Edited version of your written advice

Authorisation Number: 1013031551113

Date of advice: 5 August 2016

Ruling

Subject: Employee Share Trust

Question 1

Will the irretrievable contributions made pursuant to the Employee Share Option Plan and Company A Long-Term Incentive Plan to Company B (Trustee), as trustee of the Company A Employee Share Trust (Trust), to fund the acquisition of Company A shares by the Trustee in accordance with the Company A Employee Incentive Trust Deed, be assessable income of the Trust under sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a capital gain or capital loss that arises for the Trustee of the Trust at the time the Participants become absolutely entitled to Company A shares under the Employee Share Option Plan and Company A Long-Term Incentive Plan be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Company A shares for the same or less than the cost base of the Company A shares in the hands of the Trustee?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Relevant facts and circumstances

Company A is the head entity of the Company A tax consolidated group which also includes Company C

The Company A Australia Limited Long-Term Incentive Plan and Employee Share Option Plan

Company A currently operates the Employee Share Option Plan (ESOP) and Company A Long-Term Incentive Plan (LTIP). Both the LTIP and the ESOP (collectively referred to as the Plans) are a key part of Company A's executive remuneration framework which aims to increase alignment of employee interests to shareholders' interests, drive improved business performance and attract and retain key talent. Each of the LTIP and the ESOP are supported by their respective plan rules, namely the Company A Share Option Plan Rules (ESOP Rules) and the Long term incentive plan rules Company A (LTIP Rules).

The Plans presently apply to employees of Company C. Employees of Company C who participate in either the ESOP or LTIP become participants under the respective Plan in which they participate (Participants).

The ESOP and LTIP will enable eligible Company A executives to share in the growth of Company A's business through a grant of Options under the ESOP or either Options or Performance Rights under the LTIP Rules. The Options and Performance Rights will be capable of being exercised and converted into ordinary shares following the satisfaction of certain vesting conditions over a three-year period (LTIP) or 12-month period (ESOP).

The Plans broadly operate as follows:

• It is at the absolute discretion of the Board (defined in both the LTIP and ESOP Rules as being the Board of Company A) to extend an invitation to grant Options or Performance Rights to eligible employees.

• Subject to the terms attaching to the Options or Performance Rights, each Option or Performance Right entitles the participant to one fully paid ordinary share in Company A (Company A share). Under the LTIP, at the Boards discretion under Clause 9.5 of the LTIP Rules the Options or Performance Rights may be settled for cash. In respect of Options granted under the ESOP, where permitted by the Board, the Participant pursuant to Rule 12.5 of the ESOP Rules may elect to receive the difference between the Market Value of shares (as defined in the ESOP Rules) and the Exercise Price (as defined in the ESOP Rules) in cash or shares.

• Accordingly, once all conditions on the Options or Performance Rights, as determined by the Board have been satisfied, the vested Options or Performance Rights may be exercised and be settled into the equivalent number of shares (see Clause 8 of the LTIP Plan Rules and Clause 12 of the ESOP Rules). An Option or Performance Right will be forfeited in the circumstances set out in Clause 10 of the LTIP Rules and Clause 8 of the ESOP Rules, including failure to satisfy vesting conditions.

• Options or Performance Rights are not transferrable without the consent of the Board.

Company A Employee Share Trust

By way of the Company A Australia Limited Employee Incentive Trust Deed (Deed), Company A has established an Employee Share Trust (Trust). The sole purpose of the Trust which is to acquire Company A shares for employees of Company A pursuant to the Plans (clause 4.9 of the Deed).

By way of the Company A Australia Employee Incentive Trust Deed (Deed), Company A has established the Company A Australia Employee Incentive Trust (Trust). The sole purpose of the Trust is to acquire Company A shares for employees of Company A pursuant to the Plans so that the Trust meets the definition of 'employee share trust' for the purposes of s 130-85(4) of the ITAA 1997.

Company B (Trustee) is an independent third party acting as the trustee of the Trust.

The Trust will operate as follows:

• The Trust will be funded by contributions from Company A for the purchase of Company A shares in accordance with the Plans (clause 5.3 of the Deed).

• The funds contributed will be used by the Trustee to acquire Company A shares either on-market or via a subscription for new shares in Company A, based on written instructions from Company A (clause 5.2 of the Deed).

• Company A shares acquired by the Trustee will be allocated to the relevant employees following exercise of the Performance Rights or Options (clause 9.3 of the Deed).

• The Trustee can sell Company A shares on behalf of an employee where permitted to do so by the employee (clause 4.1(d) of the Deed).

Relevant legislative provisions

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 6-5(1)

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 subsection 6-10(1)

Income Tax Assessment Act 1997 section 10-5

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 section 104-75

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

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

Income Tax Assessment Act 1997 paragraph 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 130-90(1)

Income Tax Assessment Act 1997 subsection 130-90(2)

Reasons for decision

Question 1

Section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) defines net income in relation to a trust as follows, insofar as it is relevant:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions

Subsection 6-5(1) states:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Further, subsection 6-10(1) states:

Your assessable income also includes some amounts that are not ordinary income.

Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.

None of the provisions listed in section 10-5 are relevant in the present circumstances. Therefore, non-refundable contributions made by Company A to the Trustee will not be assessable income under section 6-10. They will only be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6-5.

Section 6-5 provides that your assessable income includes income according to ordinary concepts which is called ordinary income. Chief Justice Jordan in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 gave the classic definition of "income" in Australian law. Chief Justice Jordan considered that:

The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

The leading case on ordinary income is Eisner v Macomber 252 US 189 (1919). The decision states that:

The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being "derived" that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; …that is income derived from property. Nothing else answers the description.

In G.P. International Pipecoaters Proprietary Limited v The Commissioner of Taxation of the Commonwealth of Australia (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. Brennan, Dawson, Toohey, Gaudron and McHugh JJ 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 incurred in carrying on a business.

The contributions provided by Company A to the Trustee of the Trust are used in accordance with the terms of the Deed and the ESOP and LTIP Rules. Clause 3.1(a) of the Deed states that the Trustee will hold on Trust all Company A shares and all other benefits and privileges arising from these shares for the benefit of Participants on the terms and conditions set out in the Deed. Clause 5.3(b) of the Deed states that all funds received by the Trustee from Company A or a subsidiary of Company A will constitute accretions to the Trust and will not be repaid to Company A or a subsidiary of Company A. The Trustee must apply the funds received in the acquisition or subscription of Company A shares under the Deed and the Plans. No Participant is entitled to receive such funds from the Trustee. The contributions will not be assessable as ordinary income under section 6-5 as they constitute receipts of a capital nature to the Trustee.

Question 2

When a Participant in the Plans becomes absolutely entitled to the Company A shares as against the Trustee, CGT Event E5 will occur and under section 104-75 the Trustee will make a capital gain or loss. However, section 130-90 may operate to disregard that gain or loss where specified conditions are satisfied.

Section 130-90

Section 130-90 relevantly states:

Shares held to satisfy the future exercise of rights acquired under employee share schemes

130-90(1)

Disregard any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, to the extent that it results from a CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

(b) the CGT event happens in relation to a share; and

(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d) the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

130-90(2)

Subsection (1A) or (1) does 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

Subsection 130-85(4) states:

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 interest 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).

Paragraphs 130-85(4)(a) and (b)

The beneficial interest in a Company A share received by a Participant when an ordinary share in Company A is granted to them under the terms of the Deed is an ESS interest within the meaning of subsection 83A-10(1). Subsection 83A-10(2) defines an employee share scheme as being 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.

The ESOP and LTIP are each an employee share scheme within the meaning of subsection 83A-10(2) because each is a scheme that provides rights (Performance Rights and Options) to acquire beneficial interests in ordinary shares in Company A to employees in relation to the employee's employment.

Company A has established the Trust to acquire ordinary shares in Company A and to allocate those shares to employees in order to satisfy ESS interests (Performance Rights and Options) acquired by those employees under the ESOP and LTIP. A beneficial interest in a Company A share is itself provided under an employee share scheme because it is provided under the same scheme under which the Performance Rights and Options are provided to Participants in relation to their employment, being an employee share scheme as defined in subsection 83A-10(2).

Paragraphs 130-85(4)(a) and (b) are therefore satisfied because:

• the Trust acquires shares in a company, namely Company A; and

• the Trust ensures that ESS interests (as defined in subsection 83A-10(1), being beneficial interests in the shares of Company A), are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating those Company A shares to the employees in accordance with the Deed and the ESOP and LTIP.

Paragraph 130-85(4)(c)

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) will also require that the Trustee undertake incidental activities that are a function of managing the ESOP and LTIP.

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 sets out a number of activities which are merely incidental for the purposes of paragraph 130-85(4)(c):

• the opening and operation 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 the 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 purposes 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.

Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental.

Clause 4.9 of the Deed states that Company A and the Trustee agree that the Trust will be managed and administered in a way that satisfies section 130-85(4).

Clause 4.1 further states that Trustee has power to '…subscribe for, purchase or otherwise acquire Trust Assets, Shares, rights or privileges which the Trustee is authorised by this Deed to acquire, and (where relevant) on such terms and conditions as it thinks fit, and do all things incidental to this activity.'

Paragraph 130-85(4)(c) is satisfied as any activities undertaken by the Trustee other than the acquisition of Company A shares and the allocation of those shares to the employees in accordance with the Deed and ESOP and LTIP Rules are merely incidental to operation of these Plans.

The Trust satisfies the definition of an employee share trust in subsection 130-85(4) as:

• the Trust acquires shares in a company (being Company A);

• the Trust ensures that ESS interests (as defined in subsection 83A-10(1), being beneficial interests in the shares of Company A), are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating those Company A shares to the employees in accordance with the Deed and ESOP and LTIP Rules; and

• the Deed does not provide for the Trustee to participate in any activities which are not considered to be merely incidental to the function of administering the Trust.

Paragraph 130-90(1)(a)

CGT event E5 is the CGT event that will apply under the terms of the ESOP and LTIP at the time the Participant becomes absolutely entitled to the Company A shares as against the Trustee. Therefore paragraph 130-90(1)(a) will be satisfied.

Paragraph 130-90(1)(b)

Subsection 995-1(1) defines a share in a company to mean a share in the capital of a company. An ordinary share in Company A held by the Trustee and to which a Participant is entitled upon vesting or exercise of a Performance Right or Option is a share in the capital of a company (i.e. Company A). Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a share (in Company A) by vesting or exercising of a Performance Right or Option provided under the Plans.

Paragraph 130-90(1)(d)

Subsection 83A-20(1) of Subdivision 83A-B states:

This Subdivision applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

Subsection 83A-10(2) defines an employee share scheme as being 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.

The ESOP and LTIP are each an employee share scheme within the meaning of subsection 83A-10(2) because each is a scheme that provides rights (Performance Rights and Options) to acquire beneficial interests in ordinary shares in Company A to employees in relation to the employee's employment. Each Performance Right or Option is acquired for no cost.

Subdivision 83A-B will apply to the Performance Rights or Options provided under the Plans as pursuant to subsection 83A-20(1) the ESS interests (i.e. Performance Rights or Options issued under the Plans) will be acquired under an employee share scheme (for the reasons stated in the immediately preceding paragraph) at a discount. It should be noted however that whether a Participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

Accordingly, all the conditions in subsection 130-90(1) have been satisfied.

Provided a Participant does not acquire the beneficial interest in the Company A share for more than its cost base in the hands of the Trustee at the time that CGT event E5 happens, subsection 130- 90(1) will apply.

Under these circumstances, section 130-90 operates to disregard any capital gain or loss made by the Trustee on any Company A share when a Participant becomes absolutely entitled to that share.

CGT Event E7

Subsection 104-85(1) 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.

However, section 106-50 provides that if you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), Part 3-1 and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

A Participant, on allocation of the Company A shares by the Trustee, becomes absolutely entitled to those shares. In accordance with clauses 3.1(b) and 7 of the Deed each Participant is absolutely entitled to any Company A shares held by the Trustee on their behalf once allocated, and is entitled to the same rights in respect of those shares as if he or she was the legal owner of the shares (subject to the ESOP and LTIP).

Once a Participant is absolutely entitled to the Company A shares held on their behalf by the Trust, section 106-50 will deem the disposal of the Company A shares by the Trustee to be done by the Participant.

Therefore, section 106-50 will apply such that, if the Trustee disposes of the Company A shares under the ESOP or LTIP (by way of transfer to a Participant), the Trustee will not make a capital gain or capital loss under CGT Event E7.