Edited version of your written advice

Authorisation Number: 1012911962700

Date of advice: 19 November 2015

Ruling

Subject: Employee share scheme - options - forfeiture

Question:

Will you be able to amend your 20XX-XX assessment and 20XX-XX amended assessment to exclude the discount amounts arising due to the granting of employee share scheme options after 1 July 2009 under section 83A-310 of the Income Tax Assessment Act 1997, if you make the choice to forfeit the options?

Answer

No.

This ruling applies for the following period

Income year ending 30 June 20XX

Income year ending 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

You were an employee of Company A and participated in an employee share scheme offered by the company (the Plan).

You were granted a number of options under the Plan during the 20XX-XX income year for no consideration.

Each option entitled the holder to subscribe for one fully paid ordinary share on exercise of the option.

There was a specified exercise price for each option.

The options were divided into three tranches with each tranche subject to a specific share price hurdle as follows:

• On or after the first anniversary of the date of grant, one third of the options may be exercised provided the volume weighted average price of shares traded on the Australian Stock Exchange (ASX) for 20 business days prior to the proposed exercise is above a specified amount

• On or after the second anniversary of the date of grant, one third of the options may be exercised provided the volume weighted average price of shares traded on the Australian Stock Exchange (ASX) for 20 business days prior to the proposed exercise is above a specified amount; and

• On or after the third anniversary of the date of grant, one third of the options may be exercised provided the volume weighted average price of shares traded on the Australian Stock Exchange (ASX) for 20 business days prior to the proposed exercise is above a specified amount.

The options had to be exercised within a specified period of time, and if not exercised by that date, the options would automatically lapse.

The options vested as follows:

Company A informed you that the first tranche of options had vested and advised you of a taxable value.

You lodged your 20XX-XX income tax return and included an employee share scheme (ESS) discount amount.

Company A did not inform you that the second tranche of options had vested and no taxable value had been provided to you.

You lodged your 20XX-XX income tax return and did not include any ESS discount amount.

An audit was conducted by the Australian Taxation Office (ATO) on your 20XX-XX assessment and as a result of the audit an ESS discount amount was included in your 20XX-XX assessment.

The share price for Company A's shares had shot up and had then gone down in price and you had decided not to exercise the options and had let them lapse.

You ceased employment with Company A during the 20XX-XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-105

Income Tax Assessment Act 1997 Section 83A-110

Income Tax Assessment Act 1997 Section 83A-120

Income Tax Assessment Act 1997 Section 83A-310

Reasons for decision

Assessable income

The income tax provisions apply to all components of an individual taxpayer's remuneration package; however, there are some differences in the tax treatment depending on the form that the remuneration is paid (which might be salary or wages, non-cash benefits or superannuation).

There is specific 'employee share scheme' legislation for grants of shares and options to acquire shares to reflect the dual nature of such grants. There were major re-writes to this legislation with effect from 28 March 1995, 1 July 2009 and 1 July 2015.

The employee share scheme (ESS) provisions are used to determine when the employment aspect of a grant of shares (or options to acquire shares) should be considered to end and the investment aspect commence.

The mechanism used by the ESS provisions to achieve this outcome is based on three principles:

1. Determine an appropriate point in time to treat the grant as being earned for remuneration purposes

2. Calculate an amount as the value of the discount received that represents remuneration and include it as assessable income, and

3. Modify the capital gains tax provisions to avoid double taxation

The 'appropriate point in time' is intended to represent a compromise between:

• The grant of share or options as remuneration

• The employee's ability to exploit their ownership of the shares or options (including sell them or transfer them to associates), and

• The need to counter arrangements that attempt to manipulate the taxing point.

The effect of this process for an individual is the equivalent of them receiving a cash amount at the 'taxing point' (which is assessable to them) and then using that cash amount to purchase the shares or options to acquire shares for their market value, as, an investment.

Note: For ESS purposes, you are not considered to have paid for the ESS options or shares if you receive them in place of cash entitlements (including bonuses).

ESS - deferred taxing schemes

An ESS is a scheme under which ESS interests in a company are provided to employees (including past or prospective employees of a company, or their associates, in relation to their employment. An ESS interest is a beneficial interest in a share in a company or an option to acquire a beneficial interest in a share in a company.

If an employee acquires ESS interests under a tax-deferred scheme, and certain conditions are satisfied, the ESS discount arising in relation to the ESS interests will be calculated at the deferred taxing point and the employee will be assessed on the discount in the income year in which the deferred taxing point occurs.

The discount amount in situations where the employee receives ESS interests under a tax-deferred scheme will be the market value of the ESS interests at the deferred taxing point, reduced by the cost base of the ESS interests.

Forfeiture of ESS

There are limited instances where the ESS provisions will allow the ESS discount to be removed once the ESS interests have moved onto the investment phase.

For grants between 1 July 2009 and 30 June 2015, your liability to tax in respect of ESS shares is only removed where:

• an amount would otherwise be included in your assessable income under the ESS provisions; and

• the forfeiture is not the result of:

• a choice made by you (other than a choice to cease employment); or

• a condition of the scheme that protect you from a fall in the market value of the shares.

Under such circumstances, the forfeited ESS interest is treated as never having been acquired, and the taxpayer can claim a refund of income tax be seeking an amendment of their income tax assessment to remove the income previously included in their assessable income. There is no time limit on amending an assessment to exclude an amount from a taxpayer's assessable income for an ESS option which is lost without being exercised.

As the refund provisions are not intended to protect the employee from downside market risk, a refund will not be available where the employee allows the option to lapse if they have met the conditions that permit them to exercise it.

A participant's option would be lost or forfeited for ESS purposes once it has expired unexercised.

Application to your case

In your case, you were granted options by Company A during the 20XX-XX income year. These options provide you with the right to acquire Company A shares, so the ESS provisions apply to them.

It is viewed that the ESS options were granted to you as a form of remuneration in relation to your employment with Company A.

The information you have provided indicates that the options were granted under an ESS that is a deferral scheme. As the ESS under which you were granted the options was a deferred-taxing point scheme, the discount arising in relation to your ESS options needed to be included in the income years in which the deferred taxing points occurred in relation to each tranche of options.

The deferred taxing points in relation to the first and second tranches of the options occurred in the 20XX-XX and 20XX-XX income years.

You had included an ESS discount amount in relation to the first tranche in your 20XX-XX tax return, and an ESS discount amount had been included in your 20XX-XX amended assessment in relation to the second tranche as a result of the ATO audit.

In accordance with the Plan, the options granted to you had to be exercised within a specified period of time (the specified period) from the date they were granted and any options not exercised by that date would automatically lapse. The end of that specified period occurred during the 20XX-XX income year. This meant that in relation to the first two tranches you had from the date the options vested until the end of the specified period to exercise the options.

The share price of Company A's shares had fluctuated and you had made the choice not to exercise the options prior to them lapsing.

As outlined above, refunds of the tax paid on ESS interests are available if they are later forfeited where the taxpayer had no choice but to forfeit the ESS interests, or where the taxpayer made the choice to resign from employment. However, refunds are not available when the taxpayer chooses not to exercise ESS options because the exercise price exceeds the prevailing share price, or the value of the shares has decreased.

You ceased employment with Company A during the 20XX-XX income year after the specified period, which is after the specified period for the automatic lapsing would have occurred. Therefore, this is not a factor that is relevant to determining whether the forfeiture provision allows a refund in your situation.

Accordingly, as you were entitled to exercise the options from the date they were vested to you, but had made the choice not to exercise the options, the refund provisions will not apply. Therefore, the ESS discount amounts included in the 20XX-XX and 20XX-XX income years cannot be removed.

Note: The capital gains tax provisions apply to the investment aspect of the options. The cost base and reduced cost base of the options is equal to their market value at the ESS taxing point. Generally, the capital proceeds are $nil for options that expire.