Edited version of your written advice

Authorisation Number: 1012719293579

Ruling

Subject: Non-Commercial Losses, Employee Share Scheme and Legal Expenses

Issue 1

Non Commercial Losses

Question 1

Do you satisfy the assessable income test which therefore entitles you to claim the loss from your business against your other income in the relevant financial year?

Answer

Yes

Issue 2

Employee Share Scheme

Question 1

Will the deferred taxation point of your ESS interests be the date you ceased employment?

Answer

Yes

Question 2

Does the Commissioner have any discretion to defer the taxation point to when the shares are vested?

Answer

No

Issue 3

Legal Expenses

Question 1

Will the legal expenses incurred in taking legal action against you employer in relation to breach of contract be deductible?

Answer

Yes

This ruling applies for the following period

Income year ended 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You were made redundant from your employment.

Prior to you redundancy you received Employee Share Scheme (ESS) interests in the form of shares.

You acquire these interests on the x and x in the following tranches:

Issue Date Restriction Date # of Shares

x x x

x x x

x x x

x x x

The shares were subject to forfeiture if you ceased you employment, however as you were made redundant you were able to retain the shares.

However the shares have not vested and you are unable to sell them until they reach the restriction date.

Upon termination, your employer did not pay you accrued bonus amounts which you felt were owed to you. You subsequently sued for breach of contract to recover the owed money.

In the relevant income year you incurred legal costs of $x. In the subsequent income year you incurred further legal costs of $x.

In the subsequent income year your previous employer settled the case with you out of court and paid you $x.

In x relevant year you commenced a business.

You provide strategic advice to clients in this business activity.

Clients pay you directly for this service.

You do not currently employer other staff, but intend to do so in the future.

Your other income in the relevant income year is under $250,000. During the relevant income year you received $x of income and incurred approximately $x of costs. The costs included:

• Depreciation of assets

• Business development expenses

• Marketing expenses

• Costs of establishing a website

You projected assessable income for the subsequent income year is $x. Your business is currently profitable post the set up costs, as the running costs of the business are extremely low. Your business activity has made approximately $x assessable income in the first quarter of the subsequent income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 35-10

Income Tax Assessment Act 1997 subsection 83A-120

Reasons for decision

Issue 1 Non Commercial Losses

Division 35 of the ITAA 1997 will apply to defer a non-commercial business loss from a business activity carried on by a taxpayer who is an individual, unless:

• their business activity satisfies one of the four tests listed in section 35-10 of the ITAA 1997;

• the Commissioner has exercised the discretion in section 35-55 of the ITAA 1997 for the activity; or

• the individual comes within the exception to Division 35, contained in subsection 35-10(4) of the ITAA 1997 which may apply to a primary production or professional arts business.

Section 35-30 of the ITAA 1997 outlines the assessable income test. A business passes this test where it produces assessable income of at least $20,000 in the income year.

Paragraph 35-30(b) of the ITAA 1997 contemplates the assessable income test in situations where the activity is not carried on for the full year. In that situation a reasonable estimate of what the assessable income would have been if the activity had been carried on for the full year can be made. The estimated income needs to be at least $20,000 to pass the assessable income test.

In your case, you commenced your business activity late in the relevant year. You incurred expenses in setting up your business. You made a loss from the business activity in that year. However, you have provided that your business activity has generated $X assessable income in the first quarter of the subsequent financial year.

Based on the subsequent income year sales figures, the Commissioner is satisfied that had you operated the business for the full relevant financial year you would have passed the assessable income test.

Therefore, you are entitled to offset your business losses against your other income in the relevant financial year.

Issue 2 Employee Share Scheme

Section 83A-120 of the ITAA 1997 provides the rules for determining when the ESS deferred taxing point occurs where you as the holder of beneficial interest in a right. This will be the earliest of the following times:

• when the employment in respect of which they acquired the rights ends as per subsection 83A-120(5)

• seven years after acquiring the rights as per subsection 83A-120(6)

• 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 as per subsection 83A-120(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 as per subsection 83A-120(7).

The word 'exercise' as used in Division 83A is not a defined word, thus it should take its ordinary meaning having regard to its legislative context and the purpose or object of the statute. For the purposes of Division 83A, the concept of 'exercising a right' is not considered to necessarily require an action or activity by the beneficial owner of the right. It is enough that they become the beneficial owner of the share that was the subject of the right, without having to do anything, that is, it happens automatically or is instigated by the employer or another party. Therefore, you are taken to have exercised the rights when securities are allocated on vesting of the rights.

In respect to your circumstances, the ESS deferred taxing point will be earliest of the following:

• the time when the shares vested and were no longer under any restrictions which was x, x, x and x respectively.

• the time when you ceased employment in x, and

• seven years from the date you were granted the rights, which will be either on x and x respectively.

Therefore the ESS deferred taxing point of your ESS interests will be the when you ceased your employment in x.

Issue 3 Legal Expenses

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. 

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. 

If the advantage is of a capital or private nature, then the expenses incurred in gaining the advantage will also be of a capital or private nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer. 

It is considered that the advantage sought in the litigation was the recovery of an amount of bonus payable to you under your employment contract. A bonus paid under your employment contract is clearly assessable income and it follows that legal expenses incurred in the recovery of assessable income will be deductible under section 8-1 of the ITAA 1997.