscribes for new shares, 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 capital gains tax event under Division 104 of the ITAA 1997.

Detailed reasoning

Section 6-5 Income according to ordinary concepts

Under subsection 6-5(1) of the ITAA 1997, a payment or other benefit received by a taxpayer is included in assessable income if it is income according to ordinary concepts. Income according to ordinary concepts is not defined in the income tax legislation. However, principles to determine whether a receipt is income according to ordinary concepts have been developed by case law. In determining whether a receipt is income according to ordinary concepts, it is necessary to apply the relevant principles developed by case law to the facts of the particular case.

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

· 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.

Notwithstanding that the Trustee's subscription for shares relates to the satisfaction of the taxpayer's (and the Trust's) obligations under the plan rules, the subscription for shares is part of the taxpayer's capital management strategy.

Further, the receipt of the subscription will be accounted for as an addition to the share capital of the taxpayer in its books and records. While the treatment of the subscription proceeds in its books is not decisive in determining whether it is assessable income, it is indicative of the taxpayer's treatment and consistent with accounting principles.

The shares in the taxpayer are secured as a means to structure the business to secure and enhance its long-term profitability, which when considered with the preceding factors, leads to the conclusion that the subscription proceeds are on capital account.

Section 20-20 Assessable recoupments

Under Subdivision 20-A of the ITAA 1997, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.

The subscriptions received by the taxpayer from the Trust 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 employees are all interrelated components of the employee share plan. The character of the subscriptions paid to the taxpayer for shares is not one of 'insurance, indemnity or other recoupment'.

Division 104 CGT events

Subsection 102-5(1) of the ITAA 1997 provides that your assessable income includes your net capital gain for the income year. 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. As the transaction is the payment of subscription proceeds by the Trust to the taxpayer for shares, the possible CGT events are:

· D1 Creating contractual or other rights; or

· H2 Receipt for event relating to a CGT asset.

Subsection 102-25(3) of the ITAA 1997 provides that CGT event D1 applies in preference to CGT 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 been created at the time of the issuance of the rights and not upon the payment of the subscription proceeds to the taxpayer.

As no legal or equitable right is created CGT event D1 does not happen, further paragraph 104-35(5)(c) of the ITAA 1997 states that event D1 does not happen where a company issues or allots equity interests in the company.

As CGT event D1 is excluded, CGT event H2 is to be considered. CGT event H2 happens if an act, transaction or event occurs to a CGT asset owned by a taxpayer and the occurrence does not result in an adjustment to the cost base or reduced cost base (subsection 104-155(1) of the ITAA 1997).

Again, consideration of the subscription proceeds received by the taxpayer from the Trust 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 employees are all interrelated components of the Plan. As part of the Plan, 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.

Paragraph 104-155(5)(c) of the ITAA 1997 provides that CGT event H2 does not happen where a company issues or allots equity interests in the company, which is applicable here.

Accordingly, a CGT event under Division 104 of the ITAA 1997 does not arise when the Trustee subscribes for shares in the capital of the taxpayer.

Question 4

A consideration of all the factors referred to in paragraph 177D(b) of the ITAA 1936 leads to the conclusion that the dominant purpose of the scheme is to provide remuneration to the taxpayer's employees who participate in the scheme in a form that promotes the company's business objectives, rather than to obtain a tax benefit.