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Ruling

Subject: Assessable income - director's profit share plan

Question 1

Are retained amounts under a Profit Share (PS) Plan included in your assessable income at the time of allocation?

No

Question 2

Are you considered to be presently entitled to, and subsequently liable to be assessed under section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) on amounts of retained PS as a trust beneficiary?

No

Question 3

Are the supplementary amounts arising under the PS Plan included in your assessable income at the time of receipt?

Yes

This ruling applies for the following period

Year of income ending 30 June 2010

Year of income ending 30 June 2011

Year of income ending 30 June 2012

Year of income ending 30 June 2013

Year of income ending 30 June 2014

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You are an Australian resident for tax purposes.

You are an employee of Company A.

The remuneration package that is provided to you includes an incentive scheme, based on individual performance. The PS Rules sets out the terms on which the PS will operate, including terms relating to allocation, retention, vesting and release of PS and how the PS rules may be varied from time to time.

The annual allocations under the PS Plan (the PS allocations) are entirely performance based and submitted to the relevant Committee for approval.

Company A is under no obligation to award a PS allocation to you and you have no right or entitlement to be awarded a PS allocation. PS allocations are entirely discretionary and neither a PS allocation in any one year, nor PS allocations across a number of years, imply or guarantee a PS allocation in any subsequent year.

A certain percentage of the PS allocation will be available for remuneration purposes in the year of allocation. Remuneration includes cash payments and related on-costs.

The remaining portion of your PS allocation is deferred for a number of years (the retained PS).

If your employment continues to the end of the relevant retention release period as set out in the PS Rules, the relevant retained PS will vest and be released to you on the respective vesting and release dates for the year (subject to certain conditions being satisfied).

The amount of any retained PS which has not become a PS entitlement will never be paid, dealt with, or be available for remuneration purposes unless the Committee has determined to accelerate the vesting period, which will only occur in special circumstances.

Except in cases where there is a genuine retirement, redundancy, limited exceptional circumstances, or on death or total and permanent disability (subject to the disqualifying event provisions over a two year period) any unvested retained PS will be forfeited on termination of employment.

Retained PS amounts will never be paid, dealt with, or be available for remuneration purposes if a disqualifying event (as set out in the PS Rules) has occurred.

In addition, the Committee has the discretion to reduce or eliminate unvested PS amounts where it determines that your action or inaction has caused Company A significant reputational harm, caused a significant unexpected financial loss or caused it to make a material financial restatement.

The Retained PS amounts will be either notionally invested in managed funds, or invested in Company A's employee share scheme (ESS).

The Committee has absolute discretion to decide at any time the manner in which Retained PS amounts will be invested.

In relation to the retained PS amounts, all investments, regardless of whether they are in a Company A-managed fund equity or something else, are notional in nature. There are no actual purchases of the underlying investments. In no situation are any investments made in your name. Company A may elect, or not elect, to hedge its liability to you under the PS Plan by purchasing an interest in the underlying investment, but there is no requirement to do so.

Once the Committee has determined how much of the retained amount is to be invested in the ESS and how much through the PS plan, the executive director must apply to the ESS for that allocation. Should they not wish to accept the ESS offer, that part of the retention amount is forfeited. Amounts invested in the ESS are no longer part of the PS plan (The taxation treatment of such amounts is dealt with in a separate ruling).

You do not have the opportunity to select or influence the selection of the investments in the PS Plan nor do you have any interest, legal or beneficial, in any property owned by Company A in connection with the PS plan.

The notional return that is referrable to your retained PS may, at the discretion of the Committee, be released to you as additional remuneration (the supplementary amount) in your local currency of remuneration.

Retained PS entitlements will appear on the balance sheet of Company A as an accrued liability. On your entitlement to the retained PS (at the earlier of termination of employment without a disqualifying event or at the end of the retention release period) there will be a debit to accrued liability).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5,

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1936 section 97.

Reasons for decision

Question 1

Summary

Under the PS Plan, retained amounts are not included in your assessable income at the time of allocation.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

The legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124 at 138; 90 ATC 4413 at 4420; (1990) 21 ATR 1 at 7, 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.

Amounts that are periodical, regular or recurrent, relied upon and expected on a periodic basis by the recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 10 ATD 82; 5 AITR 443), as are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient (Hayes v. Federal Commissioner of Taxation (1956) 96 CLR 570; (1956) 11 ATD 68; Federal Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 95 ATC 4691; (1995) 31 ATR 392). Amounts paid in substitution for salary or wages foregone or lost may also be ordinary income(Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540 at 568; (1952) 10 ATD 82 at 92; 5 AITR 443 at 456 (per Fullagar J)).

Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient (Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 at 526; (1966) 14 ATD 286 at 293; (1966) 10 AITR 367 at 275; Hayes v. Federal Commissioner of Taxation (1956) 96 CLR 47 at 55; (1956) 11 ATD 68 at 73; (1956) 6 AITR 248 at 254; Federal Coke Co Pty Ltd v. Federal Commissioner of Taxation (1977) 34 FLR 375 at 402; 77 ATC 4255 at 4273; (1977) 7 ATR 519 at 539). The whole of the circumstances must be considered (Squatting Investment Company Limited v. Federal Commissioner of Taxation (1953) 86 CLR 570 at 627; (1953) 5 AITR 496; 24 ATR 527) and the motive of the payer may be relevant to this consideration (Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514 at 527, 528; (1966) 14 ATD 286 at 293; (1966) 10 AITR 367 at 376).

Any amounts received by you under the PS Plan form part of your overall remuneration package with Company A. As such, they will be assessable to you as ordinary income under subsection 6-5(1) of the ITAA 1997.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes the ordinary income derived by the taxpayer directly or indirectly from all sources, whether in or out of Australia, during the income year.

Income from employment is normally assessable on a receipts basis (FC of T v. Firstenberg (1976) 27 FLR 34; 76 ATC 4141; (1976) 6 ATR 297). Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period (Case 29 1 TBRD 88; 1 CTBR (NS) 225 Case 57; and Case B53 2TBRD 223; 2CTBR (NS) 125 Case 27).

Subsection 6-5(4) of the ITAA 1997 provides that, in working out whether, and when, an amount of ordinary income is derived, the amount is taken to have been received as soon as it is applied or dealt with in any way on the taxpayer's behalf or as the taxpayer directs. For instance, if an amount is credited to an employee in the books of his employer and can be drawn by the employee at any time, it is derived at the time it was so credited and made available to the employee (that is, constructive receipt).

The PS allocations are determined annually subject to the approval of the Committee. In accordance with the PS Rules, a fixed percentage of the PS allocation is available for remuneration in the year of allocation. The remaining percentage is deferred (retained PS). If your employment continues to the end of the relevant retention release period as set out in the PS Rules, the relevant retained PS will vest and be released to you at the end of the respective vesting and release period for that particular PS allocation.

You do not have any right to any retained PS, nor does Company A have an obligation to pay a retained PS amount to you until it is released, in accordance with the PS Rules.

Except in specific circumstances detailed in the PS Rules, any unvested retained PS amounts are forfeited on termination of employment.

Accordingly, until the retained PS vests in you, you only have a contingent and unascertainable right to the retained PS. Until specified conditions are satisfied, the retained PS is not available to you to call upon. Consequently, you cannot be deemed to have derived a retained PS amount until you have actually received it or otherwise have it applied on your behalf or as you direct.

Therefore, the retained PS is included in your assessable income under section 6-5 of the ITAA 1997 at the time of receipt of the income or when the income is otherwise applied for your benefit and not at the time of allocation.

Question 2

Summary

You are not considered to be presently entitled to and subsequently liable to be assessed under section 97 of the Income Tax Assessment Act 1936 (ITAA 1936) on amounts related to retained PS as a trust beneficiary.

Detailed reasoning

Section 97 of the ITAA 1936 applies where a beneficiary is presently entitled to a share of the income of a trust estate. Therefore it is necessary to determine whether an implied (resulting) or express trust has been created over the amount of retained PS with Company A as trustee and you the beneficiary.

A description of the nature of a trust is provided in Jacobs' Law of Trusts in Australia (Heydon and Leeming, (7^th ed, LexisNexis Butterworths, 2006), paragraph 101:

A trust exists when the holder of a legal or equitable interest in certain property is bound by an equitable obligation to hold his interest in that property not for his own benefit, but for benefit, as to the whole or part of such interest, of another person or persons or for some object or purposes permitted by law.

In Underhill, Law of Trusts and Trustees (Butterworths, 13^th edn, 1979, page 1) the following description is provided:

A trust is an equitable obligation binding a person (who is called a trustee to deal with property over which he has control (which is called the trust property), for the benefit of persons (who are called beneficiaries...) of whom he may himself be one, and any one of whom may enforce the obligation.

Trust property is defined in Underhill, Law of Trusts and Trustees (p.122) as:

All property real or personal, legal or equitable, at home or abroad and whether vested in possession or action, remainder or reversion, and whether vested or contingent, may be made the subject of a trust unless:

(a) the policy of the law or some other statutory enactment has made it inalienable ...

It is a condition of trust law that for a trust to be effective the trust property must be known and identified with certainty (Herdegen v. Federal Commissioner of Taxation (1988) 84 ALR 271 at 277; 88 ATC 4995 at 5000; (1988) 20 ATR 24 at 29). It is not possible to create a binding trust over a future expectancy (G E Dal Pont and D R C Chalmers, Equity and Trusts in Australia, (4^th ed, Lawbook Co. 2007) paragraph 17.65).

It is therefore necessary to consider whether there is any 'property' which can constitute trust property.

At the time that your PS allocation is determined by the Committee, you do not obtain a beneficial right to receive the retained amount, but rather an expectation of receiving this amount in the future. You become entitled to receive a portion of the retained PS amount if you continue in employment with Company A to the end of the relevant retention release period specified in the PS Rules, and provided there have been no disqualifying events occurring.

Except in certain specified circumstances, any unvested retained PS will be forfeited on termination of employment.

Therefore, there is no amount which can be readily identified as trust property, and it is considered that the relationship is not one of a trust. If no trust exists for the purposes of trust law, there is no present entitlement to which you can be assessed under section 97 of the ITAA 1936.

Question 3

Summary

The supplementary amounts arising under the PS Plan are included in your assessable income at the time of receipt.

Detailed reasoning

During the retention period of the retained PS amounts, the Committee may determine that a supplementary amount be paid to you. This supplementary amount represents a notional return on the retained amounts held in the PS plan. Until your supplementary amount has been determined and available to you to call upon, you cannot be deemed to have derived the amount.

Therefore a supplementary amount will be included in your assessable income at the time of receipt or when the income is otherwise applied for your benefit under section 6-5 of the ITAA 1997.