Edited version of your written advice

Authorisation Number: 1013030940223

Date of advice: 15 June 2016

Ruling

Subject: Assessability of payment

Questions and Answers

1. Is the payment received by you (per a management exit deed) in connection with a sale of shares by your related family trust a capital receipt?

No

2. Is the payment received by you (per a management exit deed) in connection with a sale of shares by your related family trust an income receipt?

Yes

This ruling applies for the following period

Year ending 30 June 2015

The scheme commenced on

1 July 2014

Relevant facts

Directorship roles

1. Person A has held a large number of directorship positions. Relevant to the matters considered in this Private Ruling they held the following positions:

1.1. They were appointed as a director of Company B.

1.2. They were appointed as a director of Company C and still maintain this directorship role. They were previously the company secretary.

1.3. They were appointed as a director of Company D and still maintain this directorship role. They were previously the company secretary.

1.4. They were appointed as a director of Company E and still maintain this directorship role. They were previously the company secretary.

1.5. They were appointed as a director of Company E Holdings and still maintain this directorship role. They were previously the company secretary.

1.6. They were appointed as a director of Company E Group and still maintain this directorship role.

1.7. They were appointed as a director of Company F and still maintain this directorship role. They were previously the company secretary.

Family Trust

2. They are the co-director of Company G with their spouse. They and their spouse each hold 50% of the issued share capital in Company G. Company G was is the trustee of the Trust.

3. The Trust was a shareholder in Company B. It had paid up share capital of $Z.

Company H's acquisition of the three companies

4. The Company H group consists of:

4.1. Company H as trustee for Y;

4.2. Company H as trustee for W; and

4.3. Their Related Bodies Corporate.

5. Company H Group controlled Company E. At that time Company E acquired all the shares in:

5.1. Company B;

5.2. Company I; and

5.3. Company D.

(Collectively referred to as "the three companies")

These companies became 100% fully owned subsidiaries of Company E and formed part of a consolidated group.

Negotiating the acquisition of the three companies by Company H and the Trust's investment in Company E

6. Person A was involved in the negotiations with the Company H Group regarding the acquisition of the three companies.

7. Prior to the acquisition the three companies was controlled by four persons; Person A, and three others. One of the others was the managing director and primary shareholder of each of the companies.

8. The primary shareholder decided to sell the three companies and commenced negotiations with a private equity entity partly owned and operated by the Company H Group.

9. All of the directors of the three companies were involved in the negotiations to sell all of shares in the three companies.

10. Agents of Company H advised Person A that the acquisition of the three companies was more likely to go ahead if the Trust used the proceeds from the sale of its shares in Company B to then purchase shares in the name of the trust in Company E Holdings. Although they did not want to reinvest the proceeds of the sale from Company B to Company E Holdings, Person A decided to do so because:

10.1. They were told by representatives of Company H that if the Trust did not 'rollover' its interest in Company B into a minority interest in Company E then the Company H group may not proceed with the acquisition of the three companies.

10.2. If they put the 'deal' into jeopardy they "risked the ire" of the primary shareholder.

10.3. Even if the sale proceeded without their participation in the rollover, failure to participate would ruin their relationship with the primary shareholder and they considered this may put their employment at risk.

10.4. The Company H group made a range of promises to them as to the capital returns that the Trust would make from investing in Company E Holdings. Specifically, the Company H Group:

1. indicated to them that its private equity vehicles aimed to be "in and out" of these types of investment within 5 years and that the Trust would each be able to exit its proposed investments at the same time as the Company H group.

2. represented to them that the Trust would make a significant capital gain on their investment, advising it 'always' ensured that management participated in private equity acquisitions in this way and that on each occasion that they had, management had made a significant capital gain.

3. provided them with a spreadsheet showing the expected capital return from an investment in Company E and said these estimates were "conservative" and "basically bankable money".

4. provided them with numerous examples of previous investments made by Company H private equity vehicles and the profit multiples achieved by the management of those businesses.

5. provided them with an un-bankable framed cheque representing a significant premium on the investment.

11. In rolling over its interest in Company B to purchase shares in Company E Holdings the Trust acquired Ordinary M Class shares at $V each.

12. The COMPANY H Group also invited Person A and the Trust to invest further cash in Company E Holdings. The Trust acquired further shares (via the trust) in Company E Holdings because of representations made to Person A, outlined in 10.4 above. The Trust made the following investments:

12.1. At the same time as the rollover the Trust invested $U to acquire additional Ordinary M class shares in Company E Holdings.

12.2. The Trust invested a further $T to acquire an additional Ordinary M class shares in Company E Holdings.

13. The above investments resulted in the Trust owning S Ordinary M Class shares in Company E Holdings.

Person A's employment with Company E

14. They signed an Executive Contract Statement (ECS) with Company E. Their commencement date was …. (ECS, Item 1 First Schedule). A Short Term Incentive Plan (SIP) applied to their contract (ECS, Item 11 First Schedule).

15. Clause 2 of the ECS provides that any payment made to them under the SIP is paid in consideration for their agreement to be strictly bound by the restrictive covenants set out in clause 6 of the ECS.

Long Term Incentive Deed

16. Person A signed a Long Term Incentive Deed (LTID) with Company H as trustee for Y; and Company H as trustee for W.

17. Clause 1.1 in Schedule 2 of the LTID provides for the payment of the LTI bonus. It states:

Subject to Condition 2, following completion of an Exit Event, Company H will pay each Executive (or as the Executive otherwise directs in writing) the LTI Bonus as calculated in accordance Condition 3 and as otherwise set out in these Conditions.

18. The LTID defines an 'LTI Bonus' to mean

any amounts payable by Company H to the Executives on the terms set out In this Deed (which for the avoidance of doubt is the total amount payable by Company H inclusive of, and company H is not required to make any additional payment on account of, any Tax, deductions on account of PAYG tax, superannuation, withholding, payroll, fringe benefits tax, Medicare levy or otherwise)

19. The LTID defines an 'Exist Event' to mean

an Asset Sale, Share Sale or IPO, or any other event or series of events which Company H declares to be an Exit Event, which together have the effect of allowing a realisation of all the Equity Securities held by Company H in Company E Holdings. For the avoidance of doubt the transfer of Equity Securities under clause 7.6 (Permitted Disposals) of the Company E Holdings SHA will not constitute an Exit Event

(LTID Clause 1.1)

20. Clause 3 in Schedule 2 of the LTID provides for the calculation of the LTI Bonus. The calculation depends on the Adjusted Trigger Price.

20.1. Where the Adjusted Trigger Price is less than $the LTI Bonus is AUD $0.

20.2. Where the Adjusted Trigger Price is AUD $the LTI Bonus is AUD $in aggregate to be paid to the Executives in their relevant portions (there were three executives)

20.3. Where the Adjusted Trigger Price is more than AU$ the LTI Bonus is AUD $plus $0.04 for every AUD $1.00 that the Adjusted Trigger Price exceeds AU$ with the LTI Bonus to be capped at AU$ in aggregate to be paid to the executives in their relevant portions (there were three executives)

21. The Adjusted Trigger Price is defined in clause 1.1 of the LTID as follows:

1. Adjusted Trigger Price means the net amount paid in either cash, other immediate funds or freely tradeable listed securities for all Equity Securities held by Company H in Company E Holdings at completion of an Exit Event after deducting the following amounts:

(a) any costs and expenses Incurred by Company H or its Associates in connection with the Exit Event and in connection with distributing any proceeds from the Exit Event;

(b) all amounts paid to the Executives or any of their Associates under or in connection with this Deed;

(c) all amounts paid to the Executives or any of their Associates as dividends, returns of capital or any other distributions associated with Equity Securities held by the Executives or their Associates in Company E Holdings, or Company E Group or either of their Related Bodies Corporate; and

(d) all amounts paid to the Executives or any of their Associates under any other long term incentive, bonus or other form of short term incentive that is payable in connection with the Exit Event;

22. Clause 4 in Schedule 2 of the LTID provides that the LTI Bonus must be paid to the executive within 10 Business Days of Completion of an Exit Event to which it is entitled. The clause further provides that "the term "Completion" has the ordinary meaning given to that term in commercial transactions, but also includes the passing of legal or beneficial title by Company H under a Share Sale, the passing of legal or beneficial title by Company E Holdings or Company E Group of all or substantially all of its business enterprise under an Asset Sale, or the quotation of the ordinary shares in Company E Holdings or Company E Group on any recognised stock market, irrespective of whether PEF Ill receives a payment of any kind at that time."

The sale of Company E

23. Through the execution of a Share Sale Agreement (SSA) and Management Exit Deed (MED) all of the Trust's Ordinary M Class shares in Company E Holdings were purchased by a third party.

24. At this time the market value of the shares held by the Trust was essentially zero.

25. Execution of the MED was a condition precedent to the SSA (SSA Clause 5.1, item 1).

26. The SSA provided that the purchase price for the Ordinary M Class Shares held by the Trust was $ (SSA Clause 4.1; Schedule 1 part B).

27. The MED provided that a 'Top-Up Payment', being $R, would be paid to the Manager Entities (person A and Company G) 'in consideration of the executive services provided by the Manager to the United Group' (MED Clause 2(a)).

28. After the sale Person A continued in his executive employment with Company E.

29. The SSA provided for an Earn-Out Amount to be paid to the Company H Group (SSA Clause 10)

30. The SSA provided for an Exit Payment on Realisation Event (SSA Clause 11). Clause 11.1 of the SSA stated "The Buyer Parties acknowledge that the implied value of its interest in the Group to be acquired from the Company H Sellers under this agreement (Company H Interest) is equal to approximately $ (Initial Value)."

Particulars of the MED

31. Both Person A and Company G (together, the Manager Entities) signed a Management Exit Deed (MED).

32. The MED was executed in favour of the Company H Group, the third party purchaser of Company E Holdings and Company E Holdings and its subsidiaries.

33. The MED provided that the Company H Entities would direct $, being a portion of the purchase price payable to the Company H Entities on Completion of the SAA, be paid to a member of the Company E Group, for that member to pay that amount to the Manager Entities "in consideration of the executive services provided by the Manager to the Company E Group" (MED Clause 2(a)).

34. Clause 2(b) gave further context to the nature of this payment in stating that:

"The Company E Group shall, subject to any Tax that the Company E Group is required by Law to withhold or deduct, pay the amount contemplated …as part of the Manager's next pay cycle…."

35. The MED provided for a number of releases to be given by the Manager Entity (MED Clause 3). The releases generally related to:

35.1. Any employment, independent contractor or consultant agreement which Person A provided to the Company E Group before Completion

35.2. Any long-term incentive plan, bonus plan or similar arrangement relating to the Company E Group before completion.

35.3. Any shareholders agreement relating to the Company or the Manager Entity's holding of shares.

36. The Manager Entities also waived "any and all rights (including pre-emptive rights, options to acquire securities and other rights) in respect of its Shares (if any) - whether at law or in equity, and whether arising under or in connection with any shareholders agreement relating to the Company, the Company's constitution or otherwise - that may be triggered by, the Proposed Transaction (MED Clause 4). The Proposed Transaction meaning the proposed sale and purchase of Shares by the Company H Entities and others to the third party on or about the date of the Deed (MED Clause 1).

37. A payment was made to Person A (per the MED).

Causes of action

38. The Trust considered it may have had the following causes of action against the Company H Group and their executives:

38.1. Breach of section 52 of the Trade Practices Act (which applied at the relevant time);

38.2. Negligent mis-statement; and

38.3. Breach of contractual warranty.

39. The Trust never commenced any proceedings against the Company H Group for those causes of action or provided formal notice of an intention to commence proceedings for these actions.

No payments were received by other minority shareholders

40. The SSA defined 'Minority Shareholders' (SAA clause 1.1). Some of those parties had indicated they would take legal action against Company H. None of the parties included as a minority shareholder received any payments as a result of the SSA or agreements associated with the SSA.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Reasons for decision

41. Under section 6-5 of the ITAA 1997, assessable income includes the ordinary income a taxpayer derived directly or indirectly from all sources, during the income year.

42. There are a number of factors which can assist in determining whether a particular receipt is ordinary income. These include:

42.1. whether the payment is the product of any employment, services rendered, or any business (FC of T v. Harris 80 ATC 4238; (1980) 10 ATR 869)

42.2. the quality or character of the payment in the hands of the recipient (Scott v Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 10 AITR 367; (1966) 14 ATD 286)

42.3. the form of the receipt, that is, whether it is received as a lump sum or periodically (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; (1952) 10 ATD 82), and

42.4. the motive of the person making the payment. Motive, however, is rarely decisive as in many cases a mixture of motives may exist (Hayes v. Federal Commissioner of Taxation (1956) 96 CLR 47; (1956) 6 AITR 248; (1956) 11 ATD 82).

43. Where a payment is made pursuant to a contract then the meaning of contract should first be ascertained from the words used, and only where the terms are ambiguous or susceptible to more than one meaning should evidence of the surrounding circumstances be considered (Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 at 352-3).

44. Where the words of a contract are clear, then terms are what the contract states.

45. The MED was clear, in clause 2(a), that the 'Top-Up Payment', being $, would be paid "in consideration of the executive services provided by the Manager [Person A] to the Company E Group."

46. Person A signed this MED, thereby agreeing to the terms contained within it.

47. The MED contemplated that tax would need to be withheld from the payment and provided that the payment would be made as part of the Manager's next pay cycle.

48. There is no ambiguity in the clause of what the payment was being made for and therefore the MED must be interpreted only from the words used and not from any extrinsic materials.

49. The reason you received the Top Up Payment was due to your role as an executive in the Company E Group (specifically they ware an executive of Company E). The payment was so related to Person A's income-earning activities that it was a product of those activities (Hayes v. FC of T (1956) 96 CLR 47 at p.54).

50. This view is supported by the fact that only the executives received the 'Top-Up Payment'. Company H has acknowledged that other minority shareholders had indicated that they would take legal action against Company H and company H did not make a payment to those shareholders. It seems the sole or alternatively dominant reason for the payment was because of Person A's executive role in the company rather than a connection to any minority shareholding held by the Trust.

51. The MED contained a number of releases. One of those releases relates to the LTID (MED Clause 3(a)(v)).

52. The LTID related to the Company E Group. It applied to Person A as an Executive of Company E in the position of Finance Director (LTID Schedule 1).

53. If the SSA could trigger an exit event for the purposes of the LTID then Person A may have been entitled to a LTI Bonus.

54. If it is concluded that the MED was intended to discharge the entitlements of Person A under the LTID, then in extinguishing the rights under the LTID the Top Up Payment replaced the LTI Bonus payment that would have otherwise become payable to Person A on completion of the exist event. The Top Up Payment would therefore be revenue in nature and assessable to Person A under s 6-5 of the ITAA 1997 as it would take the character of the payment it replaced.

55. The MED made reference to the SSA (see MED Clauses 1, 5(b), 11). Therefore if additional materials were to be consulted in interpreting the MED then the SSA would firstly be considered.

56. The SSA provided a requirement that the MED be executed. If the purpose of the MED was to extinguish rights held by Person A and/or the Trust against Company H for claims in the nature of a breach of section 52 of the Trade Practices Act (which applied at the relevant time); negligent mis-statement; and/or breach of contractual warranty, then there would be no reason the buyer parties to require the MED to be executed as a condition precedent to the SSA (SSA Clause 5.1, item 1).

57. In reading the extrinsic material to the MED, there is nothing to suggest that the dominant, if not sole purpose of the Top Up Payment, was for anything other than in consideration for the executive services Person A had provided to the Company E Group.

58. The purchaser's participation as a party to the MED supports a conclusion that the purpose of the agreement was to ensure that all of Person A's rights and entitlements as a manager to the Company E Group had been discharged prior to the purchaser acquiring the entity.

59. If the sole or dominant purpose of the top up payment had been to extinguish rights held by the Trust against the Company H group for breach of section 52 of the Trade Practices Act, negligent mis-statement or breach of contractual warranty, then a document would have been signed by the parties to those causes of action. As a matter of commercial reality a third party purchaser would not be involved in the Deed.

60. All the reasons the Top Up Payment relate to are revenue in nature and assessable to Person A under s 6-5 of the ITAA 1997 as the Top Up Payment would take the character of the payment it replaced.