Edited version of your written advice

Authorisation Number: 1012892754077

Date of advice: 16 October 2015

Ruling

Subject: Employee Share Schemes

Questions A1 to A8 apply to Company X

Question A1

Will Company X obtain an income tax deduction in respect of contributions by Company X to the Trustee of the Employee Share Trust ('Trustee') to fund the acquisition of Company X shares by the Employee Share Trust ('Trust')?

Answer

Yes

Question A2

Is an irretrievable contribution by Company X to the Trustee of the Trust to fund the acquisition of Company X shares by the Trust for allocation to the Employee, deductible to Company X in the income year in which it is made?

Answer

Yes

Question A3

Will the Commissioner seek to make a determination that Part IVA of the Income Tax Assessment Act 1936 ('ITAA 1936') applies to deny, in part or full, any deduction claimed by Company X for contributions by Company X to the Trustee to fund the acquisition of Company X shares by the Trust?

Answer

No

Question A4

Will Company X obtain an income tax deduction in respect of costs incurred in relation to the implementation and ongoing administration of the Trust in the year in which they are incurred?

Answer

Yes

Question A5

Will payments by Company X to participants to redeem Rights be deductible to Company X as 'salary or wages'?

Answer

Yes

Question A6

If the Trustee uses a contribution received from Company X to subscribe for shares in Company X, will the subscription proceeds be included in the assessable income of Company X?

Answer

No

Question A7

Will the provision of Performance Rights and shares to the Employee under the Plan be a fringe benefit within the meaning of the Fringe Benefits Tax Assessment Act 1986 ('FBTAA')?

Answer

No

Question A8

Will contributions by Company X to the Trustee to fund the acquisition of Company X shares be treated as a fringe benefit within the meaning of the FBTAA?

Answer

No

Questions B1 to B11 apply to the Trustee & the Employee

Question B1

Will the contributions by Company X to the Trustee to fund the acquisition of Company X shares by the Trust be assessable income of the Trust?

Answer

No

Question B2

Will contributions by Company X to the Trustee to fund the acquisition of Company X shares and/or the expenses of operating the Trust be treated as a deemed dividend within the meaning of Division 7A of ITAA 1936?

Answer

No

Question B3

When as a result of a participant's Rights converting to shares under the Plan, the Trustee allocates shares to a participant under the Plan; will a capital gain or capital loss arise for the Trustee or participant?

Answer

No, provided the participant acquires the shares for the same or less than the cost base of the shares in the hands of the Trustee.

Question B4

When the Trustee sells shares to a third party, being shares that were previously allocated to a participant under the Plan, will a capital gain or capital loss arise for the Trustee?

Answer

No

Question B5

When the Trustee transfers registered ownership of shares to a participant previously allocated the shares under the Plan, will a capital gain or capital loss arise for the Trustee or the participant?

Answer

No

Question B6

If the Trustee receives and accumulates dividends on unallocated shares held in the Trust:

a. Will the dividend and any franking credit be taxable to the Trustee or can the Trustee choose to be taxed on the dividend?; and

b. If so, will the Trustee be entitled to a tax offset for any franking credits attaching to the dividend?

Answer

a. Yes, the dividend and attached franking credit will be included in the assessable income of the Trust and the Trustee will be assessed on that income under section 99A of the ITAA 1936.

a. Yes, provided the Trustee holds the shares at risk for a continuous period of at least 45 days during the period beginning the day after the Trustee acquires the shares and ending 45 days after the shares become ex-dividend.

Question B7

If the Trustee receives a dividend on Allocated Shares held for a participant in the Trust during an income year, and applies Trust property representing it for the benefit of the participant by the end of the income year:

a. Will the dividend and any franking credit be included in the participant's assessable income?; and

b. Will the participant be entitled to a tax offset for any franking credit attaching to the dividend?

Answer

a. Yes

b. Yes, provided the participant holds its interest in those shares at risk for a continuous period of at least 45 days, during the period beginning the day after the participant acquires its interest in the shares and ending 45 days after the shares become ex-dividend.

Question B8

Will contributions by Company X to the Trustee to fund the acquisition of Company X shares be included in the Employee's assessable income?

Answer

No

Question B9

When shares acquired at the time of an Initial Public Offering before the Vesting Date are forfeited in the event of cessation of employment before the Vesting Date:

a. Will an amount be included in the participant's assessable income under Subdivision 83A-C of Income Tax Assessment Act 1997 ('ITAA 1997'); and

b. Will a capital gain or capital loss arise for the participant?

Answer

a. No

b. No, provided the participant receives no consideration for the forfeiture of shares and no consideration was paid by the participant to acquire the shares.

Question B10

If Performance Rights are converted to shares:

a. Is the first time the Employee will be taxed as a result of being granted Performance Rights the earliest of the following three times ('earliest time'):

• the time when the Employee ceases employment,

• 15 years after acquiring the Performance Rights, or

• expiry of any forfeiture restriction and the ESOP sale restriction,

or the time of disposal of the shares if that occurs within 30 days after that earliest time?

b. Will the amount then included in the Employee's assessable income be the market value of the shares at that time?

c. If the shares are disposed of by the Employee 30 days or more after that earliest time, in calculating any capital gain or loss, will the Employee's cost base include the amount that had thus previously been included in the Employee's assessable income?

Answer

a. Yes

b. Yes

c. Yes

Question B11

If the Employee's Performance Rights are redeemed for cash, will the amount of the payment be included in the Employee's assessable income at the time of the payment?

Answer

Yes

This ruling applies for the following periods:

From 1 June 2014 to 30 June 2019

The scheme commences on:

1 June 2014

Relevant facts and circumstances

Background

1. Company X is an Australian resident private company.

2. Fundamental to Company X's growth strategy is the implementation of the Employee Share Ownership Plan ('Plan'). The Plan seeks to align the interests of key employees with Company X's interests and allows the employees the opportunity to have a stake in a specific number of Company X shares.

3. Company X has established the Plan in accordance with governing rules ('Plan Rules').

4. Company X also established the Employee Share Trust ('Trust'), to facilitate the award of shares under the Plan to the employees of Company X. The trustee is a wholly-owned subsidiary of Company X. The Trustee is responsible for operating the Plan in accordance with the Trust Deed.

5. Company X has Y number of employees and a number of Company X employees were granted performance rights.

6. The Employee is an employee of Company X.

a. The performance rights are provided to the Employee above and beyond the terms of their employment contract, and are not in substitution for any pre-agreed remuneration.

b. The Employee does not own or control more than 10% of Company X's shares.

7. A further offer is being made by Company X around the time of lodgement of this ruling application. It is anticipated that further offers will thereafter be made annually.

8. Company X plans to establish a tax consolidated group and will be the head company of the consolidated group. The Trust would retain its own status independent of the group for tax purposes. The Trust will not be absorbed within the tax consolidated group.

Employee Share Ownership Plan (the Plan)

9. The objective of the Plan is to encourage commitment of participating employees and Directors towards the success of the Company X group. The Plan aims to further align the interests of employees with Company X, and increase employee loyalty and productivity as well as company profitability and shareholder returns.

10. The Plan broadly operates as follows:

a. The Board offers eligible employees of the Company X group ('Participants') to participate in the Plan by issuing performance rights or options. It is at the Board's discretion to determine the number and terms of performance rights offered. However this ruling does not consider the circumstance where an Eligibility Condition is included in the terms of Rights granted to a Participant.

b. There is an eligibility criteria intended to be used by the Board of Company X for determining selection of employees eligible under the Plan.

c. On acceptance of offers, performance rights are granted to participants on the grant date specified in the offers.

d. Subject to the performance rights vesting, each performance right gives Participants the right to whichever of the following is selected by the Board at the time the performance rights vest:

(i) One ordinary share in Company X, issued directly to the Participants or to the Trustee to hold on the participants' behalf; or

(ii) Cash equal to the Plan Value of an ordinary share in Company X.

e. No consideration is payable by the Participant to acquire the performance rights or convert them to shares.

f. The vesting conditions are satisfied if the rights have not been forfeited and the Participant remains employed in Company X group at earlier date of:

(i) The vesting date stated in the offer; or

(ii) A Trade Sale, being more than 75% sale of business or equity; and

(iii) Any other conditions specified in the offer have been satisfied

g. After the vesting of Rights, the Board shall resolve either to:

(i) redeem the Rights and cancel them, with the Participant then having the right to be paid the Redemption Price; or

(ii) convert the Rights to Shares, in which the Participant shall have a right to acquire Shares; or

(iii) redeem some of the Rights and convert some of the Rights.

h. If the Board resolves to redeem Rights the Participant will be entitled to payment within a certain period after the Rights vest plus interest.

i. If the Board resolves to convert Rights to Shares the Board shall procure:

(i) the issue or transfer of same number of shares to the Participant; or

(ii) the trustee of the Employee Share Trust to hold the same number of Shares beneficially for the Participant

and subject to any Sale Restrictions.

j. Performance rights can be forfeited if:

(i) Participant ceases employment before the earlier of the vesting date or a trade sale; or

(ii) There is a breach of any other vesting condition; or

(iii) The rights have expired.

k. If the Participant ceases employment in 'special circumstances' then the Board may resolve for the rights to vest, forfeit or be allowed to be held until vesting conditions are satisfied.

l. Shares acquired on the conversion of rights will rank equally with all existing shares for dividends, new issues and any other shareholder distributions or benefits on and from the date of acquisition. However, the shares will be subject to the sale and forfeiture restrictions under the Plan.

m. If an Initial Public Offering ('IPO') of Company X shares occurs before the vesting date, the Board may convert the performance rights to shares around the time of the IPO as it would be easier to achieve the IPO without performance rights being on the register. However the shares would be subject to the sale restrictions.

n. Shares acquired as a result of an IPO would be forfeited if the Participant ceases employment with Company X before the vesting date. The Participant would receive no consideration for the transfer or redemption of their shares as a result of the forfeiture.

Sale Restriction

o. The Participants are restricted from dealing with their performance rights (i.e. selling, mortgaging etc.) other than by redemption or conversion of the rights by the Board under the Plan.

p. The Participants are also restricted from dealing with shares (i.e. selling mortgaging or disposing of any legal or equitable interest etc.).

q. However, the Plan's sale restriction may cease under special circumstances, for example, if the sale is permitted or required by any Shareholder Agreement, or the Board determines it to be appropriate.

r. Within a certain period after the sale restriction ceases to apply, the Board may procure a sale of the shares by the participant as follows:

(i) Transfer of shares by Participant, or Trustee, to a third party; or

(ii) Buy-back and cancellation of shares in accordance with Corporations Act 2001 from Participant or Trustee; or

(iii) Redemption of Participant's beneficial interest in Shares by Trustee.

s. However if the Board decides not to procure a sale, then the Participant may deal with the Shares to the extent permitted by the Shareholder Agreement, Constitution and any applicable law and policies.

The Trust

11. The trust is established for the sole purpose of obtaining shares in Company X and providing beneficial interests in those shares to employees, or associates, of Company X in order to satisfy Company X's obligations under the Plan.

12. The Trust operates as follows:

a. The structure of the Trust and the Plan are such that shares are allocated on vesting of performance rights (or an earlier IPO) and will be held by the Trustee if decided by the Board.

b. Company X provides irretrievable cash contributions to the Trustee to be used in accordance with the Trust Deed and Plan Rules for the sole purpose of subscribing for and/or acquiring Company X shares for the benefit of the participants. Company X will also pay for any costs or expenses incurred in establishing, administering, maintaining or terminating the Trust or the Plan.

c. The funding will be provided by Company X to the Trust if and when the Board resolves to convert Performance Rights to shares.

d. Subsequently, the Trustee utilises the cash contributions paid by Company X to acquire Company X shares for the benefit of participants as directed by the Board of Directors in accordance with the Plan Rules and Trust Deed.

e. Allocated Company X shares are held on a separate fixed trust for the participant who will be the beneficial owner of the shares, and have the same rights, benefits and privileges as if the participant was the legal owner of the shares, subject to restrictions in the Trust Deed and Plan.

f. Any unallocated shares will be held on discretionary trust for all eligible participants.

g. The Participants do not have any entitlement in respect of any contributions made by Company X to the Trustee.

h. The contributions cannot be refunded to Company X or any subsidiary, except in the case of an administrative error.

i. The Trustee will not have the power to provide employees with additional benefits, such as a loan or other financial assistance.

j. In respect of allocated shares, dividends and other shareholder distributions/entitlements would be paid either in aggregate to the Trustee, to be distributed to participants, or directly to the participants by Company X.

k. In respect of unallocated shares, the Trustee can apply any dividends towards paying expenses incurred by the Trustee in the execution of the Trust and/or to acquire further shares to be held for purposes of the Trust.

l. The participant would need the Board's permission to require the Trustee to transfer legal title to the participant.

13. The Trustee is required to act independently of Company X.

Use of a Share Trust to facilitate the Plan

14. The commercial reasons for utilising an employee share trust by Company X include:

a. Administrative convenience, for example, streamlining general meetings, voting etc.

b. Privacy of remunerative arrangements between employees.

c. Help enforce the Plan's sale restriction.

d. Flexibility of cost management, capital management and any other future incentives.

e. Enable Company X to meet legal requirements relating to dealing with its own shares and insider trading under the Corporations Act 2001.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(f)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(ha)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(h)

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 section 97

Income Tax Assessment Act 1936 paragraph 97(1)(a)

Income Tax Assessment Act 1936 subsection 99A(4A)

Income Tax Assessment Act 1936 Division 7A in Part III

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 subsection 109C(1)

Income Tax Assessment Act 1936 section 109ZB

Income Tax Assessment Act 1936 subsection 109ZB(3)

Income Tax Assessment Act 1936 Division 1A of the former Part IIIAA

Income Tax Assessment Act 1936 section 160APHD

Income Tax Assessment Act 1936 section 160APHJ

Income Tax Assessment Act 1936 subsection 160APHJ(2)

Income Tax Assessment Act 1936 subsection 160APHJ(4)

Income Tax Assessment Act 1936 subsection 160APHJ(5)

Income Tax Assessment Act 1936 section 160APHL

Income Tax Assessment Act 1936 subsection 160APHL(10)

Income Tax Assessment Act 1936 subsection 160APHM(2)

Income Tax Assessment Act 1936 section 160APHO

Income Tax Assessment Act 1936 subsection 160APHO(3)

Income Tax Assessment Act 1936 section 160APHU

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177C(1)

Income Tax Assessment Act 1936 section 177CB

Income Tax Assessment Act 1936 subsection 177CB(2)

Income Tax Assessment Act 1936 subsection 177CB(3)

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 20-20

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 subsection 20-20(3)

Income Tax Assessment Act 1997 section 20-30

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 Division 83A

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

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

Income Tax Assessment Act 1997 subparagraph 83A-105(3)(b)(ii)

Income Tax Assessment Act 1997 section 83A-110

Income Tax Assessment Act 1997 subsection 83A-120(5)

Income Tax Assessment Act 1997 section 83A-120

Income Tax Assessment Act 1997 subsection 83A-120(6)

Income Tax Assessment Act 1997 section 83A-125

Income Tax Assessment Act 1997 section 83A-210

Income Tax Assessment Act 1997 section 83A-310

Income Tax Assessment Act 1997 section 83A-315

Income Tax Assessment Act 1997 section 83A-340

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 paragraph 104-35(5)(c)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 104-85

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 paragraph 104-155(5)(c)

Income Tax Assessment Act 1997 section 130-85

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

Income Tax Assessment Act 1997 paragraph 130-85(4)(a)

Income Tax Assessment Act 1997 paragraphs 130-85(4)(b)

Income Tax Assessment Act 1997 paragraph 130-85(4)(c)

Income Tax Assessment Act 1997 section 130-90

Income Tax Assessment Act 1997 subsection 207-35(4)

Income Tax Assessment Act 1997 subsection 207-35(6)

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 subsection 207-50(4)

Income Tax Assessment Act 1997 paragraph 207-150(1)(a)

Income Tax Assessment Act 1997 subsection 960-100

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Regulations 1997 regulation 83A.315.03

Reasons for decision

Questions A1 to A8 apply to Company X

Question A1

Will Company X obtain an income tax deduction in respect of contributions by Company X to the Trustee to fund the acquisition of Company X shares by the Trust?

Summary

Contributions made by Company X to the Trustee in accordance with the Trust Deed and Plan Rules are irretrievable and necessarily incurred in carrying on the business of Company X. There is nothing to indicate that the contributions should otherwise be excluded by subsection 8-1(2) of the ITAA 1997. As such the contributions are deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

The contributions made by Company X to the trustee of the trust will be deductible under section 8-1 of the ITAA 1997 if either of the positive limbs in subsection 8-1(1) are satisfied and none of the negative limbs in subsection 8-1(2) apply.

Subsection 8-1(1) of the ITAA 1997 provides an entitlement to a deduction from assessable income for any loss or outgoing, to the extent that it is incurred in gaining or producing assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. The relevant negative limb is paragraph 8-1(2)(a), which denies a deduction to the extent that the expenditure is capital, or of a capital nature.

Losses or outgoings incurred

Company X provides contributions to the Trustee to be used in accordance with the Trust Deed and Plan Rules for the sole purpose of enabling the Trustee to acquire Company X shares for the benefit of the participants.

A contribution will be incurred when ownership of the contribution passes from an employer to the trustee and the employer cannot retrieve the contribution. The contributions made by Company X to the Trustee are irretrievable as they cannot be refunded, except in the case of an administrative error.

• Therefore the contributions are considered to be losses or outgoings incurred for the purposes of subsection 8-1(1).

Relevant nexus

A sufficient connection must exist between the contributions made to the Trustee and the derivation of assessable income by Company X for a deduction to be available under section 8-1 of the ITAA 1997.

The Commissioner has set out in Draft Taxation Ruling TR 2014/D1 the situations in which a contribution to an Employee Remuneration Trust (ERT) would ordinarily satisfy the nexus of being necessarily incurred in carrying on a business.

TR 2014/D1 applies to ERT arrangements as described in paragraph 9 of that Draft Ruling. We consider that the Plan meets the criteria in paragraph 9 and thus the Draft Ruling applies in this case.

Paragraph 14 of the TR 2014/D1 states that a contribution will satisfy the nexus of being incurred in carrying on a business where:

• The employer engages employees in the ordinary course of carrying on the business; and

• The employer makes a contribution to the trustee of an ERT; and

• The primary purpose of the contribution is for it to be applied, within a relatively short period, to the direct provision of remuneration of employees.

The purpose of the Plan is to provide an incentive to employees linked to the operating performance of the Company X business. The purpose of the contributions is to fund the acquisition of Company X shares by the Trustee to be allocated to employees under the Plan.

It is only when the Board decides the participants' performance rights are to be converted to shares that the irretrievable contributions will be made to the Trustee. At the time of the contributions, Company X will give the Trustee a notice listing the employees for whom the contribution is being made and the number of shares to be acquired in respect of the employee participant.

Therefore it is expected the Trustee would apply the contributions in order to allocate Company X shares to specific employees within a relatively short period after the contributions have been made to the Trustee.

Accordingly, there is a sufficient nexus between Company X's contributions to the Trustee and the derivation of its assessable income.

Capital

However, deductions are not allowable to the extent that the contributions are capital in nature.

TR 2014/D1 sets out the Commissioner's view as to the circumstances in which contributions to an ERT are considered to be capital in nature.

At paragraph 186, the draft ruling states:

A contribution to the trustee of an ERT is of capital or of a capital nature, where the contribution secures for an employer an asset or advantage of an enduring or lasting nature that is independent of year to year benefits that the employer derives from a loyal and contented workforce.

The advantage obtained by the employer, due to the Trustee acquiring a direct interest in the employer, is the enhancement of capital value from the movement of value out of profit to share capital, which is structural and enduring.

However we must also consider the application of the de minimis rule. Where an advantage is only very small or trifling when compared to the arrangement as a whole, then the advantage will not be taken into account for the purposes of determining deductibility under section 8-1 of the ITAA 1997.

Paragraph 202 of TR 2014/D1 states that a capital structure advantage will be considered only small or trifling where the employer:

• Intends that any direct interest acquired by the Trustee will be transferred to Employees within a short period of time; and

• Does not anticipate that the shares will be on-sold to a third party at that time or shortly thereafter.

The employees receive beneficial interests in Company X shares within a short period of time after contributions are made by Company X to the Trust. Once the shares are allocated by the Trustee to employees (or once the vesting date has passed for shares allocated prior to vesting as a result of an IPO), the intended underlying remunerative benefit of providing shares at zero cost to the employees, is provided.

Even if legal title to the shares is retained by the Trustee, the employee acquires absolute interest of the shares and is treated as being the owner of the shares, having substantially the same rights, benefits and privileges as if the employee was the legal owner of the shares. Further the sale restriction ensures that the shares will not be immediately disposed.

As the capital advantage is sufficiently small or trifling when compared to the arrangement as a whole, the Commissioner would not seek to apportion the deduction.

Therefore, Company X would be entitled to a deduction under section 8-1 of the ITAA 1997 for irretrievable cash contributions made by Company X to the Trustee of the Trust to fund the acquisition of Company X shares by the Trust.

Question A2

Is an irretrievable contribution by Company X to the Trustee of the Trust to fund the acquisition of Company X shares by the Trust for allocation to the Employee, deductible to Company X in the income year in which it is made?

Summary

The irretrievable contributions made by Company X will be deductible in the income year in which they are incurred as the contributions are made after the Board resolves to convert existing performance rights to shares.

Detailed reasoning

The deduction for irretrievable contributions under section 8-1 of the ITAA 1997 would generally be allowable in the income year in which Company X incurred the outgoing. However, under certain circumstances, the timing of the deduction is specifically determined under section 83A-210 of the ITAA 1997.

Section 83A-210 of the ITAA 1997 applies if there is a relevant connection between the money provided to the Trustee and the acquisition of ESS interests (directly or indirectly) by the employee under an employee share scheme in relation to the employee's employment.

Section 83A-210 will operate in circumstances where the contribution occurs before the time the beneficiary acquires the ESS interest. In such circumstances section 83A-210 will operate to delay the deduction under section 8-1 until such time as the relevant ESS interest is acquired by the employee.

An ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

The performance rights provided to the participants under the Plan are indeterminate rights as they entitle the participants to acquire either Company X shares or cash equal to the value of an ordinary share in Company X, determined at a future time at the discretion of the company.

Once the Board resolves to convert the performance rights to shares, section 83A-340 of the ITAA 1997 applies and the rights are treated as having always been rights to acquire the beneficial interest in the shares. Therefore, the rights would be deemed to have been ESS interests from the time the performance rights were granted to the participant.

As the contributions by Company X to the Trustee are made after the Board resolves for the participant's existing performance rights to be converted to shares, section 83A-210 will not apply. The contributions will be deductible under section 8-1 of the ITAA 1997 in the income year they are incurred.

Question A3

Will the Commissioner seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Company X for contributions by Company X to the Trustee to fund the acquisition of Company X shares by the Trust?

Summary

Part IVA will not apply as the Commissioner does not consider that any party to the scheme entered into the scheme for the sole or dominant purpose of obtaining a tax benefit.

Detailed reasoning

Part IVA is a general anti-avoidance provision, giving the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would (but for section 177F) have been obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In order for Part IVA to apply, the following requirements must be satisfied:

• there is a scheme to which Part IVA applies;

• a tax benefit was or would (but for subsection 177F(1)) have been obtained;

• the identified tax benefit was or would have been obtained in connection with the identified scheme; and

• the person who entered into or carried out the identified scheme (or any part of the scheme) did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit.

Scheme

A 'scheme' is broadly defined in subsection 177A(1) as:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, and

(b) any scheme plan, proposal, action, course of action or course of conduct.

Under this definition, a scheme can be a series of steps taken together or a single step.

What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person entering into or carrying out the scheme, and the existence of the tax benefit, must both be considered against a comparison with an alternative.

The scheme for the purposes of section 177A(1) of the ITAA 1936 is the establishment of the Plan and the Trust, as well as payments by Company X to the Trustee to fund the acquisition of Company X shares by the Trustee to allocate and hold the shares for the benefit of the participants.

Tax Benefit

Having established the existence of a scheme, Part IVA will only apply if it is determined that a tax benefit was or would have been obtained in connection with that scheme.

Broadly, subsection 177C(1) identifies four types of tax benefits as follows:

• an amount not being included in the taxpayer's assessable income;

• a deduction being allowable to the taxpayer;

• a capital loss being incurred by the taxpayer; and

• a foreign tax credit being allowable to the taxpayer.

In order to determine that a tax benefit has been obtained, it is necessary to compare the tax consequence of the scheme in question with the tax consequences that would have arisen, or might reasonably be expected to have arisen, if the scheme had not been entered into or carried out.

Section 177CB - The bases for identifying tax benefits

For schemes entered into or carried out on or after 16 November 2012 newly enacted section 177CB provides the framework for deciding under section 177C whether any of the following tax effects would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out:

(a) an amount being included in the assessable income of the taxpayer;

(b) the whole or part of a deduction not being allowable to the taxpayer;

(c) the whole or part of a capital loss not being incurred by the taxpayer;

(d) the whole or part of a foreign income tax offset not being allowable to the taxpayer;

(e) the taxpayer being liable to pay withholding tax on an amount.

The 'would have' and 'might reasonably be expected to' limbs of subsection 177C(1) are separate and distinct bases upon which the existence of a tax effect can be demonstrated.

Subsection 177CB(2) confirms that a decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme) (the annihilation approach). In considering such a postulate, the scheme must be assumed never to have happened, that is, it is annihilated, deleted or extinguished to determine the tax effects based on the remaining events or circumstances.

Generally the annihilation approach will be applicable where there are no economic consequences from the scheme other than the tax benefit. The annihilation approach is not appropriate in this case as annihilating the scheme would be inconsistent with the non-tax results and consequences sought by the participants in the scheme.

Subsection 177CB(3) explains that a decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme (the reconstruction approach).

In determining whether such a postulate is a reasonable alternative, particular regard must be had to the substance of the scheme and any result or consequence for the taxpayer that is or would be achieved by the scheme. Any results in relation to the operation of the Act (as defined) that would be achieved by the postulate for any person (whether or not a party to the scheme) must be disregarded.

In order to determine the tax benefit that would be derived by Company X from this scheme, it is necessary to examine what Company X might reasonably have been expected to enter into to achieve its aim in relation to employee remuneration.

If the scheme was not entered into and Company X chooses to issue new shares to the employees, Company X may not receive a tax deduction for this amount. On the other hand, Company X may be entitled to a deduction if it purchased shares for employees on market via a broker, or alternatively remunerated employees directly through cash bonuses.

The applicant has stated that if the scheme had not been entered into, then Company X would have chosen to incentivise its staff using an alternative method which would result in same or similar costs for incentive remuneration, revealing no tax benefit. Nevertheless the analysis below proceeds on the assumption that the Commissioner would in fact be able to identify a relevant tax benefit.

Dominant Purpose

Section 177D provides that Part IVA applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose of:

(a) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or

(b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers.

Subsection (2) states that the following matters be regarded:

(a) The manner in which the scheme was entered into or carried out;

(b) The form and substance of the scheme;

(c) The time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result from the scheme;

(f) Any change in the financial position of any person who has, or has had any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g) Any other consequences for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

The applicant provides various commercial reasons for entering into the scheme (in particular to motivate and reward its employees in an efficient, private and convenient manner). The Trust provides non-tax, commercial benefits to the operation of the Plan that would not be available if Company X provided shares directly to employees.

The scheme does not contain the elements of artificiality or unnecessary complexity and the commercial drivers sufficiently explain entry into the Plan and Trust arrangements.

In light of the commercial objectives of the scheme, and having regard to substance of the scheme and the eight matters listed above, the Commissioner does not consider that any party to the scheme entered into the scheme for the sole or dominant purpose of obtaining a tax benefit.

Question A4

Will Company X obtain an income tax deduction in respect of costs incurred in relation to the implementation and ongoing administration of the Trust in the year in which they are incurred?

Summary

The costs incurred in relation to the implementation and ongoing administration of the Trust are deductible under section 8-1 of the ITAA 1997 as they are part of the ordinary recurring costs to Company X in order to remunerate employees.

Detailed reasoning

As discussed in question A1 above, section 8-1 of the ITAA 1997 provides that a taxpayer can deduct from their assessable income any loss or outgoing to the extent that it is incurred in gaining or producing their assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing their assessable income.

Company X pays expenses incurred in establishing, administering, maintaining and terminating the employee share trust, including brokerage fees, audit fees, bank charges and other ongoing administrative expenses.

These expenses are part of the ordinary employee remuneration costs of Company X and are therefore deductible under section 8-1 of the ITAA 1997 in the year in which they are incurred. This is consistent with the ATO view expressed in ATO ID 2014/42.

Further, the costs are revenue and not capital in nature on the basis that they are regular and recurrent employment expenses. Therefore, the expenses are not excluded from being deductible under paragraph 8-1(2)(a) of the ITAA 1997.

Question A5

Will payments by Company X to participants to redeem Rights be deductible to Company X as 'salary or wages'?

Summary

The payments are deductible under section 8-1 of the ITAA 1997 as they are necessarily incurred in carrying on the business of Company X and there is nothing to indicate that the contributions are otherwise excluded by subsection 8-1(2) of the ITAA 1997.

Detailed reasoning

The performance rights provided to the participants under the Plan are indeterminate rights as they entitle the participants to acquire either Company X shares or cash, determined at a future time at the discretion of the company. If the Board resolves that the participants are to receive cash, then Company X redeems the performance rights and pays participants cash equal to the value of an ordinary share in Company X within a certain period from the date of vesting, along with interest.

ATO ID 2010/142 provides as follows:

Where an employee's indeterminate rights are ultimately satisfied with cash instead of shares, the granting of the rights:

• will be viewed as one of a series of steps in the payment of salary or wages; and

• will not be viewed as a separate benefit to the payment of salary or wages…

Therefore the payments by Company X to participants to redeem rights will be viewed as a payment of salary and wages.

As discussed in question A1 above, section 8-1 of the ITAA 1997 provides that a taxpayer can deduct from their assessable income any loss or outgoing to the extent that it is incurred in gaining or producing their assessable income or it is necessarily incurred in carrying on a business for the purpose of gaining or producing their assessable income.

In this case the payments have been incurred by Company X as part of carrying on their business to produce the assessable income of the business. There is nothing to indicate that the payments are otherwise excluded by subsection 8-1(2) of the ITAA 1997. As such the payments are deductible to Company X under section 8-1 of the ITAA 1997.

Question A6

If the Trustee uses a contribution received from Company X to subscribe for shares in Company X, will the subscription proceeds be included in the assessable income of Company X?

Summary

The subscription proceeds will not be included in the assessable income of Company X as they are:

• considered to be capital in nature and will not be ordinary income under section 6-5 of the ITAA 1997;

• not recoupments under section 20-20 of the ITAA 1997; and

• excluded from being a CGT event by subsections 104-35(5)(c) and 104-155(5)(c) of the ITAA 1997.

Detailed reasoning

Section 6-5 of the ITAA 1997 provides that assessable income includes income according to ordinary concepts, which is called ordinary income. Further, section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income.

Ordinary Income

Income according to ordinary concepts is not defined in the ITAA 1997. However, there is a substantial body of case law which discusses factors which indicate whether an amount has the character of income according to ordinary concepts.

In GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. They further stated at page 138 that:

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.

Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not acquired in carrying on a business.

The character of the subscription proceeds received by Company X from the Trustee can be determined by the character of the right or thing disposed of in exchange for the receipt. In this case, Company X shares were provided to the Trustee in exchange for the proceeds. The character of the shares is capital.

As the character of the shares is capital, it can be concluded that the subscription proceeds take the character of the share and accordingly are also capital in nature. Therefore, the subscription proceeds received by Company X will not be ordinary income under section 6-5 of the ITAA 1997.

Statutory Income

Recoupment

Subsection 20-20(2) of the ITAA 1997 provides that if a taxpayer receives an amount as a recoupment of a loss or outgoing, it will be assessable income if the taxpayer received it by way of insurance or indemnity and that amount can be deducted as a loss or outgoing in the current year or earlier income year.

The subscription proceeds received by Company X for the subscription of shares by the Trustee do not have the character of insurance or indemnity.

Subsection 20-20(3) of the ITAA 1997 makes assessable a recoupment of a loss or outgoing that is deductible, or has been deducted in a previous income year, where the deduction was claimed under a provision in section 20-30 of the ITAA 1997.

The receipt by Company X is made in return for issuing shares to the Trust, not as a recoupment of previously deducted expenditure under section 8-1 regarding bad debts or rates and taxes to which section 20-30 of the ITAA 1997 will apply.

Therefore the subscription proceeds will not be an assessable recoupment under section 20-20 of the ITAA 1997.

Capital Gains Tax

Section 102-20 of the ITAA 1997 states that:

You make a capital gain or loss if and only if a CGT event happens.

The relevant CGT events that may be applicable when the subscription proceeds are received by Company X are CGT events D1 (creating a contractual or other rights) and H2 (receipt for event relating to a CGT asset).

However, both CGT events do not happen if a company issues or allots equity interests or non-equity shares in the company. In this case, Company X is issuing shares, being equity interests as defined in section 974-75 of the ITAA 1997, to the Trustee. Therefore CGT events D1 and H2 do not happen.

As no CGT event occurs, there is no amount that will be assessable as a capital gain to Company X.

Conclusion

Therefore, when the Trustee satisfies its obligations under the Plan by subscribing for shares in Company X, the subscription proceeds will not be included in the assessable income of Company X under section 6-5 or section 20-20, nor trigger a CGT event under Division 104 of the ITAA 1997.

Question A7

Will the provision of Performance Rights and shares to the Employee under the Plan be a fringe benefit within the meaning of the FBTAA?

Summary

The performance rights given to the Employee are indeterminate rights and will be excluded from the definition of a fringe benefit by either paragraph 136(1)(f) or (h) of the FBTAA, depending on whether the rights are ultimately satisfied with cash or shares. The provision of shares will not give rise to a fringe benefit as a benefit has not been provided in respect of the Employee's employment, but rather in respect of the ending of a right under the Plan.

Detailed reasoning

A fringe benefit is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee 'in respect of' the employment of the employee. However, certain benefits are excluded from being a fringe benefit by virtue of paragraphs (f) to (s) of the fringe benefit definition.

Performance Rights

The performance rights provided by Company X to the participants under the Plan are indeterminate rights as they entitle the participants to acquire either Company X shares or cash, determined at a future time at the discretion of the company.

ATO ID 2010/142 provides that:

The grant of indeterminate rights to employees of a company in relation to their employment is excluded from the definition of fringe benefit by paragraph 136(1)(f) or 136(1)(h) of the FBTAA.

…

Although the indeterminate rights are not ESS interests within the meaning of subsection 83A-10(1) of the ITAA 1997 at the time they are granted, where they are ultimately satisfied with shares instead of cash (or when the number of shares the employee is entitled to receive is determined):

• the indeterminate rights will, pursuant to section 83A-340 of the ITAA 1997, be treated as if they had always been ESS interests; and

• as they will constitute the acquisition of ESS interests acquired under an employee share scheme (within the meaning of the ITAA 1997) to which Subdivision 83A-B or Subdivision 83A-C of the ITAA 1997 applies, they will be excluded from the definition of fringe benefit by paragraph 136(1)(h) of the FBTAA.

Alternatively, where an employee's indeterminate rights are ultimately satisfied with cash instead of shares, the granting of the rights:

• will be viewed as one of a series of steps in the payment of salary or wages; and

• will not be viewed as a separate benefit to the payment of salary or wages which are excluded from the definition of fringe benefit by paragraph 136(1)(f) of the FBTAA.

The definition of a fringe benefit in paragraph 136(1)(h) of the FBTAA states that a fringe benefit does not include:

a benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83AB or 83AC of that Act applies.

As stated previously in question A2, an ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

Once the Board resolves to convert the performance rights to shares, section 83A-340 of the ITAA 1997 applies and the rights are treated as having always been rights to acquire the beneficial interest in the shares of Company X. Therefore, the performance rights would be deemed to have been ESS interests from the time they were granted to the participant, and therefore be excluded from the definition of a fringe benefit.

The definition of a fringe benefit in paragraph 136(1)(f) of the FBTAA states that a fringe benefit does not include:

a payment of salary or wages or a payment that would be salary or wages if salary or wages included exempt income for the purposes of the Income Tax Assessment Act 1936;

As stated previously in question A5, payments by Company X to participants to redeem performance rights will be viewed as a payment of salary and wages, and therefore be excluded from the definition of a fringe benefit.

Therefore, the provision of performance rights to the Employee in relation to their employment will be excluded from the definition of fringe benefit by either paragraph 136(1)(f) or (h) of the FBTAA, depending on whether the indeterminate rights are ultimately satisfied with cash or shares.

Shares

As stated above, in general terms, a fringe benefit is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee in respect of the employment of the employee.

The meaning of the phrase 'in respect of' was considered by the Full Federal Court in J & G Knowles & Associates Pty Ltd v Federal Commissioner of Taxation (2000) 96 FCR 402. The court at page 410 said:

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment.

Under the Plan, shares are provided to employees if the Board resolves to convert the performance rights to shares, instead of redeeming them for cash. Therefore, when performance rights are converted to shares, any benefit received by the employee would be in respect of the exercise of existing rights, and not in respect of employment.

Therefore, the provision of shares will not give rise to a fringe benefit as a benefit has not been provided in respect of the employment of the Employee, but rather in respect of the ending of a right under Plan.

Similarly, the Trustee of the EST, as an associate of Company X is a provider to employees of Company X for the purpose of the FBTAA. Under the Plan the Board can direct the Trustee to transfer legal ownership of the shares to the participant. Where the Trustee of the EST provides shares to the Employee the benefit has not been provided in respect of the employment of the Employee, but rather due to their interest in the trust.

Question A8

Will contributions by Company X to the Trustee to fund the acquisition of Company X shares be treated as a fringe benefit within the meaning of the FBTAA?

Summary

As the Trust is an employee share trust, contributions made by Company X to the Trust to fund the acquisition of Company X shares will be excluded from being a fringe benefit.

Detailed reasoning

Under the Plan a right granted to an employee will be an ESS interest as it is a right to acquire a beneficial interest in a share in Company X. This ESS interest is granted under an ESS in relation to the employee's employment. The share acquired by the Trustee of the Employee Share Trust (EST) to satisfy the right granted under the ESS to an employee is in relation to the employee's employment.

The granting of the beneficial interests in the rights, the provision of the money to the Trustee of the EST under the Plan, the acquisition and holding of the shares by the Trustee of the EST and the allocation of shares to the participating employees are all interrelated components of the Plan. All the components of the Plan must be carried out so that the Plan can operate as intended.

In relation to this Plan, at the time of each contribution, the Board will provide the Trustee a notice listing the Company X's employees for whom the contribution is being made, i.e. the portion of the contribution and the applicable number of shares to be acquired in respect of each employee. Therefore the contributions made by Company X to the Trustee will be made in respect of a particular employee, as the Board will know prior to making the contribution which particular employee will benefit from the contribution. Such a contribution will be a fringe benefit unless it is specifically excluded by the definition of fringe benefit in subsection 136(1) of the FBTAA.

The definition of a fringe benefit in paragraph 136(1)(ha) of the FBTAA states that a fringe benefit does not include:

a benefit constituted by the acquisition of money or property by an employee share trust (within the meaning of the Income Tax Assessment Act 1997)

An 'employee share trust' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

Subsection 130-85(4) of the ITAA 1997 provides that an employee share trust for an 'employee share scheme' 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.

As stated previously, once the Board of Company X resolves to convert the performance rights to shares, section 83A-340 of the ITAA 1997 applies and the rights are treated as having been ESS interests from the time the performance rights were granted to the employees.

Thus the Plan is an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which performance rights and ultimately shares are provided to eligible employees in relation to the employee's employment.

Under the Plan, Company X has established the Trust for the sole purpose of the Trustee acquiring shares in Company X and allocating those shares to employees. Therefore, paragraphs 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

• the Trust acquires shares in Company X; and

• the Trust ensures that the ESS interests, being beneficial interests in Company X shares, are provided under an employee share scheme by allocating those shares to the employees in accordance with the Trust Deed and relevant Plan Rules.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will also require that the Trustee undertake incidental activities that are a function of managing the employee share plan and administering the Trust.

ATO ID 2010/108 explains that the activities which are considered to be merely incidental (in accordance with paragraph 130-85(4)(c) of the ITAA 1997) include:

• the opening and operating of a bank account to facilitate the receipt and payment of money;

• the receipt of dividends in respect of shares held by the trust on behalf of an employee, and their distribution to an employee;

• the receipt of dividends in respect of unallocated shares and using those dividends to acquire additional shares for the purposes of the employee share scheme;

• dealing with shares forfeited under an employee share scheme including the sale of forfeited shares and using the proceeds of sale for the purpose of the employee share scheme;

• the transfer of shares to employee beneficiaries or the sale of shares on behalf of an employee beneficiary and the transfer to the employee of the net proceeds of the sale of those shares;

• the payment or transfer of trust income and property to the default beneficiary on the winding up of the trust where there are no employee beneficiaries; and

• receiving and immediately distributing shares under a demerger.

The provisions of the Plan Rules and Trust Deed collectively make it clear that the Trustee can only use the contributions for the acquisition of shares for eligible employees in accordance with the Plan. Further the Trust Deed states that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of subsection 130-85(4) of the Income Tax Assessment Act 1997.

Therefore, the Trust is an employee share trust as the activities of the trust involve acquiring shares and allocating beneficial interests in those shares to employees. Its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997.

As such, paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes the contributions to the Trustee to fund the acquisition of Company X shares from being a fringe benefit.

Questions B1 to B9 apply to the Trustee & the Employee

Question B1

Will the contributions by Company X to the Trustee to fund the acquisition of Company X shares by the Trust be assessable income of the Trust?

Summary

Irretrievable cash contributions by Company X to the Trustee to fund the acquisition of Company X shares by the Trust will not be assessable income of the trust.

Detailed reasoning

Section 95 of the ITAA 1936 defines the 'net income of the trust estate' as the total assessable income of the trust, calculated as if the trust were a taxpayer in respect of that income, less all allowable deductions.

As stated in question A6, assessable income includes both ordinary and statutory income.

None of the provisions listed in section 10-5 of the ITAA 1997 are relevant in this situation and therefore irretrievable contributions will be net income of the trust only if they are income according to ordinary concepts.

Pursuant to the Trust Deed, all contributions by Company X to acquire Company X shares constitute accretions to the corpus of the trust. Contributions received by the Trustee must be used to acquire Company X shares in accordance with the terms of the Trust Deed and the Plan Rules.

Consistent with ATO ID 2002/965, as contributions to the Trustee are used in accordance with the Trust Deed and Plan Rules for the sole purpose of providing shares under the employee share schemes, contributions will constitute capital receipts of the Trustee, and will not be assessable income.

Question B2

Will contributions by Company X to the Trustee to fund the acquisition of Company X shares and/or the expenses of operating the Trust be treated as a deemed dividend within the meaning of Division 7A of ITAA 1936?

Summary

Contributions made by Company X to the Trustee will not be deemed dividends under section 109C of the ITAA 1936, as its operation would be excluded under section 109ZB(3) of the ITAA 1936.

Detailed reasoning

Division 7A of the ITAA 1936 deals with the circumstances under which certain payments made by a private company will be treated as dividends.

Payments treated as dividends

Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity if the private company makes a payment to the entity during the year and either:

• the entity is a shareholder or an associate of the shareholder in the company at the time of the payment; or

• a reasonable person would conclude that the payment was made because the entity has been a shareholder or associate at some time.

An entity is defined in subsection 960-100 of the ITAA 1997 and includes the trustee of a trust.

The contributions made by Company X to the Trustee would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Company X shares at the time the contribution is made. Section 109C of the ITAA 1936 would apply to treat the amount of the contributions to be a deemed dividend, subject to Company X's distributable surplus for the relevant income year.

Exception

However, certain payments made by a private company to an entity are excluded from the operation of section 109C of the ITAA 1936.

Section 109ZB(3) of the ITAA 1936 provides that Division 7A does not apply to a payment made to a shareholder, or shareholder's associate, in their capacity as an employee or an associate of an employee.

Subsection 109ZB(3) of the ITAA 1936 appears within a provision designed to set an 'ordering' between Division 7A and the fringe benefits tax provisions in the FBTAA. Specifically, what is meant by 'an employee' for the purpose of this provision takes on the meaning it is given in the FBTAA. In considering benefits provided to employees or associates of employees in the context of that Act (specifically, in the definition of a 'fringe benefit'), Edmonds J in Indooroopilly concluded that the reference to an employee is a reference to a particular employee.

The Trustee is an associate of any Company X employee who is a beneficiary of the trust. Contributions are made by Company X to the Trustee once the Board resolves to provide a particular participant a share. At the time of each contribution, the Board will provide the Trustee a notice listing the Company X's employees, for whom the contribution is being made, i.e. the portion of the contribution and the applicable number of shares to be acquired in respect of each employee. As the contribution would be made to the Trustee in respect of a particular Company X employee, they would satisfy section 109ZB of the ITAA 1936.

Therefore, the contributions made by Company X to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936, as its operation would be excluded under section 109ZB of the ITAA 1936.

Question B3

When as a result of a participant's Rights converting to shares under the Plan, the Trustee allocates shares to a participant under the Plan, will a capital gain or capital loss arise for the Trustee or participant?

Summary

A capital gain or capital loss that arises for the Trustee, or participants, at the time the participants become absolutely entitled to Company X shares, will be disregarded under section 130-90 of the ITAA 1997 if the participants acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee.

Detailed reasoning

Under section 130-90 of the ITAA 1997, any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, will be disregarded to the extent that:

1. it results from a CGT event E5 or E7;

2. the CGT event happens in relation to a share;

3. the beneficiary had acquired a beneficial interest in the share by exercising a right;

4. the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C applied; and

5. the beneficiary did not acquire the beneficial interest in the share for more than its cost base in the hands of the Trust at the time the CGT event happens.

Employee share trust

The term 'employee share trust' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

As discussed in question A8 above, the Trust constitutes an employee share trust under subsection 130-85(4) of the ITAA 1997.

CGT event E5 happens in relation to a share

Under section 104-75 of the ITAA 1997, CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust against the trustee.

Pursuant to section 130-85 of the ITAA 1997, participants who acquire an ESS interest through an employee share trust are deemed to be absolutely entitled to the shares from the time they acquired the ESS interests.

Once the Board resolves to convert the rights to shares, and the trustee allocates the shares to the participants, the participants become absolutely entitled to Company X shares.

Therefore, CGT event E5 happens in relation to Company X shares allocated to participants at the time the participants become absolutely entitled to Company X shares as against the Trustee.

Acquisition of beneficial interest in share

Under Plan Rules, once the Board resolves to convert a participant's right to a share, the participant acquires a beneficial interest in the share. The participant is treated as being the owner of the share, having substantially the same rights, benefits and privileges as if the employee was the legal owner of the share, subject to the sale restrictions under the Plan.

ESS interest to which Subdivision 83A-B or 83A-C applies

Pursuant to subsections 995-1(1) and 83A-10(1) of the ITAA 1997, an ESS interest in a company is a beneficial interest in either a share in the company or a right to acquire a beneficial interest in a share of the company. As discussed in question A2 above, the performance rights are ESS interests.

Under the Plan, ESS interests are provided to participants in relation to their employment. The ESS interests will be acquired at a discount as the participants will acquire the rights for no consideration. Therefore, either subdivision 83A-B or 83A-C will apply to the rights acquired under the Plan.

Acquisition at less than cost base of Employee Share Trust

The participants do not acquire the beneficial interest in the shares for more than the cost base to the Trustee, as the participants pay nothing for converting the rights to shares. Although an exercise price is paid by the participant if an option is exercised to acquire shares, it is assumed that the exercise price will be less than or equal to the cost base to the trustee.

Therefore, section 130-90 of the ITAA 1997 will disregard any capital gain or capital loss made by the Trustee or participant under section 104-75 of the ITAA 1997, if the participant does not acquire their beneficial interest in the Company X share for more than its cost base in the hands of the trust at the time the CGT event E5 happens.

Question B4

When the Trustee sells shares to a third party, being shares that were previously allocated to a participant under the Plan, will a capital gain or capital loss arise for the Trustee?

Summary

The capital gain or capital loss from the trustee selling shares, to which the participant was absolutely entitled, to a third party will arise for the participant, not the Trustee.

Detailed reasoning

Under section 106-50 of the ITAA 1997, once a participant becomes absolutely entitled to a CGT asset as against the trustee of a trust, the asset is treated as being the participant's asset, instead of being an asset of the trust.

Pursuant to section 130-85 of the ITAA 1997, participants who acquire an ESS interest through an employee share trust are deemed to be absolutely entitled to the shares from the time they acquired the ESS interests.

Therefore, from the time the participants are allocated shares, for CGT purposes the shares are treated as being owned by the participants. As such, any capital gain or capital loss from the trustee selling the shares allocated to a participant to a third party will arise for the participant, not the trustee.

Question B5

When the Trustee transfers registered ownership of shares to a participant previously allocated the shares under the Plan, will a capital gain or capital loss arise for the Trustee or the participant?

Summary

No capital gain or capital loss will arise for the Trustee or the participant as there is no change in ownership for CGT purposes.

Detailed reasoning

Under section 104-85 of the ITAA 1997, CGT event E7 happens if the trustee disposes of a CGT asset of the trust to the beneficiary in satisfaction of the beneficiary's interest in the trust capital.

Subsection 104-10(2) of the ITAA 1997 states that a CGT asset is disposed if a change of ownership occurs from one entity to another.

As discussed in question B4 above, from the time the participants are allocated shares, they are deemed to be absolutely entitled to the shares and the shares are treated as being owned by the participants.

At the time the trustee transfers the registered ownership of shares to the participant, for CGT purposes, the shares are already treated as being owned by that participant. Therefore, there is no disposal of a CGT asset as there is no change in ownership for CGT purposes. Therefore CGT event E7 does not occur.

Question B6

If the Trustee receives and accumulates dividends on unallocated shares held in the Trust:

a. Will the dividend and any franking credit be taxable to the Trustee or can the Trustee choose to be taxed on the dividend?; and

b. If so, will the Trustee be entitled to a tax offset for any franking credits attaching to the dividend?

Summary

If the Trustee chooses to accumulate dividends on unallocated shares, instead of allocating the dividends for the benefit of eligible employees and distributing that income to the eligible employee, then the Trustee will pay tax on the dividend income. The franking credit attached those dividends will be included in the assessable income of the trust.

The Trustee will be entitled to a tax offset for any franking credits attached to dividends received on unallocated shares and accumulated in the Trust, provided the Trustee holds the shares at risk for a continuous period of at least 45 days during the qualification period.

Detailed reasoning

(a) Tax liability in relation to accumulated dividends and franking credits attached to unallocated shares

The net income of the trust is defined in section 95 of the ITAA 1936 to be the total assessable income of the trust estate calculated under Division 6 of the ITAA 1936 as if the trustee were a taxpayer in respect of that income, less all allowable deductions.

Subsection 44(1) of the ITAA 1936 includes in the assessable income of a resident shareholder dividends that are paid to the shareholder by the company out of profits derived by it from any source. Therefore the dividends would be included in the Trustee's calculation of its net income for a year of income under section 95 of the ITAA 1936.

Under section 97 of the ITAA 1936, the beneficiary of a trust, who is not under any legal disability, is assessed on its share of the net income of the trust estate to which it is presently entitled to.

The Trust Deed provides that each participant is presently entitled to so much of the net income of the trust which is attributable to that participant's allocated shares.

The Trust Deed provides that the participant has no legal or beneficial interest in unallocated shares. The participants would only be deemed to be presently entitled to franked distributions on unallocated shares if the Trustee allocates those distributions to the participants.

However, if the trustee does not allocate the distributions on unallocated shares to participants, then the distributions would be accumulated as an accretion to the Trust Fund.

When there is a part of the net income of a resident trust estate that is not included in the assessable income of a beneficiary of the trust estate in accordance with section 97 of the ITAA 1936, the trustee shall be assessed and is liable to pay tax on that part of the net income of the trust estate.

Therefore, if the Trustee chooses to accumulate dividends on unallocated shares, instead of allocating the dividends for the benefit of eligible employees, the Trustee will be liable to pay tax on those dividends as the participants would not be presently entitled to those dividends.

Further, in accordance with subsection 207-35(6) of the ITAA 1997 the Trustee will include any franking credits on the distributions attached to unallocated shares, and accumulated in the trust, in its assessable income.

(b) Entitlement to tax offset for franking credits attached to dividends on unallocated shares

Section 207-45 of the ITAA 1997 provides that an entity to whom a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution.

The note to section 207-45 of the ITAA 1997 explains that the entities in the section are the ultimate recipients of the distribution because the distribution does not flow indirectly through them to other entities and are the ultimate taxpayer to acknowledge the tax already paid in respect of the profits underlying the distribution.

Where a franked distribution is made to the Trustee and the Trustee is liable to a share of the trust's net income for that income year under section 99A of the ITAA 1936, a franked distribution is taken to flow indirectly to the trustee.

Where a franked distribution flows indirectly to a taxpayer, paragraph 207-150(1)(a) of the ITAA 1997 will deny a tax offset otherwise provided under section 207-45 of the ITAA 1997 if the taxpayer is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

The former section 160APHO of the ITAA 1936 sets out the definition of a qualified person for the purpose of Division 1A of the former Part IIIAA of the ITAA 1936. Effectively, the Trustee will be a qualified person if they hold shares on which a dividend has been paid for a continuous period of not less than 45 days, during the period beginning the day after the Trustee acquires the shares and ending on the 45^th day after the shares become ex-dividend.

However, under subsection 160APHO(3) of ITAA 1936, days during which an entity has a materially diminished risk are to be excluded. An entity is taken to have a materially diminished risk on a particular day if their net position on that day is less than 30% of the risks and opportunities relating to the shares.

The net position of a taxpayer or fund in relation to shares is calculated by adding the taxpayer's or fund's 'long position' in the shares and 'short position' in the shares. A long position includes shares in relation to themselves with a delta of +1. At the time the Trustee acquires the shares from Company X their net position will be 1.

Under the Plan Rules and Trust Deed, there are no further positions entered into over the shares which would affect the Trustee's net position. Therefore, provided the Trustee holds the shares at risk for the qualification period, the Trustee will be a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936, and be entitled to a tax offset for any franking credits attaching to the dividends on unallocated shares.

Question B7

If the Trustee receives a dividend on Allocated Shares held for a participant in the Trust during an income year, and applies Trust property representing it for the benefit of the participant by the end of the income year:

a. Will the dividend and any franking credit be included in the participant's assessable income?; and

b. Will the participant be entitled to a tax offset for any franking credit attaching to the dividend?

Summary

The participant's assessable income will include the dividends, and any franking credits on the dividends, received by the Trustee which are attributable to the participant's allocated shares.

The participant will be entitled to a tax offset for any franking credits attaching to distributions on shares allocated to them, provided they have held the interest in those shares at risk for a continuous period of at least 45 days, not counting the day of acquisition or disposal.

Detailed reasoning

(a) Tax liability in relation to dividends and franking credits attached to allocated shares

As stated in QB6, the net income of the trust is defined in section 95 of the ITAA 1936 to be the total assessable income of the trust estate calculated under Division 6 of the ITAA 1936 as if the trustee were a taxpayer in respect of that income, less all allowable deductions.

Subsection 44(1) of the ITAA 1936 includes in the assessable income of a resident shareholder dividends that are paid to the shareholder by the company out of profits derived by it from any source. Therefore the dividends would be included in the Trustee's calculation of its net income for a year of income under section 95 of the ITAA 1936.

Under section 97 of the ITAA 1936, the beneficiary of a trust, who is not under any legal disability, is assessed on its share of the net income of the trust estate to which it is presently entitled to.

Pursuant to the Trust Deed, dividends on allocated shares must be held and applied by the Trustee for the benefit of the participant.

The Trust Deed provides that each participant is presently entitled to so much of the net income of the trust which is attributable to that participant's allocated shares.

Therefore the participant's assessable income will include the dividends received by the Trustee which are attributable to the participant's allocated shares. Further, in accordance with subsection 207-35(4) of the ITAA 1997 the participant will include any franking credits on the distributions attached to allocated shares held for their benefit in their assessable income.

(b) Entitlement to tax offset for franking credits attached to dividends on unallocated shares

Section 207-45 of the ITAA 1997 provides that an individual to whom a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution.

Where a franked distribution is made to the Trustee and the beneficiary includes in their assessable income a share of the trust's net income for that income year under paragraph 97(1)(a) of the ITAA 1936, a franked distribution is taken to flow indirectly to the beneficiary.

Where a franked distribution flows indirectly to the participant, paragraph 207-150(1)(a) of the ITAA 1997 will deny a tax offset otherwise provided under section 207-45 of the ITAA 1997 if the participant is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

However, the participant, being a beneficiary of the trust, will only be a qualified person under former Division 1A of Part IIIAA of the ITAA 1936, if the Trustee is also a qualified person in relation to the dividends.

As stated in question B6, the Trustee will be a qualified person in relation to the dividends provided Trustee holds the shares at risk for a continuous period of at least 45 days during the qualification period.

Whether or not the participant is a qualified person in relation to the dividends depends on whether the trust is a widely held trust as defined in former section 160APHD of the ITAA 1936. A widely held trust is defined as a trust that is neither a closely held fixed trust nor a non-fixed trust.

The Trust is a non-widely held trust as it is a non-fixed trust. A beneficiary of a non-widely held trust is a qualified person in relation to the dividend 'if the taxpayer has held that interest at risk, not counting the day of acquisition or disposal, for a continuous period of at least 45 days'.

However, former section 160APHO of ITAA 1936 requires that the shares be held for a continuous period (not counting the day on which the taxpayer acquired the shares or, if the taxpayer has disposed of the shares, the day on which the disposal occurred) of not less than 45 days. Any days where an entity has a materially diminished risk are excluded. An entity is taken to have a materially diminished risk on a particular day if their net position on that day is less than 30% of the risks and opportunities relating to the shares.

As the participant's interest in the share allocated to it is an employee share scheme security, disposal and forfeiture conditions are not considered to be a position for the purpose of former Division 1A and can be disregarded.

Former section 160APHL of the ITAA 1936 calculates the taxpayer's interest in the relevant share using a formula. It also provides that the taxpayer's interest in the relevant shares is a long position with a delta of +1 in relation to itself. For the purpose of subsection 160APHL(10) the additional short position required by this subsection is disregarded because the taxpayer's interest is an employee share scheme security. The taxpayer's net position will be +1 in relation to their interest in the relevant share.

Therefore, the participants will be entitled to a tax offset for any franking credits attaching to distributions on shares allocated to them, provided they have held the interest in those shares at risk for a continuous period of at least 45 days, not counting the day of acquisition or disposal.

Question B8

Will contributions by Company X to the Trustee to fund the acquisition of Company X shares be included in the Employee's assessable income?

Summary

As the contributions made by Company X to the Trustee are as a result of its obligations under the Plan, and not by reason of the services performed by the Employee, the contributions will not be included in the Employee's assessable income.

Detailed reasoning

As stated in question A6, assessable income includes both ordinary and statutory income.

None of the provisions listed in section 10-5 of the ITAA 1997 are relevant in this situation. Therefore, the irretrievable contributions will be included in the Employee's assessable income if they are income according to ordinary concepts.

Paragraph 221 of TR 2014/D1 states as follows:

Contributions that are provided to the trustee of an ERT for the benefit of a particular employee by reason of the services performed by the employee will be assessable to that employee as salary or wages.

Company X makes contributions to the Trustee to fulfil its obligations under the Plan. Under the Trust Deed, Company X has an obligation to make irretrievable contributions to the Trustee once the Board has resolved to provide shares to the participant through the Trust.

Further, the Employee has entered into an employment contract with Company X and is entitled to a base salary and super. The Plan is above and beyond the terms of the Employee's contract, and is not in substitution for any pre-agreed remuneration. The Employee will not forego any part of its remuneration for the contribution.

Therefore as the contributions made by Company X to the Employee are as a result of its obligations under the Plan, and not by reason of the services performed by the Employee, the contributions will not be included in the Employee's assessable income.

Question B9

When shares acquired at the time of an Initial Public Offering before the Vesting Date are forfeited in the event of cessation of employment before the Vesting Date:

a. Will an amount be included in the participant's assessable income under Subdivision 83A-C of the ITAA 1997; and

b. Will a capital gain or capital loss arise for the participant?

Summary

The participant's assessable income will not include any amount under Division 83A of the ITAA 1997 if the shares acquired by the participant at the time of an IPO are forfeited due to the participant ceasing employment before the vesting date.

No capital gain or loss will arise for the participant, provided the participant received no consideration for the forfeiture of shares, and no consideration was paid by the participant to acquire the shares.

Detailed reasoning

(a) Subdivision 83A-C

Division 83A of the ITAA 1997 applies to an ESS interest acquired at a discount under an employee share scheme.

As discussed above, the performance rights are ESS interests, as they are rights to acquire a beneficial interest in a share. The ESS interests are provided to participants under an employee share scheme at a discount, as the participants will acquire the rights for no consideration. Therefore Division 83A applies.

Generally, the discount in relation to the ESS interest is included in an employee's assessable income in the income year in which the interest is acquired. However, under subdivision 83A-C of the ITAA 1997, where there is a real risk of forfeiture, the discount on the ESS interest is included in the employee's assessable income in the income year in which the deferred taxing point occurs.

An ESS interest acquired by an employee is at a real risk of forfeiture if a reasonable person would consider that there is a real risk that the employee may forfeit or lose their ESS interest. This includes the condition where retention of the ESS interest is subject to a minimum term of employment.

Company X shares acquired by participants at the time of an IPO before the vesting date would be forfeited if the participant ceases employment with Company X before the vesting date. Therefore, there is a real risk that the participants would forfeit or lose their beneficial interest in the shares acquired as a result of exercising rights due to an IPO. Hence, subdivision 83A-C will apply.

Section 83A-120 of the ITAA 1997 states that the deferred taxing point of rights to acquire shares is the earliest of the following:

• The time when there are no restrictions on disposing of the right.

• The time when the employment in respect of which the interest is acquired ceases.

• 15 years from the date the right was acquired.

• The time when there are no restrictions on exercising the right and disposing of the share.

The deferred taxing point for performance rights converted to shares as a result of an IPO before the vesting date would be the time when the participant ceases employment.

Pursuant to section 83A-110 of the ITAA 1997, the participant's assessable income for the income year in which they ceased employment, would include the market value of the ESS interest, at that time of cessation, reduced by the cost base of the interest.

However, section 83A-310 of the ITAA 1997 provides that Division 83A of the ITAA 1997 is taken to have never applied in relation to an ESS interest if an individual forfeits the interest and the forfeiture is not the result of:

• A choice made by the individual (other than a choice to cease employment); or

• A condition of the scheme protecting the individual against a fall in the market value of the share.

Therefore the participant's assessable income will not include any amount under Division 83A of the ITAA 1997 if the shares acquired by the participant at the time of an IPO are forfeited due to the participant ceasing employment before the vesting date.

(b) Capital gain or capital loss

The Plan Rules state that if shares acquired at the time of an IPO are forfeited due to cessation of employment before the vesting date then all rights and entitlements, and any beneficial or legal interest, of a Participant under the Plan in respect of the shares shall cease and be of no legal effect

Thus, the forfeiture of shares can result in CGT event C2 happening, as the forfeiture would result in the participant's rights in respect of the shares ending.

However, the participant will receive no consideration for the forfeiture of shares. Provided the participant did not pay any consideration in order to acquire the shares, no capital gain or loss will arise for the participant.

Question B10

If Performance Rights are converted to shares:

a. Is the first time the Employee will be taxed as a result of being granted Performance Rights the earliest of the following three times ('earliest time'):

• the time when the Employee ceases employment,

• 15 years after acquiring the Performance Rights, or

• expiry of any forfeiture restriction and the ESOP sale restriction,

or the time of disposal of the shares if that occurs within 30 days after that earliest time?

b. Will the amount then included in the Employee's assessable income be the market value of the shares at that time?

c. If the shares are disposed of by the Employee 30 days or more after that earliest time, in calculating any capital gain or loss, will the Employee's cost base include the amount that had thus previously been included in the Employee's assessable income?

Summary

The first time the Employee will be taxed as a result of being granted Performance Rights is at the earliest time or the time of disposal of the shares if the disposal occurs within 30 days after the earliest time.

The amount included in the Employee's assessable income will be the market value of the shares at the time the deferred taxing point occurs.

Therefore, the Employee's cost base will include the market value of the share, which had previously been included in the employee's assessable income.

Detailed reasoning

a. Earliest time Employee taxed

As discussed in question A2 above, once the Board resolves to convert the Employee's performance rights to shares, they are deemed to have been ESS interests, being rights to acquire a beneficial interest in a share, from the time the rights were granted to the Employee.

As established in question B9 above, subdivision 83A-C will apply and defer the inclusion of the discount on the performance rights received by the Employee in the Employee's assessable income to the income year in which the deferred taxing point occurs.

Pursuant to section 83A-120 of the ITAA 1997, the deferred taxing point for the performance rights will be the earliest of the following ('earliest time'):

• The time when the Employee ceases employment.

• 15 years from the date the performance rights were acquired.

• The time when there are no restrictions on disposing the right or no restrictions on disposing the share after exercising the right.

However, if the Employee disposes its beneficial interest in the share acquired on vesting of the performance rights within 30 days of one of the earliest time mentioned above, then the deferred taxing point will be the time the share is disposed.

b. Amount included in the Employee's assessable income

Subsection 83A-110(1) of the ITAA 1997 states that the taxpayer's assessable income includes the market value of the ESS interest at the deferred taxing point, reduced by the cost base of the interest. However, section 83A-315 of the ITAA 1997 provides that the market value of the ESS interest can be substituted by an amount specified in the Income Tax Assessment Regulations 1997 (Cth) ('ITAR')

Regulation 83A.315.03 of the ITAR states as follows:

If the lowest amount that must be paid to exercise a right to acquire a beneficial interest in a share is nil or can not be determined, the value of the right on a particular day is the same as the market value of the share on that day.

No consideration is payable by the Participant to convert the performance rights to shares. Therefore, the amount included in the Employee's assessable income will be the market value of the shares at the time the deferred taxing point occurs (as discussed in question B10(a)).

c. Employee's cost base

When calculating a capital gain or loss as a result of the Employee disposing their share 30 days or more after the earliest time mentioned in question B10(b) above, the cost base will include the money paid, or required to be paid, by the Employee at the time of acquisition.

Section 83A-125 of the ITAA 1997 provides that the ESS interest, and the share or right of which it forms part, is taken to have been acquired for its market value (or the amount substituted for market value by the ITAR) immediately after the ESS deferred taxing point.

Therefore, the Employee's cost base will include the market value of the share, which had previously been included in the employee's assessable income.

Question B11

If the Employee's Performance Rights are redeemed for cash, will the amount of the payment be included in the Employee's assessable income at the time of the payment?

Summary

When the Employee's performance rights are redeemed for cash, the amount of payment will be included in the Employee's assessable income at the time of payment.

Detailed reasoning

As discussed in question A5 above, the cash payment by Company X to the Employee to redeem the performance rights will be viewed as a payment of salary and wages. Therefore, the payment will be included in the Employee's assessable income under section 6-5 of the ITAA 1997 at the time of payment.