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Ruling

Subject: ESS

1. What amount will be assessable income to the employee unit holder in the event of a disqualifying event?

Answer: The proceeds from the redemption of employee units in the event of a disqualifying event will be assessable.

2. Will the employee be assessed on contributions made by the employee to acquire additional units in the employee share trust (trust)?

Answer: No

3. Will the employee be liable to income tax on the value of employee units issued by the trust if the employer is not liable for fringe benefits tax?

Answer: Yes

4. If the employees are liable to income tax on the value of employee units, will the value of employee units be limited to the amount that the employee will receive if the disqualifying event (as defined in the proposed the trust deed) occurs?

Answer: Yes

5. Will the employee be liable for capital gains tax on any capital gain made on redemption of employee units?

Answer: Yes

6. Will the employee be liable for capital gains tax on any capital gain made on redemption of additional employee units?

Answer: Yes

7. Will the general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme described?

Answer: No

8. Is Taxation Ruling TR 2010/6 Income Tax, Pay As You Go Withholding and fringe benefits tax; tax consequences on the issue, holding and redemption of bonus units as part of an employee benefits trust arrangement, applicable?

Answer: No

9. Does it make a difference if the trust becomes a major shareholder of the employer?

Answer: No

10. Will it make a difference if only one of the employees is invited to participate in the employee share scheme (ESS) or if additional employees (not being directors or shareholders of the employer) are invited to participate in the ESS?

Answer: No

Relevant facts and circumstances

11. This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

To establish the employee share scheme

The employer is an Australian company registered with the Australian Securities and Investments Commission.

The employer intends to implement an employee share scheme (ESS) to attract, retain and motivate employees.

The employees invited to participate in the ESS are arm's length employees of the employer. For the purposes of this Ruling, an 'arm's length employee' is a person in respect of whom a contribution of money is made by the employer pursuant the employee shares scheme trust deed (trust deed). The expression 'at arm's length' is defined in The CCH Macquarie Concise Dictionary of Modern Law, 1988, CCH Australia Ltd/Macquarie Library Pty Ltd, Sydney as meaning that the parties to a transaction are not connected in such a way as to bring into question the ability of one to act independently of the other.

In order to facilitate the ESS, the employer proposes to create the trust.

Both the employer and one or more invited employees (who satisfy the qualifying criteria set out below) will be able to make contributions to the ESS.

The trust will have a special purpose corporate trustee, the trustee, established to manage the affairs of the trust.

The trustee will have restricted investment powers set out in the draft trust deed as follows:

(a) the investment powers of the trust are limited to obtaining shares, or rights to acquire shares, of the employer company (or a holding company of the employer company); and

(b) restrict distributions of income or capital to employees or associates of employees.

Income of the trust will be distributed to each employee unit holder on an annual basis, based on the number of units held by the eligible employee unit recipient holder as a proportion of total redeemable units held at the end of the financial year. Under the terms of the trust deed no income of the trust may be distributed to the employer unit holder.

Issue of units

The employer will apply for employer units.

The application by the employer for employer units in the trust will:

(a) entitle the employer to nominate an employee as an eligible employee unit recipient to hold employee units in the trust

(b) entitle the employer to set the conditions which would disentitle the employee to the reward (a 'disqualifying event"). Disqualifying discounts can be tailored to provide for benefits to be reduced on a proportionate basis, eg 60% if the employee does not complete 3 years of service; and

(c) require the employer to pay a premium in respect of employer units to be issued to The employer in order to secure loyalty of eligible employee unit recipients.

The employer will apply for redeemable employer units under the terms of the trust deed. The employer units will be purchased for a set amount and an additional premium amount will be paid to the trust fund. The amount of premium will be a percentage amount above the employer's base profit target for the financial year.

Only employees may become an eligible employee unit recipient and be allocated employee units. The shareholders or directors of the employer will not be eligible to be nominated as an eligible employee unit recipient in the ESS.

The employer will apply for employee units under the terms of the trust deed. The employer will also nominate eligible employee unit recipients to receive employee units.

There will be two qualifying criteria for employees to become an eligible employee unit recipient and invited to hold employee units in the ESS, as outlined the deed;

· an employee must have worked for the employer for an initial period (i.e. 12 months) ; and

· an employee must be classified by the employer as a senior employee (or equivalent for administrative staff).

From time to time, additional employees may be nominated by the employer to be eligible employee unit recipients and hold employee units in the trust, none of whom will be directors or shareholders of the employer.

The value of the employer will be determined by an independent valuer each financial year. From this valuation the underlying share price will be determined. Employee units will be referable to the share price.

Employee units in the trust will be issued for an issue price set by the amount of the premium paid by the employer and the number of employee units issued. Employee units will be subject to a disqualifying discount and disqualifying event conditions set by the employer.

Employee unit holders and/or their associates may apply for additional unissued redeemable units in the ESS.

Employee units may be redeemed or transferred under the terms of the trust deed. Employee units nominated for transfer may be firstly, redeemed by the trustee or, secondly, transferred to other employee unit holders and or their associates or, lastly, transferred to other employees and or their associates (excluding any direct shareholder of the employer).

The ESS does not involve any salary sacrifice arrangement.

The ESS does not involve the trustee making loans to employees (whether interest bearing or interest free and whether of a limited recourse nature or not).

Redemption of units

Upon redemption of the employer units, the employer is only entitled to an amount equivalent to the issue price of the employer units (and not the premium, which is an irretrievable payment made by the employer in order to secure the loyalty of the eligible employee).

Upon redemption of the employee units, the eligible employee unit recipient holder will be entitled to receive an employee redemption amount being the greater of an amount based upon a calculation of the value of the beneficial interest in the shares or options forming part of the employee share trust fund (trust fund) which have been allocated to each employee unit and the proceeds of sale of those shares or options net of selling costs or the issue price of the employee unit.

If a disqualifying event occurs, the employee will only be entitled to receive the disqualification amount on employee units. A disqualifying event includes:

· any acts of fraud, dishonesty or wilful or serious misconduct;

· periods where the employee unit holder is not an employee for a continuous period of 12 months or any non continuous period of three years within a continuous period of five years;

· the employee unit holder is declared insane; or

· the employee is dismissed from employment.

A disqualifying event does not include death or bona fide retirement, including for reasons of trauma or total and permanent incapacity.

The employee redemption amount is also subject to the disqualification discount. An employee must continue to work for the employer for a designated time before realising the value of the investment (i.e. employees whose employment is terminated in the first two years may only receive 40% of the employee redemption amount, after three years 60%, after four years 80% and only after five years 100%).

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 83A-10(1)

Income Tax Assessment Act 1997 Subsection 83A-10(2)

Income Tax Assessment Act 1997 Section 83A-15

Income Tax Assessment Act 1997 Subsection 83A-25(1)

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Subsection 130-85(4)

ATO View documents

TR 2010/6

1. What amount will be assessable income to the employee unit holder in the event of a disqualifying event?

Under section 83A-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997), an employee's assessable income for the income year in which that employee acquires an ESS interest will include any discount to the market value of the ESS interest. An ESS interest is defined as a beneficial interest in a share in a company or a beneficial interest in a right to acquire a share in a company (subsection 83A-10(1) of the ITAA 1997).

Employee units acquired by employees and/or their associates under the terms of the trust provide employees with beneficial interests in shares in the employer's employee units are ESS interests.

Where employee units are issued at a discount, the discounted amount of the market value of the employee units issued to employees will be included as assessable income of the employee unit holder and will be taxed upfront in the year in which the employee unit holder acquired the employee units (section 83A-15 and subsection 83A-25(1)). Under the terms of the trust the employee acquires an ESS interest once the employee unit is issued to them. Employee unit holders are not eligible for deferral of taxation as the ESS interests are not subject to a real risk of forfeiture.

If a disqualifying event (as defined in the trust deed) occurs, the relevant employee will only be entitled upon redemption of the employee unit to receive the disqualification amount (refer to trust deed), subject to the disqualification discount. The relevant employee will effectively forfeit most, but not all of the redemption Amount.

Where an ESS interest has been forfeited through no choice of the employee, except where that choice is to cease employment, or where a condition of the scheme has the direct effect of protecting (wholly or partly) the employee against a fall in the market value of the ESS interest, section 83A-310 may operate so that Division 83A is taken never to have applied in relation to that ESS interest. The employee may request an amendment (item 30 in the table in subsection 170(10AA) of the ITAA 1997) to exclude a forfeited amount from the income tax assessment that includes an amount disclosed as assessable income under section 83A-15 and subsection 83A-25(1) in respect of the ESS interest forfeited.

2. Will the employee be assessed on contributions made by the employee to acquire additional units in the trust?

Answer: No

The trust does not involve any salary sacrifice arrangement. The purchase of additional units by the employee is considered to be an outgoing of capital or of a capital nature (section 8-1(2)(a) of ITAA 1997) which will form part of the cost base of those additional units. Accordingly, contributions made by those employees to acquire additional units in the trust will not be a deductible expense by the employee under section 8-1 of the ITAA 1997.

3. Will the employee be liable to income tax on the value of employee units issued by the trust if the employer is not liable for fringe benefits tax?

Answer: Yes

Under section 83A-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997), an employee's assessable income for the income year in which that employee acquires an ESS interest will include any discount to the market value of the ESS interest. An ESS interest is defined as a beneficial interest in a share in a company or a beneficial interest in a right to acquire a share in a company (subsection 83A-10(1) of the ITAA 1997).

Employee units acquired by employees under the terms of the trust provide employees with beneficial interests in shares in the employer. Employee units are ESS interests.

Where employee units are issued at a discount, the discounted amount of the market value of the employee units issued to employees will be included as assessable income of the employee unit holder and will be taxed upfront in the year in which the employee unit holder acquired the employee units (section 83A-15 and subsection 83A-25(1)). Under the terms of the trust the employee acquires an ESS interest once the employee unit is issued to them. Employee unit holders are not eligible for deferral of taxation as the ESS interests are not subject to a real risk of forfeiture.

The provision of an ESS interest under an employee share scheme is excluded from the definition of 'fringe benefit' under paragraph (h) of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986).

4. If the employees are liable to income tax on the value of employee units, will the value of employee units be limited to the amount that the employee will receive if the disqualifying event (as defined in the proposed the trust deed) occurs?

Answer: Yes

Refer to response to question 1.

5. Will the employee be liable for capital gains tax on any capital gain made on redemption of employee units?

Answer: Yes

The redemption of employee units will represent a disposal of those employee units and each disposal will constitute a CGT event C2 under section 104-25 of the ITAA 1997. The employee's assessable income will include any net capital gain upon the redemption of employee units during that income year (section 102-5 of the ITAA 1997).

6. Will the employee be liable for capital gains tax on any capital gain made on redemption of additional employee units?

Answer: Yes

The redemption of additional employee units will represent a disposal of those additional employee units and each disposal will be a disposal of an asset constituting a CGT event C2 under section 104-25 of the ITAA 1997. The employee's assessable income will include any net capital gain upon the redemption of additional employee units during that income year (section 102-5 of the ITAA 1997).

7. Will the general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme described?

Answer: No

The trust deed and all other information received explicitly provide that the trustee will acquire money/property to be utilised solely in the activity of obtaining shares or rights to acquire shares in the employer or its holding companies. Provided that the scheme as implemented is materially identical to the scheme described in this ruling it is considered that Part IVA of the ITAA 1936 would not apply in respect of the employer, the trust or the employees.

8. Is Taxation Ruling TR 2010/6 Income Tax, Pay As You Go Withholding and fringe benefits tax; tax consequences on the issue, holding and redemption of bonus units as part of an employee benefits trust arrangement, applicable to the trust?

Answer: No

The proposed arrangement the subject of this ruling application does not involve:

· the issue of bonus units;

· salary sacrifice arrangements; or

· the trustee of the trust making loans to employees (whether interest bearing or interest free and whether of a limited recourse nature or not).

9. Does it make a difference if the trust becomes a major shareholder of the employer?

Answer: No

The trust is an employee share trust set up by the employer for an employee share scheme. Subsection 130-85(4) of the ITAA 1997 provides that an employee share trust for an 'employee share scheme' (having the meaning given by subsection 83A-10(2) of the ITAA 1997) is a trust whose sole activities are:

a)  obtaining shares or rights in a company; and

b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of:

(i)  the company; or

(ii)  a subsidiary of the company; and

c)  other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b).

An employee share scheme is defined in subsection 83A-10(2) of the ITAA 1997 as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

While the trust satisfies the requirements of subsection 130-85(4) of the ITAA 1997 it will be immaterial as to whether or not the proposed trust becomes (at any time) a majority shareholder of the employer.

10. Will it make a difference if only one of the employees is invited to participate in the ESS or if additional employees (not being directors or shareholders of the employer) are invited to participate in the ESS?

Under the terms of the trust only arms length employees may be eligible employee unit recipients and acquire employee units. Shareholders and directors of the employer are excluded from acquiring employee units.

Where the operation of the employee share scheme does not meet the requirements for concessional treatment or the deferral of tax on any discount to the market value of ESS interests, the default position is to tax that discount upfront in the year in which those ESS interests are provided. The trust does not meet the requirements for concessional treatment or deferral of tax. The market value of ESS interests acquired by an employee in the trust will be subject to tax upfront in the income year in which the employee acquires the ESS interests.

Subsection 83A-10(2) defines an employee share scheme as a scheme under which ESS interests in a company are provided to employees, or associates of employees, (including past or prospective employees of the company or subsidiaries of the company in relation to the employees' employment. The definition under subsection 83A-10(2) does not stipulate a minimum or maximum number or employees participating in an employee share scheme. The default upfront tax position under section 83A-15 and subsection 83A-25(1) does not impose any requirements as to the number of employees participating in the employee share scheme.