Edited version of your written advice

Authorisation Number: 1012849264473

Date of advice: 4 August 2015

Ruling

Subject: Employee share scheme - options - foreign service

Question 1:

Is the amount of the discount on each parcel of options calculated as at the time you sold the shares acquired by exercising the options?

Answer:

Yes.

Question 2:

Is any part of the discounts on these parcels of options included in your assessable income for the 20AA-BB income year or for the 20BB-CC income year?

Answer:

No.

This ruling applies for the following period<s>:

20AA-BB income year

20BB-CC income year

The scheme commences on:

1 July 2002

Relevant facts and circumstances

You were an employee of a listed company in a foreign country for some 15 years prior to your return to Australia some five years ago. During this time you were not a resident of Australia for income tax purposes.

From the date of your return until the date of this request, you have been employed by the listed company in Australia.

You acquired parcels of stock options pursuant to Stock Option Agreements as follows:

• Some ten or so years ago, you acquired the parcels of options to purchase shares in the common stock of the company. These options were granted at an exercise price that was related to the market value of the stock at the grant date

• The vesting schedule for each parcel of options was:

• X% became exercisable after three years

• A further Y% became exercisable after four years, and

• The final Y% became exercisable after five years

• Each parcel of options were to expire ten years after the grant date (or earlier in certain situations)

• During the 20AA-BB income year, you exercised the first parcel of options and sold all resulting shares

• Just after the end of the 20AA-BB income year, you were issued with an employee share scheme statement showing the amount that would be assessable if all relevant service had occurred within Australia at label G - re discount on ESS interests acquired pre 1 July 2009

• During the 20BB-CC income year, you exercised the second and third parcels of options and sold all resulting shares

• Just after the end of the 20BB-CC income year, you were issued with an employee share scheme statement showing the amount that would be assessable if all relevant service had occurred within Australia at label G - re discount on ESS interests acquired pre 1 July 2009

All of the options had vested before you became a resident of Australia for tax purposes.

Certain documents were provided with the private ruling application. These documents are to be read with and form part of the description of the scheme for the purpose of this ruling.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A,

Income Tax (Transitional Provisions) Act 1997 Division 83A and

Income Tax Assessment Act 1936 Division 13A of Part III.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

The amount of the discount on each parcel of options calculated is as at the time you sold the shares acquired by exercising the options.

Detailed reasoning

Options to acquire shares form part of your remuneration if the options are granted to you in relation to your employment and at a discount to their market value.

The employee share scheme provisions are used to work out:

• When you need to include this discount in your assessable income, and

• The amount of the discount.

Options that are granted under employee share schemes that meet certain conditions qualify for tax deferral.

The employee share scheme provisions were amended as from 1 July 2009. Some options were granted when the former provisions applied but will be assessable after the new provisions have commenced. Transitional rules apply in such cases.

As the transitional rules apply, the deferred taxing point of the options is based on the cessation time as determined under the former provisions, but may be adjusted if a sale happens within 30 days of the cessation time.

Looking at each individual option, the 'cessation time' is the earliest of:

• The time when you disposed of the option (other than by exercising it)

• The time when your employment with a relevant employer ceased

• The later of the time when any selling restrictions end and any forfeiture conditions cease on any share acquired by exercising the option

• If there are no selling restrictions or forfeiture conditions on the share acquired by exercising the option - when the option was exercised, and

• 10 years from the date of grant of the option.

During the 20AA-BB income year, you exercised the first parcel of options granted to you. You sold the resulting shares on the same day.

During the 20BB-CC income year, you exercised the second and third parcels of options. You sold the resulting shares on the same day.

The information provided to you by your employer means that the employee share scheme provisions apply to you in the following manner:

• You were granted options in relation to your employment before 1 July 2009 at a discount to their market value

• These options were qualifying rights and therefore the taxing point was to be deferred until the cessation time

• The cessation time for the first parcel of options happened during the 20AA-BB income year

• Before reduction for foreign service, your assessable discount in the 20AA-BB income year was the amount specified

• The cessation time for the second and third parcels of options happened during the 20BB-CC income year

• Before reduction for foreign service, your assessable discount in the 20BB-CC income year was the specified amount

In your case, the amount of the discount is calculated as at the sale date of the shares because it is the deferred taxing point being the first potential cessation time to occur in relation to the options.

Any capital gain or capital loss made on the options or shares at this time is disregarded.

Question 2

Summary

No part of the discounts on these parcels of options is included in your assessable income for the 20AA-BB income year or for the 20BB-CC income year.

Detailed reasoning

As mentioned above, the transitional rules apply to the options because they were granted to you before 1 July 2009 and their taxing point occurred after 30 June 2009.

The foreign service transitional rule excludes the foreign service component of an employee share scheme discount from your assessable income in Australia.

The relevant legislation does not provide a mechanism for determining the extent to which remuneration in the form of options should be assigned to foreign or domestic service. Therefore, the outcome will depend on the facts and circumstances of your case.

Guidance is provided in the Explanatory Memoranda that supported the 2006 and 2009 amendments to the employee share scheme provisions.

Paragraph 1.352 of the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 states:

1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development and Cooperation (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005.

Paragraph 4.6 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 states:

4.6 The OECD commentary on the articles of the model tax convention is relevant in interpreting Australia's tax treaties. The revised commentary treats the benefit accruing up to the exercise of a right as an employment benefit to which Article 15 (Income from Employment) of the model tax convention applies. The commentary recognises that the facts and circumstances of the particular case will determine the period of employment to which the right relates. The number of days worked in a treaty country during this employment period then determines the extent of that country's source taxing rights.

Paragraph 4.32 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 states:

4.32 Individuals will need to examine their circumstances and specific employee share plan to determine whether the period after becoming an Australian employee is relevant to the acquisition of the employee share or right The period of employment after becoming an Australian employee will generally not be relevant if no forfeiture conditions remain at the time an individual becomes an Australian employee. If the employee share or right may be forfeited unless the individual undertakes further employment or services at the time employment commences in Australia, a portion of the discount will generally be assessable in Australia.

Paragraphs 12.7 to 12.15 of the OECD commentary concerning the taxation of income from employment suggest the following principles for determining the service period in relation to employee stock options:

12.7 The first principle is that, as a general rule, an employee stock-option should not be considered to relate to any services rendered after the period of employment that is required as a condition for the employee to acquire the right to exercise that option...

12.11 The second principle is that an employee stock-option should only be considered to relate to services rendered before the time when it is granted to the extent that such a grant is intended to reward the provision of such services by the recipient for a specified period…

12.13 Finally, there may be situations in which some factors may suggest that an employee stock-option is rewarding past services but other factors seem to indicate that it relates to future services. In cases of doubt, it should be recognised that employee stock-options are generally provided as an incentive to future performance or as a way to retain valuable employees…

Paragraph 12.9 of this commentary assists in interpreting the first principle and states:

It is also important to distinguish between a situation where a period of employment is required as a condition for the acquisition of the right to exercise an option, i.e. the vesting of the option, and a situation where an option that has already vested may be forfeited if it is not exercised before employment is terminated (or within a short period thereafter). In the latter situation, the benefit of the option should not be considered to relate to services rendered after vesting since the employee has already obtained the benefit and could in fact realise it at any time…

This means that generally, options with forfeiture conditions are considered to be earned during the period between the grant date and the vesting date (that is, the vesting period). In special cases, an alternate 'earning period' may be warranted.

We have considered all of the documents that you have presented with your private ruling application. They show that you were not required to perform any additional duties beyond the vesting date to be entitled to full ownership of any shares that you could acquire by exercising the options.

Therefore, we consider the options to be earned during the vesting period meaning that they relate only to your foreign service. Consequently, none of the employee share scheme discount is to be included in your assessable income for the 20AA-BB and 20BB-CC income years.