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Ruling

Subject: Employee Share Scheme

Question 1

Will the proceeds received by the employee in exchange for his shares upon disposal constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the proceeds received by the employee in exchange for his shares upon disposal in the Trust constitute assessable income under section 15-2 of the ITAA 1997?

Answer

No

Question 3

To the extent that the proceeds received in exchange for the shares upon disposal will not constitute assessable income under section 6-5 or section 15-2 of the ITAA 1997 for the employee:

a) will the proceeds received by the employee in exchange for his shares upon disposal be taken into account in calculating a net capital gain under Division 102 of the ITAA 1997; and

b) 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

a) Yes

b) Yes

Question 4

Where the employee receives distributions from the trustee that represent franked dividends paid to the trustee, will the employee be entitled to a tax offset for the credits under Sub-division 207-B of ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 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 6-5

Income Tax Assessment Act 1997 - section 15-2

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

Income Tax Assessment Act 1997 - Division 115

Income Tax Assessment Act 1997 - section 207-145

Income Tax Assessment Act 1997 - section 207-150

Income Tax Assessment Act 1936 - Division 1A

Income Tax Assessment Act 1936 - subsection 160APHU(1)

Income Tax Assessment Act 1936 - section 160APHO

Income Tax Assessment Act 1936 - section 160APHD

Income Tax Assessment Act 1936 - subsection 160APHG(3)

Income Tax Assessment Act 1936 - subsection160APHM(2)

Income Tax Assessment Act 1936 - section 160APHL

Reasons for decision

Question 1

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 (1990) 170 CLR 124; 21 ATR 1; 90 ATC 4413 (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. It 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.

Question 2

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 3

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.

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 4

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 paragraph 160APHO(2)(b) of the ITAA 1936, where a taxpayer who holds an interest in 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 90 days for preference shares or 45 days for shares other than preference shares.

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 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 (or 90^th day for preference shares) 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 per cent 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 were 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 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.

An 'employee share scheme security' is defined in section 160APHD as:

(a) a share that is or except for subsection 139C(3) and (4) would be, a qualifying share for the purposes of Division 13A of Part III; or …

Division 13A has been repealed and replaced by Division 83A of the ITAA 1997. The taxpayer's interest in the relevant shares is considered to be an 'employee share scheme security' for the purposes of subsection 160APHL(10) of ITAA 1936. As such no further short or long position pursuant to subsection 160APHL(10) of ITAA 1936 will result.

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

The Employee will be entitled to a tax offset for the credits under subsection 207-40 of the ITAA 1997 provided the Trustee has held the shares at risk for the qualifying period and neither the Trustee nor the Employee nor any associate of the Trustee or of the Employee has made, is under any obligation to make, or is likely to make, a related payment in respect of the dividend.