Edited version of your written advice

Authorisation Number: 1013015608039

Date of advice: 3 June 2016

Ruling

Subject: Employee Share Scheme

Question 1

Will contributions of funds by the Employer to the Trustee to fund its employee share plans be assessable income of Employee Share Scheme Trust ('the Trust') pursuant to sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 ('ITAA 1997'), or Division 6 of the Income Tax Assessment Act 1936 ('ITAA 1936') or any other provisions of the ITAA 1997 or ITAA 1936?

Answer

No.

Question 2

At the time the employee becomes absolutely entitled to the shares acquired upon exercise of his/her rights to acquire shares; will any capital gain derived by the Trustee be disregarded in accordance with Subdivision 130-D of the ITAA 1997?

Answer

Yes. Provided the Participant 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 Participant becomes absolutely entitled to the share.

This ruling applies for the following period<s>:

Year ended 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Employer is an Australian listed company, which is engaged in developing and selling residential land. Its operations also include the development, construction and sale of house and land packages.

The Employer has established two employee share plans, the Option Plan and the Executive Long Term Incentive Plan, collectively the Employee Share Schemes (the 'Plan').

The Employee Share Schemes ('the Plan')

Under the Option Plan, senior executives are provided with options (being a right to acquire shares in the future at an agreed exercise price) subject to vesting conditions.

Under the Executive Long Term Incentive Plan, senior executives are provided with performance rights (being a right to acquire shares in the future at no cost) subject to vesting conditions.

The Plan, with the participation of the Trustee, will at all times be operated in accordance with the requirements of Division 83A of the ITAA 1997.

Employee share scheme trust ('the Trust')

In order to facilitate the Plan, the Employer has established the Employee Share Scheme Trust ('the Trust') by way of a declaration of trust by the Trustee on a specific date. Parties to the Employee Share Scheme Trust Deed ('the Trust Deed') are the Employer and the Trustee.

The stated purpose of the Trust is to obtain ordinary shares of the Employer for the benefit of participating senior executives, through which it subscribes for, acquires, allocates, holds and delivers shares in the Employer under the Plan. The Trust also intends to facilitate the requirements of any future equity plans to be implemented by the Employer. Pursuant to clause 4.2 of the Trust Deed, the Trust must, at all times, be managed and administered so as to satisfy the Sole Activities Test and the definition of 'employee share trust' for the purposes of section 130-85(4) of the ITAA 1997.

Use of an Employee Share Trust to facilitate the Plan

The Employer provides the following reasons for implementing the Plan by way of the Trust:

• the Trust provides employees with the knowledge that the shares, and any incidental dividend income or associated rights, are held independently of the Employer and the trustee has a fiduciary obligation to act in the interests of its beneficiaries, i.e. The employees;

• the Trust can enable the shares to be acquired progressively over time either on-market or by subscription;

• The Employer can manage its costs and share capital position by having the Trust acquire shares to hold on executives' behalf for a period of time, before the executives meet the vesting criteria and become entitled to the shares. If the executives do not meet the vesting criteria, the Trust can reallocate the shares to back future grants;

• the Trust provides the opportunity to improve cash flow planning as the Employer can make contributions to the Trust periodically throughout the vesting period, thus giving the Employer the flexibility to determine the most appropriate time to make contributions;

• the Trust is the most appropriate vehicle to be used to acquire shares and accumulate dividend income during the vesting period for the purpose of acquiring further shares, meeting the costs of the plan or distributing dividends to employees;

• the Trust enables easier administration of the Employee Share Schemes.

• the Trust provides the flexibility that the Employer requires for its capital management and cash flow purposes including the ability for shares to be acquired progressively for employees over the vesting period;

• the Trust provides the opportunity to distribute dividends to employees (including those who hold rights to acquire shares that will not vest until future years); and

• the current Plan proposal gives the Trustee the alternative of receiving funds from the Employer and subscribing for shares, or purchasing the shares on market, as well as distributing dividends to beneficiaries prior to the rights vesting

Operation of the Trust

The Trust broadly operates as follows:

• The Trust is funded by cash contributions from the Employer to be used for the purchase of shares in accordance with the Trust Deed, the relevant Plan Rules and/or the relevant Terms of Participation, such that shares can be provided to employees of the Employer in satisfaction of any share or right grant (Clause 6.7 of the Trust Deed).

• These funds will be used by the Trustee to acquire shares in the Employer either on-market or via a subscription for new shares in the Employer (Clause 4.1.2 of the Trust Deed), based on written instructions from the Employer (Clause 6.1 of the Trust Deed).

• The structure of the Trust and the Plan are such that shares allocated on exercise of Options or Performance Rights post vesting will be held by the Trustee. At the direction of the Participant, the shares may be sold by the Trustee or transferred into the name of the Participant (Clause 12 of the Trust Deed).

• The Trustee shall hold all the shares acquired on capital account, and be registered as the legal owner of the shares at any time.

• Clause 3.2.1 of the Trust Deed states that each Participant will be absolutely entitled to shares held by the Trustee from the time the Trustee allocates shares on their behalf as a result of the Participant exercising their Options or Performance Rights.

• Pursuant to clause 4.1 of the Trust Deed, the Trustee has all powers that are legally permissible for the Trustee to exercise, including the power to establish and/or support the employee share plan. Further, the Trustee can exercise its discretion to distribute any capital receipts, dividends, distributions or other entitlements received in respect of any shares to beneficiaries of the Trust.

• The Trust Deed limits the Trustee to be bound by any applicable law with respect to the offer, issue or acquisition of any share or any right to any share (Clause 4.4 of Trust Deed). Similarly, the Trustee is not permitted to carry out activities which are not necessary to maintaining the Trust for its sole purpose.

• Clause 4.2 of the Trust Deed provides that the Trust be managed so that it satisfies the legislated sole activity test. Recital B to the Trust Deed also states that the Employer wishes to establish a trust for the sole purpose of obtaining shares for the benefit of Participants.

• Clause 4.5 of the Trust Deed allows for separate cash contributions to be made by the Employer to the Trustee for the purpose of remuneration.

• Clause 12.1 of the Trust Deed provides for the sale of Shares held by the Trustee on behalf of Participants. From the proceeds of sale paid to the Participant, sale costs will first be applied. Clause 12.2 provides for the transfer of Shares to a Participant when required to do so under the Plan, if the Trust is terminated or at the Board's discretion.

Contributions to the Trust

The Employer submitted that it would make initial contributions to the Trust commencing in 20YY, with the expectation that the first potential vesting of ESS interests will occur later that year.

In respect of the potential vesting in 20YY and subsequent years, the Employer submitted that it would make further contributions to the Trust prior to the vesting date to ensure an appropriate number of shares are held to satisfy the exercise of the respective rights. Additional options and performance rights granted under the Plan will also vest in future years.

Should further contributions be required, the Employer will assess such need in accordance with the Trust Deed and the protocols (applied by the Board to the Trust for the acquisition of the shares using past and future contributions by the Employer), as follows:

• the Trust may acquire the Employer's shares as deemed appropriate and necessary by the management of the Employer;

• funds are then transferred to the Trust to enable it to acquire the Employer's shares;

• the amount of funds transferred will be determined based on an estimated forecast following a review of the quantum of outstanding unvested options and performance rights, together with consideration of the likelihood of rights vesting to determine if the Trust holds sufficient shares to satisfy the future potential vesting of rights;

• the management of the Employer will review these forecasts and provide recommendations to the Board periodically;

• the Board will provide its instructions to the Trustee on how the Trustee should acquire the shares whether by way of on market purchase or subscription (Clause 6.1 of the Trust Deed);

• The Trustee will then consider the Board's instructions and having regard to its broader obligations under the Trust Deed and under trust law will then act accordingly;

• If that course of action includes subscription then the Employer must issue to the Trustee the requisite number of Shares on behalf of the Participants;

• To ensure these contributions are timely, the CEO, and any nominees of the CEO, have the authority to approve contributions to the Trust

The amount of the contributions made by the Employer to the Trust will also depend on:

• the number of rights granted to employees;

• the estimated forecast of options and performance rights vesting; and

• the number of shares held at that time by the Trustee.

Both the initial contributions and any additional contributions required to fund the Trust, cannot be refunded, repaid or returned to the Employer or Participants (other than by way of the Trustee paying the issue price where it subscribes for shares in the Employer).

Beneficiaries of the Trust

Under clause 3.7 of the Trust Deed, the Employer has no legal or beneficial entitlement to any of its shares forming part of the Trust fund at any time, and may not acquire such an interest. Instead, the beneficiaries of the Trust are ESS Plan Participants. The Trust was established and maintained for the benefit of all employees of the Employer tax consolidated group.

Corpus and income of the Trust

Employees will have no beneficial entitlement to the shares (corpus) or the income of the Trust at any time, unless the Trustee exercises its discretion to distribute its corpus or income, under the terms of the Trust Deed and in fulfilment of the Trustee's fiduciary duty to beneficiaries.

Pursuant to clauses 8.1 and 9.1 of the Trust Deed, should the interest or dividend income derived from the holding of shares be in excess of the costs of the Trust, the excess may be used to acquire more shares to deliver to employees or may be distributed to employees who have become beneficially entitled to the income. To the extent that there is no one presently entitled to the income of the Trust, the Trustee will pay tax on this income.

Assumption

This ruling is provided on the assumption that all the rights provided under the scheme can only be settled by the provision of shares. As the rights cannot be settled in cash, they are not indeterminate rights under section 83A-340 of ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5,

Income Tax Assessment Act 1997 Section 6-10,

Income Tax Assessment Act 1997 Section 10-5,

Income Tax Assessment Act 1997 Subdivision 83A-B,

Income Tax Assessment Act 1997 Subdivision 83A-C,

Income Tax Assessment Act 1997 Section 83A-10,

Income Tax Assessment Act 1997 Section 83A-20,

Income Tax Assessment Act 1997 Section 104-75,

Income Tax Assessment Act 1997 Section 104-85,

Income Tax Assessment Act 1997 Subdivision 115-C,

Income Tax Assessment Act 1997 Subdivision 130-D,

Income Tax Assessment Act 1997 Section 130-75,

Income Tax Assessment Act 1997 Section 130-85,

Income Tax Assessment Act 1997 Section 130-90,

Income Tax Assessment Act 1997 Section 995,

Income Tax Assessment Act 1936 Part III of Division 6 and

Income Tax Assessment Act 1936 Section 95.

Reasons for decision

Question 1

Summary

The contributions of the funds by the Employer to the Trustee will not be assessable income of the Trust pursuant to sections 6-5 or 6-10 of the ITAA 1997, and Division 6 of the ITAA 1936.

Detailed reasoning

The basic trust assessing provisions are contained in Division 6 in Part III of the ITAA 1936. In general terms, it is the beneficiaries of a trust who are ultimately entitled to receive and retain the income of a trust and are taxable on that income. The trustee is generally taxed on the balance of the net income defined for tax purposes where no beneficiary is presently entitled to the income.

Subsection 95(1) of the ITAA 1936 defines net income of a trust as the total assessable income of the trust calculated as if the trustee were a resident taxpayer in respect of that income, less all allowable deductions.

Subsection 6-5(1) of the ITAA 1997 provides that the assessable income includes income according to ordinary concepts, which is also called ordinary income.

Subsection 6-10(1) of the ITAA 1997 provides that assessable income also includes some amounts that are not ordinary income.

Subsection 6-10(2) of the ITAA 1997 details that amounts that are not ordinary income, but are included in your assessable income by the operation of provisions about assessable income called statutory income provisions.

ATO Interpretive Decision ATO ID 2002/965 - Income Tax - Trustee not assessable on employer contributions made to it under the employer's employee share scheme provides the Commissioner's view on whether the Trustee of an employee share trust will be assessed under sections 6-5 or 6-10 of the ITAA 1997 on contributions made to it by an employer for the purpose of and under the employer's employee share scheme. In the reasons for decision, ATO ID 2002/965 states that when the funds provided to the Trustee are used in accordance with the Trust Deed and the Plan Rules for the sole purpose of and under the employee share scheme, the contributions constitute capital receipts to the Trustee and are not assessable under sections 6-5 or 6-10 of the ITAA 1997.

An employee share trust is defined in subsection 130-85(4) of the ITAA 1997 as 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 ESS interest, in a company, is defined in subsection 83A-10(1) of the ITAA 1997 as either a beneficial interest in a share in the company or the right to acquire a beneficial interest in a share in the company. In this case, the ESS interests are the Options or Performance Rights granted to the Participants of the Plan

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. For the purposes of this subsection, section 995 of the ITAA 1997 defines the term 'scheme' as any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

On the facts, the Employer has established the Trust (under the Trust Deed) to facilitate the Plan by acquiring Shares and allocating those Shares to Participants, in order to satisfy the Options and Performance Rights acquired under the employee share scheme. The right to acquire beneficial interest (Options or Performance Rights to acquire) in the Employer's shares is provided under an employee share scheme to the Participant in relation to the Participant's employment, as defined in subsection 83A-10(2).

Therefore, the Trust is an employee share trust as defined in subsection 995-1(1) of the ITAA 1997, as the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997.

The Trustee also undertakes some incidental activities to operate and administer the Trust, such as clerical and administrative functions. They are however, merely incidental and in accordance with subsection 130-85(4)(c) and ATO Interpretative Decision ATO ID 2010/108 Income Tax - Employee share trust that acquires shares to satisfy rights provided under an employee share scheme and engages in other incidental activities.

The Commissioner is also satisfied that the irretrievable cash contributions made by the Employer to the Trustee are for the sole purpose of procuring the Employer's shares for the benefit of Participants in accordance with the Trust Deed and the Plans. The reasons are:

• Recital B of the Trust Deed provides that the trust was established for the sole purpose of subscribing for or acquiring, allocating, holding and delivering the Employer's shares under the Plans;

• Clause 4.1 of the Trust Deed indicates that the Trust's sole activities are to acquire shares and to hold these shares until they vest in the employee and then transferring them to the employee.

• Clause 4.2 of the Trust Deed provides that the Trust must, at all times, be managed and administered so as to satisfy the Sole Activities Test or the requirements to satisfy the definition of 'employee share trust' for the purposes of section 130-85(4) of the ITAA 1997

• The general powers granted to the Trustee pursuant to clause 4.1 of the Trust Deed are restricted by clause 4.4 which require that these powers must be exercised only for the purposes of the Trust and only to give effect to the Plan which the Trust supports. To this end, the contributions received from the Employer must, therefore, be used for the sole purpose of enabling the Trustee to acquire Shares in accordance with the terms of the Trust Deed and the Plan Rules.

• Clause 6.8 of the Trust Deed provides that all contributions by the Employer to the Trustee constitute accretions to the corpus of the Trust;

Further, the irretrievable cash contributions made by the Employer to the Trust are distinct from those provisions listed in section 10-5 of ITAA 1997, and therefore will not be assessable income under section 6-10.

Consequently, these contributions constitute capital receipts to the Trust and are not assessable under section 6-5 of the ITAA 1997 (ordinary income) or section 6-10 of the ITAA 1997 (statutory income).

Question 2

Summary

A capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to Shares (CGT event E5) or when the Trustee disposes of the Shares to the employees (CGT event E7) will be disregarded under section 130-90 of the ITAA 1997 if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee.

Detailed reasoning

Section 130-90

Section 130-90 of the ITAA 1997 operates to disregard any capital gain or capital loss made by an employee share trust or a beneficiary of the trust where the specified conditions in subsection 130-90(1) are satisfied.

The conditions in subsection 130-90(1) of the ITAA 1997 are that CGT event E5 or E7 happens in relation to a beneficial interest in a share and it was acquired by the beneficiary by exercising a right and the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C of the ITAA 1997 (about employee share schemes) applied.

However subsection 130-90(2) of the ITAA 1997 provides that subsection 130-90(1) of the ITAA 1997 will not apply if the beneficiary acquired the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time the CGT event happens.

Employee share trust

In order for the Trustee to be able to disregard any capital gain or capital loss made under CGT event E5 or E7 under section 130-90 of the ITAA 1997, it is necessary for the Trust to satisfy the definition of an 'employee share trust' as defined in subsection 130-90(1) of ITAA 1997.

As detailed in Question 1, the Trust is an 'employee share trust' under subsection 130-85(4) of the ITAA 1997 and the Plan is an 'employee share scheme' under subsection 83A-10(2) of the ITAA 1997. The Option or Performance Right is an ESS interest under subsection 83A-10(1) of the ITAA 1997 as it is a right to acquire a beneficial interest in the Employer share.

Paragraph 130-90(1)(a)

CGT event E5

Subsection 104-75(1) of the ITAA 1997 provides that CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies), as against the trustee.

Subsection 104-75(3) of the ITAA 1997 provides that the trustee will make a capital gain if the market value of the asset (at the time of the event) is more than its cost base, but will make a capital loss if that market value is less than the asset's reduced cost base.

In determining whether a beneficiary is absolutely entitled to the asset, any legal disability is ignored. In Draft Taxation Ruling TR 2004/D25 - Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 the Commissioner stated his view that the core principle underlying the concept of absolute entitlement in the CGT rules is the ability of a beneficiary who has a vested and indefeasible interest in the entire trust asset to be transferred to them or as they so direct.

Subdivision 130-D of the ITAA 1997 treats an employee who acquires an ESS interest through an employee share trust to be 'absolutely entitled' to the share or right to which the ESS interest relates, from the time that they acquire the ESS interest (subsections 130-85(1) and 130-85(2) of the ITAA 1997).

In the present case, clause 3.2.1 of the Trust Deed provides that each Participant is absolutely entitled to the Trust Shares held by the Trustee on their behalf, all Trust Assets in respect of the Trust Shares and all other benefits and privileges attached to, or resulting from holding, the Trust Shares. However, the operation of this clause is restricted by 3.2.2 of the Trust Deed, in which Trust Shares must be dealt with in accordance with the directions of the relevant Participant, and the terms of the relevant Plans and/or Terms of Participation.

Pursuant to subsection 104-75(3) of the ITAA 1997, where a Participant becomes absolutely entitled to Shares as against the Trustee, CGT event E5 will occur (under the terms of the Plan), and the Trustee will make a capital gain or loss.

CGT event E7

Subsection 104-85(1) of the ITAA 1997 provides that CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital.

Relevantly, clause 12.1 of the Trust Deed deals with sale of Trust Shares by the Trustee. It provides that the Trustee may, at the Participant's direction, sell Trust Shares to which the Participant is entitled. The sale proceeds would be distributed to relevant Participants, after paying any brokerage and expenses of the sale incurred by the Trustee (including tax liability incurred by the Trustee resulting from that sale).

Clause 12.2 of the Trust Deed deals with the transfer of the legal title in Trust Shares. It provides that the Trustee must do all things required by it to transfer legal title in Trust Shares to a Participant on whose behalf Trust Shares are held.

Upon transfer of the legal title in those Trust Shares, in accordance with the relevant Plan rules and the relevant Terms of Participation, CGT event E7 will occur at the time legal title in the shares is transferred to either the Participant, or a third party as directed by the Participant.

Paragraph 130-90(1)(b)

Subsection 995-1(1) of the ITAA 1997 defines a share to mean a share in the capital of a company. A share in the Employer held by the Trustee and to which a Participant is entitled to upon exercising an Option or a Performance Right is a share in the capital of the Employer. Accordingly, paragraph 130-90(1)(b) of the ITAA 1997 is satisfied as CGT event E5 or E7 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) of the ITAA 1997 is satisfied as a Participant will have acquired a beneficial interest in a share in the Employer by exercising an option or performance right granted under the Plan.

Paragraph 130-90(1)(d)

Pursuant to subsection 83A-20(1) of the ITAA 1997, subdivision 83A-B applies to an ESS interest acquired under an employee share scheme at a discount.

As discussed in Question 1, 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997, and the Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest (i.e. a beneficial interest or the right to acquire a beneficial interest in a share in the Employer) is provided to Participants in relation to their employment in the Employer in accordance with the Trust Deed.

The Options and Performance Rights are issued under the Plan at a discount, as they are issued for no consideration and the exercise price will be either nil (Performance Rights) or will not exceed the share price paid by the Trust to acquire those Shares (Options). Shares will be acquired by the Trust under the Plan using contributions from the Employer.

Accordingly, prima facie, Subdivision 83A-B will apply to Options or Performance Rights acquired under the Plan as pursuant to subsection 83A-20(1), the ESS interest (i.e. Options and Performance Rights issued under the Plan) will be acquired under an employee share scheme at a discount.

Whether a Participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B of the ITAA 1997) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C of the ITAA 1997), will depend on which of the additional requirements in Subdivisions 83A-B or 83A-C of the ITAA 1997 have been satisfied. Under either circumstance paragraph 130-90(1)(d) of the ITAA 1997 will be satisfied.

Section 130-90(2)

Question 2 has been framed on the assumption that the Participants will acquire the shares for the same or less than the cost base of the shares in the hands of the Trust.

Given that the Performance Rights and Options will be acquired for nil consideration and will have either no exercise price or one that does not exceed the cost paid by the Trustee it is reasonable for the Commissioner to assume that the Participants will acquire the shares for less than the cost base for the shares in the hands of the Trust.

Provided that the beneficiary does not acquire the beneficial interest in the share for more than its cost base in the hands of the Trust at the time that CGT event E5 or E7 happens, subsection 130-90(2) of the ITAA 1997 is also satisfied.

Conclusion

Accordingly, section 130-90 of the ITAA 1997 operates to disregard a CGT event E5 or E7 capital gain or loss made by the Trustee on the Shares.