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Ruling

Subject: Employee Share Scheme

Question 1

Is the Employee Share Scheme (ESS) Plan, a deferred tax scheme pursuant to Subdivision 83A-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

For the purposes of meeting the reporting obligations contained in Division 392 of the Taxation Administration Act 1953 (TAA), when will the deferred taxing point for the ESS interests occur pursuant to section 83A-120 of the ITAA 1997 if the employee exercises the vested option through payment of the exercise price with cash?

Answer

The deferred taxing point for an option that can only be exercised by the payment of cash occurs on cessation of employment after 12 months service, or if employment continues, when the share is first available for sale in an 'open season.'

This ruling applies for the following period

1 July 2012 to 30 June 2013

1 July 2013 to 30 June 2014

1 July 2014 to 30 June 2015

The scheme commenced on

1 July 2012

Relevant facts and circumstances

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

· Application for the Private Ruling

· Plan rules

· Shareholders agreement

· Other documents

Assumptions

The fair market value of the options and shares will always be greater than nil.

Relevant legislative provisions

Income Tax Assessment Act 1997

Division 83A

Subsection 83A-10(1)

Subsection 83A-10(2)

Subdivision 83A-B

Section 83A-20

Subdivision 83A-C

Section 83A-105

Paragraph 83A-105(3)(b)

Section 83A-120

Section 83A-315

Income Tax Assessment Regulations 1997

Div 83A

Taxation Administration Act 1953

Division 392

Reasons for decision

Issue 1

Question 1

Division 83A of the ITAA 1997 provides for the taxation of shares and rights acquired under an employee share scheme on or after 1 July 2009.

An employee share scheme (ESS) interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 to mean a beneficial interest in the share of the company or a right to acquire a beneficial interest in a share of the company. An employee share scheme is defined in subsection 83A-10(2) as a scheme under which the ESS interests in a company are provided to employees, or associates of employees, of the company or subsidiaries of the company in relation to the employees' employment. The options to shares in the ordinary stock of the parent company offered under the Plan by the taxpayer provide the employee (subject to meeting certain conditions of employment) or their associates, with a beneficial interest in a right to a acquire a beneficial interest in a share, that is, an ESS interest.

Is the Plan a taxed upfront scheme as described in subdivision 83A-B of the ITAA 1997?

Subdivision 83A-B includes a discount received by a taxpayer on an ESS interest they acquire under an employee share scheme in their assessable income for the financial year in which they acquire the interest.

Section 83A-20 of the ITAA 1997 provides that Subdivision 83A-B applies to an ESS interest if an employee acquires the interest under an employee share scheme at a discount, unless Subdivision 83A-C¹ applies to the interest.

The Commissioner accepts that the rights granted an employee under the Plan, are acquired at a discount.

Therefore, unless subdivision 83A-C of the ITAA 1997 applies to the rights, subdivision 83A-B of the ITAA 1997 will apply and the rights will be subject to tax on acquisition.

Is the Plan a tax deferred scheme to which subdivision 83A-C of the ITAA 1997 applies?

Subdivision 83A-C of the ITAA 1997 includes in the assessable income of an employee for the year in which the deferred taxing point for the interest occurs an amount (the discount amount) which is calculated as the market value of the interest at the deferred taxing point less the cost base of the interest.

Section 83A-105 of the ITAA 1997 provides that Subdivision 83A-C applies and Subdivision 83A-B does not apply to an ESS interest that is a beneficial interest in a right to acquire a beneficial interest in a share if all of the following conditions are satisfied:

1. Subdivision 83A-B would apart from this section apply to the interest.

2. When the employee acquires the interest they are employed by the company.

3. When the employee acquires the interest all the interests available for acquisition under the employee share scheme relate to ordinary shares.

4. When the employee acquires the interest the predominant business of the company is not the acquisition, sale or holding of shares, securities or other investments.

5. Immediately after the employee acquires the interest they do not hold a beneficial interest in more than 5% of the shares in the company and are not in a position to cast or control the casting of more than 5% of the maximum number of votes that might be cast at a general meeting of the company.

6. When the employee acquires the interest there is a real risk that under the conditions of the scheme they will forfeit or lose the interest (other than by disposing of it, exercising the right or letting the right lapse) or forfeit or lose the beneficial interest in the share (other than by disposing of it).

The Plan provides for the granting of options to acquire ordinary shares in the parent company to the Australian subsidiary's employees and their associates at a discount. Neither the parent company nor any of its subsidiaries is a share trading or investment company. No Australian employee holds or controls the right to cast more that X% of the votes at an annual general meeting of the parent. With five of the six conditions above satisfied we must consider whether a real risk of forfeiture exists for the options as required in paragraph 83A-105(3)(b) which states:

(b) if the ESS interest is a beneficial interest in a right to acquire a beneficial interest in a share:

(i) there is a real risk that, under the conditions of the scheme, you will forfeit or lose the ESS interest (other than by disposing of it, exercising the right or letting the right lapse); or

(ii) there is a real risk that, under the conditions of the scheme, if you exercise the right, you will forfeit or lose the beneficial interest in the share (other than by disposing of it).

Is the Plan a tax-deferred scheme with a real risk of forfeiture?

Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009 which inserted Division 83A, explains the real risk of forfeiture test at paragraph 1.156 as follows:

'The 'real risk of forfeiture test' does not require employers to provide schemes in which their employee share scheme benefits are at a significant or substantial risk of being lost. However, real is regarded as something more than a mere possibility. Something is not a real risk if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility. '

It is further explained at paragraph 1.158 of the Explanatory Memorandum that the 'real risk of forfeiture' test is intended to provide for deferral of tax when there is a real alignment of interests between the employee and employer, through the employee's benefits being at risk.

Real risk of forfeiture in a scheme may include conditions where retention of the ESS interests is subject to performance hurdles or a minimum term of employment. In cases where an employee share scheme has both employment and performance conditions to be met, and one of these conditions satisfies the 'real risk of forfeiture' test, it is not necessary to consider whether the other condition also satisfies the test.

Where there is some doubt whether a condition will satisfy the 'real risk of forfeiture' test then the other condition will also be examined.

ATO Interpretative Decision ATO ID 2010/61 Income tax: Employee share scheme: real risk of forfeiture-minimum term of employment and good leaver provisions provides the Commissioner's view of when the conditions of a scheme determine that the rights will be forfeited. When an employee acquires rights under an employee share scheme, the Commissioner considers that there is a real risk of forfeiture if, under the conditions of the scheme, the employee will forfeit or lose the rights if they cease employment before the vesting date of the rights where that date is 12 months or more from the date the rights were granted. He elaborates on the real risk of forfeiture by stating:

'In considering whether a condition in a scheme imposes a real risk of forfeiture, regard should be had to whether a reasonable person would consider that there is a genuine connection between the forfeiture condition and aligning the interests of the employee and employer. If the risk of forfeiture is over a very short period of time to gain access to a relatively long period of deferral the risk will not be considered real.'

The Plan does not allow an employee to dispose of the option other than by exercising the right or allowing the option to lapse. All options are non-transferable. The Plan does not identify any performance conditions but not all eligible employees will be offered options in the parent company as a motivation and reward to retain employees. Once a grant of options is made to an employee, a minimum service period must elapse before options may be vested in the employee who may then either exercise the rights to the first tranche or allow the rights to lapse within a specified exercise period. The remaining four tranches will become vested on each anniversary of the first tranche. If at any time the employee leaves the company over that number of years period all the unvested rights are forfeited. Presuming an employee is given a further grant of options in a latter year, there will be more options to forgo should the employee resign. All unvested options carry a real risk of forfeiture. It is only the vested options, where the service period has already been met, that may be exercised within specific amount of months of a triggering event or within Y months of vesting. The scheme encourages employees to exercise the rights and obtain shares in the company rather than forfeit the rights if the rights are not exercised within the prescribed period. The Plan encourages long term employment aligned with the employer's interests through the use of the staggered allocation of non-transferable options with a 'use it or lose it' policy on exercise of the options. We consider the Plan to be a tax-deferred scheme with a real risk of forfeiture.

Question 2

As Subdivision 83A-C of the ITAA 1997 applies to the rights granted under the Plan and Subdivision 83A-B does not apply, participants in the Plan will need to include in their assessable income the market value of the rights at the deferred taxing point reduced by the cost base of the rights in the income year in which the deferred taxing point occurs in accordance with section 83A-110 of the ITAA 1997.

Section 83A-120 of the ITAA 1997 provides that the 'ESS deferred taxing point' for rights to acquire shares occurs at the earlier of the following times:

1. when the right has not been exercised, there is no real risk of forfeiting the right, and the scheme no longer genuinely restricts disposal of the right (subsection 83A-120(4));

2. when the participant ceases the employment in respect of which they acquired the rights within the meaning of section 83A-330 (subsection 83A-120(5));

3. seven years after the participant acquired the rights (subsection 83A-120(6));

4. when there is no real risk of forfeiting the right or underlying share, and the scheme no longer genuinely restricts exercise of the right or disposal of the resulting share (subsection 83A-120(7));

Once the employee fulfils the specified amount of months service, the non-transferable option will then be vested in the employee. At vesting the employee has a maximum period of Y months in which to choose to exercise the right or to allow the right to lapse. However the employee is unable to dispose of the right before the exercise period.

The vested option may be converted into a share subject to the employee:

· becoming a party to the Shareholders Agreement

· completing the relevant paperwork to exercise the rights.

· providing consideration at the FMV for the shares.

Subsequently the shares acquired from the exercise of the options can only be sold in a trading window subject to the employee:

· Holding the shares for a minimum period of months.

· Not selling more than a certain portion of their maximum share ownership in any one year

· Retaining a certain ratio of shares to salary for some employees

Deferred taxing point 1

The options are non-transferable until vested in the employee. At vesting, the employee has either a Y month period (or specified amount of months if a triggering event occurs), in which to make the choice of exercising the rights to obtain the underlying share or to forfeit the rights. Between vesting and the date the exercise choice is made the employee is genuinely unable to dispose of the rights but there is no longer a real risk of forfeiture until the exercise choice is made. Subsection 83A-120(4) will not apply to establish a deferred taxing point before the right has been exercised, because the Plan still restricts the employee from disposing of the right before the right is exercised.

Deferred taxing point 2

When an employee ceases his service with the Australian subsidiary and does not take up employment with the parent or other subsidiaries, a triggering event occurs. All unvested options will immediately lapse but the employee or his successors may choose to exercise any vested options to acquire shares within three months of ceasing employment. Vested options held by the employee at the date employment is ceased will have the cessation date as the deferred taxing point by virtue of subsection 83A-120(5). The earliest cessation date that could be a deferred taxing point under this subsection would occur when the options vest in the employee after 12 months and simultaneously the employee ceases employment.

Deferred taxing point 3

Subsection 83A-120(6) provides a maximum time period for deferral of a taxing point as seven years from the date the rights were acquired.

Deferred taxing point 4

Once the employee fulfils the specific amount of months service condition, the first tranche of options is vested in the employee and there is no longer a real risk of forfeiture of the right or underlying share of that tranche of options. The employee is immediately free to exercise the rights within an exercise period of Z or X months, during which a choice is made to acquire shares for cash or simply to forfeit the options.

The applicant has stated that the Plan rules impose disposal restrictions on shares acquired upon exercise of the options. The shares must be held for a minimum period before they may be sold back to the parent company in the first available trading window. This is the time when all of the conditions in subsection 83A-120(7) of the ITAA 1997 will have been met for example, there is no real risk of forfeiting the right or underlying share, and the scheme no longer genuinely restricts exercise of the right or disposal of the resulting share.

We have established that deferred taxing point 1 (subsection 83A-120(4)) cannot apply to the options granted under the Plan. Deferred taxing point 3 (subsection 83A-120(6)) will never be the earliest point as both deferred taxing points 2 and 4 occur within seven years of the options being granted. The earliest date at which the deferred taxing point could occur will be when the employee ceases employment simultaneously with vesting of the options.

Where employment does not cease soon after the service period, the earliest deferred taxing point occurs when the conditions under subsection 83A-120(7) of the ITAA 1997 (deferred taxing point 4) are fulfilled and there is no longer any risk of forfeiture or disposal restrictions on the rights or the underlying share. The earliest deferred taxing point in this situation occurs when the share is available for sale in a trading window.

Therefore the Plan is a tax deferred scheme with the earliest possible deferred taxing point occurring on cessation of employment or when the share is first available for sale in a trading window.