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Ruling

Subject: Employee share scheme - taxed upfront scheme - discount amount

Question:

Does the Commissioner have any discretion to refund any discount amount included as assessable income at the taxing point when the market value of the relevant shares falls after the taxing point?

Answer:

No.

This ruling applies for the following period

Income year ended 30 June 2011.

The scheme commenced on

1 July 2010

Relevant facts and circumstances

While you were an employee of Company A, you were offered a special offer of shares as a result of your remuneration review in which you were issued equity in Company A in lieu of cash incentive payments.

You accepted the offer and participated in Company A's ESS plan (the Plan).

Under the Plan, you were issued the shares in two tranches, Tranche 1 and Tranche 2.

You made the choice for a portion of your Tranche 1 shares to be taxed upfront with no exception, with the other portion of shares being held in escrow for a number of years and taxed at a deferred taxing point.

You did not pay any consideration to acquire the shares.

There are no performance hurdles to be met or vesting conditions in relation to your Company A ESS shares.

You are privy to insider information almost all of the time in the position you hold at Company A and are prohibited from trading your Company A shares when in possession of inside information.

Under the rules of the AIM market and Company A's trading policy, you are prohibited from trading during blackout periods, which occur during a number of months in the income year.

You included a discount amount in your 2010-11 assessment.

The market value of your Company A shares has decreased since the taxing point.

You have provided copies of a number of documents, which should be read in conjunction with, and form part of this private ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Subsection 104-10(4)

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-20

Income Tax Assessment Act 1997 Section 83A-25

Income Tax Assessment Act 1997 Subsection 83A-35(7)

Income Tax Assessment Act 1936 Division 13A

Reasons for decision

Employee share schemes

Generally, Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997) applies where an employee acquires an ESS interest under an ESS at a discount from 1 July 2009.

Division 83A of the ITAA 1997 taxes discounts on ESS interests acquired either upfront, for example at acquisition, or on a deferred basis. The method will depend on the nature of the employee share scheme rather than at the election of the employee, as was the case under Div 13A of the Income Tax Assessment Act 1936 (ITAA 1936).

Subsection 83A-35(7) of the ITAA 1997 applies to those ESS interests if, when you acquire them there is no real risk under the conditions of the scheme that the ESS interest will be forfeited or lost other than by disposing of it. Under these schemes, the discount is taxed upfront and is included in the income year in which the ESS interests have been acquired.

An ESS interest acquired by an employee is at real risk of forfeiture if a reasonable person would consider that there is a real risk that the employee may forfeit or lose the ESS interest, other than by intentionally taking no action to realise the benefit.

Real risks of forfeiture in a scheme may include conditions where the retention of the ESS interests is subject to:

· performance hurdles; or

· a minimum term of employment.

There is no real risk of forfeiture where a scheme includes conditions which:

· restricts an employee from disposing of an ESS for a specified time

· allows an employee to request that the ESS interest be forfeited; or

· provides for an employee to forfeit an ESS interest if they are dismissed for fraud or gross misconduct.

Where the discount received in relation to an ESS interest is taxed upfront under subdivision 83A-B of the ITAA 1997, the ESS interest is deemed for CGT purposes to have been acquired for its market value at the time it was acquired under section 83A-30 of the ITAA 1997. The market value is viewed as the first element of the cost base of the ESS interest for CGT purposes. Any subsequent increase or decrease in the value of the ESS interest in relation to the market value after the taxing point will be accounted for under the CGT provisions.

On the subsequent disposal of the shares after the taxing point has occurred, the taxpayer will make a capital gain if the capital proceeds from the disposal of the shares are greater than the market value of the shares on the date they were acquired, being the first element of the shares cost base. The taxpayer will make a capital loss on the disposal of the shares if the capital proceeds from the disposal are less than the market value.

Application to your situation

In your case, you were granted a number of Company A ESS shares on a number of occasions. The shares were granted in two tranches and you selected to be taxed upfront on your Tranche 1 shares.

Company A has policies in place in relation to "black hold" periods when you were restricted from disposing of your shares. It also has trading policies which prevent specific employees from disposing of their shares when they are in possession of insider knowledge.

Enforceable restrictions are a common factor in ESS plans and are often referred to as holding locks. The end result of such restrictions is that generally employees are not able to sell shares during the time the restrictions when the holding locks are in force. 

Often the processes in place in relation to the disposal of shares or rights are viewed as being largely governance processes, which do not constitute restrictions on the disposal of ESS interests. This includes processes in place in relation to the disposal of ESS interests of parties who may be in the possession of insider knowledge, These processes are a means of protecting the interests of both the employer and employee, but in the absence of the employee having any insider knowledge at that time, it does not effectively prevent the employee from being able to dispose of their ESS interests.

While Company A had restrictions on the disposal of ESS interests during the "black hold" periods and policies in place in relation to the disposal of ESS interests by specific employees who may have insider knowledge, these do not constitute a real risk that your ESS shares will be forfeited or lost other than by disposing of them in accordance with the application of Division 83A of the ITAA 1997.

The Company A letters of offer outline that there is no risk of forfeiture in relation to your Tranche 1 shares and that the market price at the issue of the shares must be included in your assessable income in the income years in which the shares were issued, to be taxed at your marginal tax rate.

Therefore, as there was no real risk of forfeiture in relation to your Tranche 1 shares, the discount in relation to your Tranche 1 shares is taxed upfront in the income year in which the shares were granted. You have correctly included the discount amount arising in relation to your Tranche 1 shares in your 2010-11 assessment, which was taxed at your marginal tax rate of X%.

The market value of your Tranche 1 shares has fallen from the time of grant to the current value. As with all ventures undertaken in relation to shares, there is a risk that the share prices will fall, and a loss will may be made. It is stated in the Plan that the risk of loss arising for any reason, including the share prices falling in value, lies with the participant of the plan.

Regardless of whether the share price increases or decreases after the taxing point, the discount amount attributable to the ESS shares at the taxing point is their market value on the date they were granted. There are no legislative provisions which enable the Commissioner to exercise his discretion to refund discount amounts included in taxpayer's assessable income due to the decrease in the market value of the shares after the taxing point.

As the taxing point in relation to your first Tranche 1 shares has occurred, those shares are now viewed as CGT assets for taxation purposes, and you will make a capital gain or capital loss on their disposal.

The first element of the cost base of your Tranche 1 shares will be their market value on the date they were granted. Any fluctuation in the share price does not affect the ESS regime. If the capital proceeds you receive from the disposal of your Tranche 1 shares are greater that the shares cost base, you will make a capital gain on their disposal. If the capital proceeds are less than the cost base of your Tranche 1 shares, you will make a capital loss on the disposal of your Tranche 1 shares.