Edited version of your written advice

Authorisation Number: 1013048350777

Date of advice: 15 July 2016

Ruling

Subject: Employee Share Scheme, start-up concession, beneficial interest

Question 1

For the purposes of satisfying the reporting requirements in Division 392 of the Taxation Administration Act 1953, and determining if the issue of options to a Founder should be reported by Company A under the start-up concession, will the options issued to a Founder satisfy both of the further conditions applicable to the start-up concession in subsection 83A-45(6) of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

28 April 2016 to 30 June 2016

1 July 2016 to 30 June 2017

The scheme commences on:

2016

Relevant facts and circumstances

1. Company A is a privately held company.

2. The founders of Company A are individuals, together the 'Founders'.

Some Founders are current directors of Company A.

A Founder is a current employee of Company A.

3. Company A has two shareholders, Company B and Company C.

4. Company B holds Q ordinary shares in Company A. Company C holds T Preference Shares in Company A, amounting to Q% and T% of the issued share capital in Company A respectively.

5. Company B is a privately held company. The current directors of Company B are the same Founders who are the current directors of Company A.

6. Each Founder, in their individual capacity, owns a percentage of ordinary shares in Company B, which has a total of M ordinary shares on issue.

7. Company C is a private equity firm with a wide range of shareholders.

8. Pursuant to Company A's Shareholders Agreement, in addition to a participating reference right and a right to convert the Preference Shares into ordinary shares at any time upon written notice to Company A, the Preference Shares held by Company C carry the same right and obligations as ordinary shares. This includes with respect to voting.

9. As a result, Company B and Company C hold Q% and T% respectively of the votes that might be cast at a general meeting of Company A.

10. Company A's Shareholders Agreement provides that Company B and Company C have the right to nominate and appoint one director each.

11. You state that despite the ability to control more than half of the available votes at a general meeting of Company A, Company B is restricted by Company A's Shareholder Agreement. Resolutions relating to certain matters including, amongst other things, any change to the share capital of Company A, expenses outside the annual budget over an amount of $X or any declaration of a dividend are subject to consent of Company C or its nominee director. You state that Company C has a veto right in relation to many operational aspects of Company A's business.

12. You state that none of the Founders are relatives of one another, nor have any of them formed a partnership. Further to this, you state there is no shareholder agreement between the Founders in respect of Company B and no one Founder acts in concert with, or at the direction of another.

13. You state Company B is not accustomed to or under any obligation to act on the directions or instructions of any of the Founders individually.

14. When deciding how Company B will vote at a general meeting of Company A, the shareholders of Company B vote independently at the Company B board level. If a decision is made at this level, in line with the constitution of Company B, the resulting decision is used for the purpose of the Company B shareholder vote at the Company A general meeting.

Employee Share Scheme

15. Company A wishes to establish and implement an Employee Incentive Plan ('Plan') to provide long term incentives for key employees. Founders will participate in the Plan along with senior staff at Company A.

16. Under the Plan, each individual Founder would receive a grant of options. Each option carries a right to acquire an ordinary share in Company A.

17. The total options pool available under the Plan will be 10% of Company A shares.

18. The total number of options issued to each individual Founder will carry the rights to acquire significantly less than 10% of the total shares.

19. It is intended that Company A, and therefore the Plan, qualifies for the concessional treatment under the Employee Share Scheme Start-up Rules within Division 83A of the Income Tax Assessment Act 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 318

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 section 83A-45

Income Tax Assessment Act 1997 subsection 83A-45(6)

Income Tax Assessment Act 1997 subsection 83A-45(7)

Income Tax Assessment Act 1997 section 83A-305

Income Tax Assessment Act 1997 section 995-1

Taxation Administration Act 1953 Division 392

Taxation Administration Act 1953 section 392-5

Reasons for decision

RECORD KEEPING OBLIGATIONS - EMPLOYEE SHARE SCHEMES

20. Section 392-5 of the Taxation Administration Act 1953 (TAA) outlines the circumstances where an entity (the provider) must give the Commissioner a statement in relation to Employee Share Scheme (ESS) interests. In summary, a statement must be given to the Commissioner in relation to the financial year if:

a. the provider has provided an ESS interest to an individual during the year and Subdivision 83A-B or 83A-C of the ITAA 1997 applies to the interests, or

b. the provider has provided an ESS interest to an individual, during the year or during an earlier year, Subdivision 83A-C applies to the interests and the ESS deferred taxing point for the interests occurs during the year.

21. The provider must give the statement to the Commissioner in the approved form, per subsection 392-5(2) of the TAA.

22. Subsection 392-5(3) of the TAA provides a list of information that may be required to be disclosed within the approved form. However, subsection 392-5(4) of the TAA provides that this list does not limit the information the Commissioner may require.

23. The ATO has published guidance on the approved 'ESS - annual report' form required to be submitted. The 'ESS annual report' must include detailed information for each employee participating in an ESS, and for each ESS that the employee is participating in.

24. For the 2016 and later financial years, the 'ESS - annual report' must include the following details for employees eligible for the ESS start-up concession:

a. the number of ESS interests acquired

b. the market value of the interests

c. the acquisition price of ESS interests that are shares, and

d. the exercise price of ESS interests that are rights.

1. Therefore, in order for a company to fulfil its ESS reporting requirements outlined within Division 392 of the TAA 1953, the company is required to know whether employees participating in an ESS are eligible for the start-up concessions.

EMPLOYEE SHARE SCHEMES

25. Division 83A of the ITAA 1997 contains specific rules about how tax applies to ESS interests that have been provided to employees at a discount under an ESS.

26. Generally, Division 83A provides that your assessable income includes discounts on shares, rights and stapled securities you (or your associate) acquire under an employee share scheme.

27. Concessional tax treatment may be available for some employees, subject to certain conditions, including a reduction in the taxable discount received or a deferral of the taxing point for the discount.

ESS start-up concession

28. The ESS start-up concession within section 83A-33 provides for an employee to exclude a discount on ESS interests acquired from their assessable income, subject to certain conditions being met by the scheme and their employer. Section 83A-33 is applicable in relation to ESS interests acquired on or after 1 July 2015.

29. Subsection 83A-33(1) outlines the requirements that must be met for the start-up concession to apply. As per paragraph 83A-33(1)(b), one of the requirements for the start-up concessions to apply is that section 83A-45 applies to the ESS interests.

30. Section 83A-45 provides further conditions for reducing amounts included in assessable income, including:

a) an employment requirement

b) ordinary shares requirement

c) the predominant business of the company not being share trading

d) minimum holding period requirements, and

e) a 10% limit on shareholding and voting power.

10% limit on shareholding and voting power

31. For the ESS start-up concession to apply, an employee cannot, immediately after an issue of ESS interests to them by a company, hold a beneficial interest in more than 10% of the shares in that company, and control more than 10% of the maximum voting rights in that company.

32. This requirement is outlined in subsection 83A-45(6):

83A-45(6): This subsection applies to an ESS interest in a company if, immediately after you acquire the interest:

a) you do not hold a beneficial interest in more than 10% of the shares in the company; and

b) you are not in a position to cast, or to control the casting of, more than 10% of the maximum number of votes that might be cast at a general meeting of the company.

33. For the purposes of determining whether the 10% limit within subsection 83A-45(6) is exceeded in the case of options, subsection 83A-45(7) works out the beneficial interest and number of votes as if those options have been exercised.

Beneficial interest

34. The term 'beneficial interest' is not defined for the purposes of Division 83A, or within the wider ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936). Accordingly the phrase 'is to be construed in context and must reflect the purposes of the section in which it occurs': Commissioner of Taxation v Linter Textiles Australia Ltd (in liq) (2005) 2005 ATC 4255 at 4263.

35. The Explanatory Memorandum (EM) to the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 provides guidance on the intention of subsection 83A-45(6) and the meaning of the term 'beneficial interest'. In determining whether an employee holds a beneficial interest in their employer for the purposes of subsection 83A-45(6), paragraph 1.61 of the EM states: 'The interest provided to an employee must not result in the employee (along with their associates) having effective ownership of greater than 10 per cent of their employer, and not controlling more than 10 per cent of the maximum voting rights in the employer.'

36. The above paragraph from the EM implies the intention of subsection 83A-45(6) was to include the 'effective ownership' of an employee in their employer. The term 'effective ownership' used in the EM appears to encompass a broader range of possibilities than beneficial interest.

37. However, the EM to the introduction of section 83A-45 cannot be read so as to restrict the plain reading of the words used in the provision: per Perram J in Davies v DFC of T [2015] FCA 773; 2015 ATC 20-520 at [72]. Therefore, it is necessary to consider the ordinary and natural meaning of the phrase 'beneficial interest' within the context of the purposes of Division 83A.

Ordinary meaning

38. A share in a company is accepted as being an interest in that company. Once issued, a share comprises 'a collection of rights and obligations relating to an interest in a company of an economic and proprietary character, but not constituting a debt': Pilmer v. The Duke Group Limited (in liq) [2001] HCA 31; 49 ATR 324.

39. In Charles v Federal Commissioner of Taxation [1954] HCA 16; (1954) 90 CLR 598 (Charles) the Full Court of the High Court explained 'A share confers upon the holder no legal or equitable interest in the assets of the company'.

40. This statement from the judgement in Charles was used in the context of distinguishing the nature of an interest in a unit, and in doing so contrasted it with an interest in a share, such that a unit held under a unit trust was fundamentally different from a share in a company.

41. In FC of T v ElecNet (Aust) Pty Ltd [2015] FCAFC 178; 2015 ATC 20-550 (ElecNet) at [91], the Full Federal Court cited with approval the above conclusion from Charles, within the context of discussing the concept of a unit trust in comparison with shareholders in a company.

42. In Taxation Determination TD 2009/3 Income tax: employee share schemes: for the purpose of subsection 139CD(6) of the Income Tax Assessment Act 1936, does a taxpayer become the holder of a beneficial interest in shares merely by acquiring a contractual right to obtain shares in a company (the particular, individual shares not being ascertained at the time)?, the Commissioner considered whether, by acquiring an option to obtain a share, an employee will acquire a beneficial interest in a share for the purposes of subsection 136CD(6) of the ITAA 1936. Subsection 136CD(6) (now repealed) provided that for a right to be qualifying right for ESS purposes, immediately after acquiring the right, the taxpayer must not hold a legal or beneficial interest in more than 5% of the shares in the company.

43. Relevantly, at paragraph 11 of TD 2009/3, the Commissioner's view is the expression 'hold a legal or beneficial interest' in a share will cover any kind of proprietary right over a share, whether recognised by law or equity.

44. This view is considered applicable when considering the phrase 'hold a beneficial interest' in a share for the purposes of subsection 83A-45(6).

Associates

45. Subsection 83A-305(1) provides that if an associate (other than an employee share trust) of an individual acquires an ESS interest in relation to the individual's employment (including past or prospective employment), then, for the purposes of Division 83A:

a) treat the interest as having being acquired by the individual (instead of the associate)

b) treat any circumstance, right or obligation existing or not existing in relation to the interest in relation to the associate as existing or not existing in relation to the individual, and

c) treat anything done or not done by or in relation to the associate in relation to the interest as being done or not done by or in relation to the individual.

46. For the purposes of determining an individual's effective ownership and voting rights within subsections 83A-45(6) and (7), subsection 83A-305(2) provides an individual must also take into account ESS interests acquired by their associate other than in relation to the individual's employment.

47. Subsection 995-1(1) states that the term 'associate' has the meaning given by section 318 of the ITAA 1936.

48. Subsection 318(1) of the ITAA 1936 states:

For the purposes of this Part, the following are associates of an entity (in this subsection called the primary entity) that is a natural person (otherwise than in the capacity as trustee):

a) a relative of the primary entity

b) a partner of the primary entity or a partnership in which the primary entity is a partner

c) if a partner of the primary entity is a natural person otherwise than in the capacity of a trustee - the spouse or a child of that partner

d) a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust

e) a company where:

(i) the company is sufficiently influenced by:

(A) the primary entity; or

(B) another entity that is an associate of the primary entity because of another paragraph of this subsection; or

(C) another company that is an associate of the primary entity because of another application of this paragraph; or

(D) 2 or more entities covered by the preceding sub-subparagraphs; or

(ii) A majority voting interest in the company is held by:

(A) the primary entity; or

(B) the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the preceding paragraphs of this subsection; or

(C) the primary entity and the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and because of the preceding paragraphs of this subsection.

49. Paragraph 318(6)(b) of the ITAA 1936 provides that a company is sufficiently influenced by an entity if the company, or its directors, are accustomed or under an obligation (whether informal or formal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity.

50. Paragraph 318(6)(c) of the ITAA 1936 provides an entity holds a majority voting interest in a company if the entity is in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be cast at a general meeting of the company.

Application to your circumstances

51. For Company A to fulfil its ESS reporting requirements outlined within Division 392 of the TAA 1953, Company A is seeking to confirm whether the options issued to a Founder are eligible for the start-up concessions. The specific question is whether the options issued to a Founder satisfy both of the further conditions applicable to the start-up concession in subsection 83A-45(6) of the ITAA 1997.

Associates

52. Section 83A-305 operates to deem the beneficial interest and number of votes held (or controlled) by a person for the purposes of section 83A-45(6) to be worked out on an associate basis. As such, it must be determined whether:

a) each Founder is an associate of another Founder, or

b) Company B is an associate of each Founder.

Are any of the Founders associates of one another?

53. In relation to whether any of the Founders are associates of one another, the information you provided states:

a) none of the Founders are relatives of one another, and

b) none of the Founders have formed a partnership

Therefore, subsections 318(1)(a) and (b) of the ITAA 1936, relating to associates of a natural person, will not be satisfied.

54. Based upon the information provided, the Founders are not associates of each other.

Is Company B an associate of any Founder?

55. To determine whether Company B is an associate of any Founder, it is necessary to determine whether Company B is sufficiently influenced by, or a majority voting interest in Company B is held by, a Founder for the purposes of paragraph 318(1)(e) of the ITAA 1936.

56. The information you provided states

a) there is no shareholders agreement between the Founders in respect of Company B

b) the Founders are able to vote at a general meeting of Company B as they see fit, and

c) no one Founder acts in concert with, or at the direction of another.

57. Company B is not accustomed to or under any obligation to act on the directions or instructions of any of the Founders individually. Further, there is no reasonable expectation that Company B would act in accordance with the directions, instructions or wishes of one individual Founder.

58. It is noted that two of the Founders are directors of both Company A and Company B. However, they have fiduciary obligations in respect of each directorship to act in the best interests of each company. Therefore, their directorships alone are insufficient to establish that either Founder has sufficient influence over Company A or Company B.

59. Accordingly, Company B is not sufficiently influenced by any one individual Founder, per the interpretation within paragraph 318(6)(b) of the ITAA 1936. Therefore subparagraph 318(1)(e)(i) of the ITAA 1936 will not be satisfied.

60. Each individual Founder owns a percentage of ordinary shares in Company B, and therefore controls that percentage of the votes at a general meeting of Company B. When deciding how Company B will vote at a general meeting of Company A, the shareholders of Company B vote independently at the Company B board level. Additionally, no one Founder acts in concert with or at the direction of another Founder. Therefore, no one individual Founder is in a position to cast, or control the casting of, more than 50% of the votes at a general meeting of Company B, per the interpretation within paragraph 318(6)(c) of the ITAA 1936. This means subparagraph 318(1)(e)(ii) of the ITAA 1936 will not be satisfied.

61. As paragraph 318(1)(e) of the ITAA 1936 will not be satisfied, Company B is not considered an associate of any of the Founders.

10% limit on beneficial interest - paragraph 83A-45(6)(a)

62. To determine whether paragraph 83A-45(6)(a) will apply to the options proposed to be granted to each Founder, it is necessary to determine whether each Founder will hold a beneficial interest in more than 10% of the shares in Company A immediately after the Founder acquires the option.

63. From the information provided, at the time immediately after issue of the options:

a) Company A will have shares on issue, Company B holding Q ordinary shares and Company C holding T preference shares

b) Company B holds rights attached to the ordinary shares it owns

c) each Founder holds a beneficial interest in a percentage of issued share capital in Company B

d) each Founder will individually hold options carrying a right to acquire ordinary shares in Company A, and

e) the total number of options issued to each individual Founder will be less than 10% of the total shares in Company A.

64. Section 83A-305 operates to deem the beneficial interest and number of votes held (or controlled) by a person for the purposes of section 83A-45(6) to be worked out on an associate basis. However, as already concluded, the Founders are neither associates of each other nor associates of Company B.

65. Upon holding the options, subsection 83A-45(7) will treat each Founder as holding a beneficial interest in the shares underlying these options for the purposes of subsection 83A-45(6).

66. However, even with the application of subsection 83A-45(7), each individual Founder will be deemed to hold less than 10% of the shares in Company A, as the total number of options issued to each individual Founder will be less than 10% of the total shares in Company A.

67. Based upon the facts, Company B is the legal owner of, and holds the rights attached to, the ordinary shares in Company A. These rights include the right to vote and right to receive dividends. If a general meeting of Company A was called then Company B has the right to vote. If dividends were declared or capital returned by Company A, then Company B would be the recipient of the payment.

68. There is no evidence that Company B is holding the shares in Company A for or on behalf of any of the Founders individually. Company B is holding the rights attached to the shares for its own benefit. Company B is not subject to direction by any one Founder.

69. Company B carries the risks and benefits of ownership of the shares it holds in Company A. None of the Founders benefit directly from the rights attached to the Company A shares owned by Company B. The Founders carry the rights attached to their shares in Company B but do not hold any proprietary rights over the shares Company B holds in Company A.

70. The Founders could benefit indirectly via Company B's shareholding in Company A, for example, if Company B decides to pass on dividends received from Company A. However, the shareholders of Company B (being the Founders) must still determine through majority agreement, and in accordance with the company's constitution, how Company B will apply any benefits associated with the shares held in Company A. Any indirect benefit received is insufficient to conclude the Founders have a beneficial interest in Company A for the purposes of Division 83A.

71. Although each Founder has a beneficial interest in the shares in Company B, they do not have a beneficial interest in the assets of that company or the shares that Company B holds in Company A.

72. It follows that the Founders have no beneficial interest in the Q ordinary shares in Company A held by Company B.

73. Accordingly, at the time immediately after the Founder acquires the options, each Founder will not have beneficial interest of more than 10% of the shares in Company A and paragraph 83A-45(6)(a) will be satisfied.

10% limit on voting power - paragraph 83A-45(6)(b)

74. To determine whether paragraph 83A-45(6)(b) will apply to the options proposed to be granted to each Founder, it is necessary to determine whether each Founder will be in a position to cast, or to control the casting of, more than 10% of the maximum number of votes that might be cast at a general meeting of Company A immediately after the Founder acquires the option.

75. From the information provided, at the time immediately after issue of the options:

a) Company A will have shares on issue, Company B holding Q ordinary shares and Company C holding T preference shares

b) Company B holds rights attached to the ordinary shares it owns

c) each Founder will individually hold options carrying a right to acquire ordinary shares in Company A, and

d) the total number of options issued to each individual Founder will be less than 10% of the total shares in Company A.

76. Upon holding the options, subsection 83A-45(7) will treat each Founder as holding a beneficial interest in the shares underlying these options, for the purposes of subsection 83A-45(6).

77. However, even with the application of subsection 83A-45(7), each individual Founder will be deemed to be in a position to cast, or control the casting of, less than 10% of the votes at a meeting of Company A.

78. Company B is in a position to cast Q votes that might be cast at a general meeting of Company A. Each Founder holds a percentage of ordinary shares in Company B, and as such, each Founder has the ability to cast that percentage of the votes at a general meeting of Company B.

79. However, as previously mentioned, there is no shareholders agreement between the Founders in respect of Company B. The Founders are able to vote at a general meeting of Company B as they see fit. No one Founder acts in concert with, or at the direction of another. As such no one Founder can control the votes of Company B, as individually, no one Founder has a majority vote.

80. When deciding how Company B will vote at a general meeting of Company A, the shareholders of Company B vote independently at the Company B board level. If a decision is made at this level, in line with the constitution of Company B, the resulting decision is used for the purpose of the Company B shareholder vote at the Company A general meeting.

81. Accordingly, as no one Founder can control the votes at a general meeting of Company B, no one Founder could be considered to individually control the casting of any of the votes associated with the voting rights attached to the ordinary shares held by Company B, at a general meeting of Company A.

82. Therefore, paragraph 83A-45(6)(b) will be satisfied, as immediately after an issue of options to a Founder, the individual Founder will not be considered to be in a position to cast, or control the casting of, more than 10% of the maximum number of votes that may be cast at a general meeting of Company A.

Conclusion

83. The options proposed to be issued to the Founders satisfy both of the further conditions applicable to the start-up concession within subsection 83A-45(6). Therefore, the acquisition of the options by a Founder should be reported by Company A as under the start-up concession, dependent upon all of the other conditions relevant for satisfying the start-up concession being met.