Edited version of your written advice

Authorisation Number: 1013057651934

Date of advice: 22 July 2016

Ruling

Subject: Employee Share Trust

Question 1

Are irretrievable cash contributions made to the Trustee of the Company Employee Share Trust (the EST), to fund the subscription for Company Limited shares (Shares) or acquisition of Shares on-market, assessable income of the EST under section 6-5 or section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Where Shares are acquired by the EST and then allocated to participants under the Company Limited Employee Retention Plan (ERP) and Executive Service Agreement (ESA), will any capital gain or loss made by the EST, or the relevant beneficiary of the trust, that arises as a result of CGT Event E5 or E7 be disregarded pursuant to subsection 130-90(1) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

1 July 20xx - 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Company's shares are quoted and traded on the 'Unlisted' trading platform overseas. Its shares may be traded on the exchange or directly transferred between investors (both being referred to as 'on-market' transactions for the purposes of this private ruling).

The Company is the head company of a tax consolidated group.

The Company has implemented two equity based compensation plans (Plans).

The Plans have been administered under the Company's Employee Share Plan Trust Deed (Trust Deed).

Operation of the Plans

The Company, at the sole discretion of the board of the Company (Board), may issue invitations to an eligible Participant to participate in the Plan.

On acceptance of the invitation by the eligible Participant, the Board, at its sole discretion, may issue Rights to eligible Participants.

The Rights will vest to the extent that "Performance Hurdles" are met during the "Measurement Period" at which point all or a portion of the Rights will be convertible into Company shares (Shares).

Rights are granted to eligible Participants for nil consideration.

Operation of the Trust

An employee share trust (EST) has been established as a separate vehicle for the sole purpose of acquiring ordinary shares in the Company for the benefit of eligible Participants under the Company's employee equity plans.

The Company's Employee Performance Rights Plan Trust (Trust) was established during the financial year ended 30 June 20xx.

The Trust has been established with the sole purpose to acquire and hold Plan Shares pursuant to the Plan Rules for the benefit of Beneficiaries of the Trust.

Contributions made to the Trust by the Company

Shares are acquired by the Trustee through contributions made by the Company to the Trustee. Shares acquired are held by the Trustee absolutely on behalf of the Participants.

It is the Company's intention to continue making contributions to the Trust on an annual basis.

The cash contributions made by the Company to the Trustee of the Trust to fund the subscription for or acquisition of Shares by the Trust are irretrievable and non-refundable under the Trust Deed.

The Company will also incur costs associated with the services provided by the Trustee of the EST and various implementation costs.

Use of a Share Trust to facilitate the Plan

It is increasingly common for Australian companies to use a share trust to facilitate the provision of shares to employees as part of equity based employee incentive and retention strategies.

The applicant has provided the following commercial benefits of using a trust

The ability to attract, retain and motivate high quality employees is one driver behind the Company's success. In particular, the Company needs to provide rewards and incentives to encourage the right people to join and stay committed to the company to ensure its future success.

The Company's remuneration policy is designed to be competitive and equitable and, with the Company's current and planned growth, the company intends to provide employees with an opportunity to share in any future growth in the value of the company. This aligns the economic interests of employees with those of the Company's shareholders as employees will be given the opportunity to earn significant rewards by potentially acquiring an equity interest in the Company based on creating shareholder value.

The EST will provide the Company with greater flexibility to accommodate the long term incentive arrangements of the Company whilst the business continues to expand in terms of operation and employee numbers in future years. The EST will also accommodate capital management flexibility for the Company in that the EST can use the contributions from the Company to either acquire Shares on-market or alternatively subscribe for new Shares.

Similarly, it will allow for a streamlined approach to the administration of the Plans. The EST will also provide a range of incentives involving Shares as circumstances change in the labour market and can be used in conjunction with different incentives required to be provided in order to attract, reward and retain key employees.

The use of an EST for the Company has a range of commercial benefits in addition to being a vehicle for the delivery of Shares to employees. In particular the EST can:

• provide an arm's length vehicle for acquiring and holding Shares, either by way of new issue or acquiring on-market, and provide the Company with a convenient and efficient way to undertake on-market acquisitions as compared to if no trust is used;

• assist the Company with meeting its Corporations Law requirements in relation to dealing in its own Shares. The Corporations Act generally prohibits a company from acquiring its own Shares. The EST can provide a mechanism to allow for the acquisition of Shares through the EST and the EST is not prohibited from doing so because the Company will have no beneficial interest in any Shares held by the EST or the EST itself;

• allow for Shares to be acquired and warehoused in the EST prior to vesting to effectively allow for a price hedge. That is, Shares can be acquired up-front at today's price and held until they are needed to be allocated to a particular employee;

• assist the Company with managing any insider trading issues as the Trustee, an independent party, will be acquiring Shares in accordance with a set policy. This is in part because the Corporations Regulations specifically exempt certain activities from some of the insider trading prohibitions in the Corporations Act. In particular, the regulations provide an exemption where there is an acquisition of the financial products of a company by, or by a trustee for, employees of that company or its related companies, under a scheme established solely or primarily for the benefit of employees. In addition, the ability of the EST to acquire Shares in advance may allow the EST to hold those Shares on behalf of employees at a time when the Company would be otherwise prevented from issuing Shares to its employees in order to satisfy obligations under the Company's Plans;

• provide the Company with capital management flexibility, i.e. by allowing for on-market purchases of Shares using cash or a new issue of Shares by the Company where cash is retained;

• allow for the Company to give effect to disposal restrictions after vesting. As the Trustee is the legal owner of the Shares, employees as beneficial owners have no ability to deal in the Shares;

• provide a single vehicle for the administration of the Company's Plans, and for the convenient and efficient outsourcing of the administration to a third party administrator;

provide the Company with an efficient mechanism for the administration and operation of any new employee equity plans which it introduces in the future.

Relevant legislative provisions

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 subsection 83A-10(1),

Income Tax Assessment Act 1997 subsection 83A-10(2),

Income Tax Assessment Act 1997 subsection 83A-20(1),

Income Tax Assessment Act 1997 subsection 104-75(1) ,

Income Tax Assessment Act 1997 subsection 104-85(1) ,

Income Tax Assessment Act 1997 section 106-50,

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 subsection 130-90(1),

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

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

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

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

Income Tax Assessment Act 1997 subsection 995-1(1) and

Income Tax Assessment Act 1936 section 95.

Reasons for decision

All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Summary

The irretrievable cash contributions made to the Trustee of the Trust to fund the acquisition of or subscription for shares by the EST will not be assessable income of the EST under section 6-5 or section 6-10.

Detailed reasoning

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:

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

Subsection 6 10(1) states:

(1) 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, the irretrievable cash contributions made to the EST will not be assessable income under section 6 10.

Accordingly, the irretrievable cash contributions will only be included in the calculation of the net income of the EST under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6 5.

Assessable income under subsection 6-5(1)

The leading case on ordinary income is Eisner v Macomber 252 US 189 (1919). It was said in that case 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 GP International Pipecoaters Pty Ltd v Federal Commissioner of Taxation (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. The court further 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.

In this case, the EST is established for the purpose of acquiring and holding Shares in according with the plans (clause xx of the Trust Deed). The Trustee must operate the EST in accordance with the plans as applicable and in a way that satisfies the definition of 'employee share trust' for the purposes of subsection 130-85(4) (clause xx of the Trust Deed).

The Trustee must, when directed by the employer, acquire Shares for the purpose of enabling the employer to satisfy its obligations to allocate Shares under the terms of the plans (clause xx of the Trust Deed). The employer must make sufficient irretrievable cash contributions to fund the acquisition of the Shares (clause xx of the Trust Deed).

Irretrievable cash contributions, other than those paid in respect of the Trustee's fees and expenses, constitute accretions to the corpus of the EST and cannot be repaid to the employer other than through subscription for Shares (Clause xx of the Trust Deed).

Accordingly, the irretrievable cash contributions made to the Trustee to fund the acquisition of Shares will not be assessable income under section 6 5 but constitute capital receipts of the Trustee of the EST. As the irretrievable cash contributions constitute capital receipts they will not be assessable income of the EST under section 6-5.

This is consistent with the view expressed in ATO Interpretative Decision ATO ID 2002/965 Income Tax: Trustee not assessable on employer contributions made to it under the employer's employee share scheme.

Conclusion

The irretrievable cash contributions made to the Trustee of the EST to fund the acquisition of or subscription for Shares by the EST will not be assessable income of the EST under section 6-5 or section 6-10.

Question 2

Summary

Any capital gain or loss made by the EST, or a beneficiary of the EST, in respect of Shares being acquired by the EST and then allocated to participants under the plans, and that arises as a result of CGT Event E5 or E7, will be disregarded pursuant to subsection 130-90(1) of the ITAA 1997.

Detailed reasoning

Subsection 130-90(1) operates to disregard any capital gain or capital loss if the conditions of the section are satisfied. Subsections 130-90(1) and (2) relevantly state:

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

(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.

(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.

Therefore, in order for subsection 130-90(1) to operate and disregard a particular capital gain or capital loss of a trust (or a beneficiary of that trust) arising as a result of CGT Event E5 or E7, the following requirements must be satisfied:

• The trust is an 'employee share trust' for the purposes of the ITAA 1997

• Paragraphs 130-90(1)(b), (c) and (d) are satisfied, and

• Subsection 130-90(2) does not apply.

Employee Share Trust

The relevant definition of 'employee share trust' is contained in subsection 130-85(4), which states:

Meaning of employee share trust

(4) 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 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).

ESS Interest

An 'ESS interest' in a company is defined in subsection 83A-10(1) as being either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in a company.

Rights that provided to xx under the xx plan and Rights that will be issued under the xx plan are ESS interests for the participating employees, as they each comprise of a right to acquire a beneficial interest in one or more Shares (over which the relevant employee has a beneficial interest).

Furthermore, Shares held by the Trustee of the EST are ESS interest for participating employees when they are allocated to the participant, as they each comprise of a beneficial interest in a share in the company held indirectly through the EST.

Employee share scheme

The term 'employee share scheme' is defined in subsection 83A-10(2), which states:

(2) An employee share scheme is a scheme under which ESS interests in a company are provided to employees, or associates of employees, (including past or prospective employees) of:

(a) the company; or

(b) subsidiaries of the company;

in relation to the employees' employment.

For the purposes of subsection 83A-10(2), subsection 995-1(1) defines the term 'scheme' as follows:

scheme means:

(a) any arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The plans are employee share schemes for the purposes of Division 83A as they are arrangements which, provide an ESS interest (i.e. a beneficial interest in a share or a right), to a Participant in relation to their employment in the employer or a company in the employer Group.

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

The employer has established the EST under the Trust Deed to acquire Shares and to allocate those Shares to employees in order to satisfy ESS interests acquired by those employees under the plans.

Therefore, paragraphs 130-85(4)(a) and (b) are satisfied for the EST because:

• the EST acquires Shares or Rights in a company, and

• the EST ensures that the ESS interests, being beneficial interests in those Shares or Rights, are provided or satisfied under an employee share scheme by allocating those shares to the employees in accordance with the Trust Deed and plan rules.

Is the EST an employee share trust?

In order to meet the definition of employee share trust, a trust's sole activities must be the activities covered by paragraphs 130-85(4)(a) and (b) and any other activities that are merely incidental.

Undertaking the activities mentioned in paragraph 130-85(4)(a) and (b) will require the Trustee to undertake incidental activities that are a function of managing the plans and administering the EST.

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 list of activities that are merely incidental (and that are therefore covered by paragraph 130-85(4)(c)). However, activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire shares) are not considered merely incidental.

In this case, clause 4.16 of the Trust Deed states:

4.16 Sole activities test

Without limiting the generality of clause 4.7, the Company and the Plan Trustee agree that the Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of section 130-85(4) of the ITAA.

Consequently, all other activities of the EST are merely incidental to the activities covered by paragraphs 130-85(4)(a) and (b). As the trust also meets the requirements of paragraphs 130-85(4)(a) and (b) themselves, the EST is therefore an 'employee share trust' within the meaning of the ITAA 1997.

Paragraphs 130-90(1)(b), (c) and (d)

Paragraphs 130-90(1)(b)

Paragraphs 130-90(1)(b) requires that the relevant CGT event, being either CGT event E5 or CGT event E7, happens 'in relation to a share'.

CGT event E5 and CGT event E7 will happen in the circumstances set out in subsection 104-75(1) and subsection 104 85(1) respectively, which state:

104–75 Beneficiary becoming entitled to a trust asset: CGT event E5

(1) 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 (disregarding any legal disability the beneficiary is under).

104–85 Disposal to beneficiary to end capital interest: CGT event E7

(1) 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.

Consequently, CGT event E5 will happen in relation to a Share of the EST when a participating employee becomes absolutely entitled to that Share as against the trustee. This occurs, subject to the exact terms of the plans, at the time the Shares are allocated by the Trustee of the EST.

In addition, CGT event E7 may happen in relation to a Share of the EST when the Trustee disposes of that Share to a participating employee in satisfaction of that employee's beneficial interest in the Share. However, it should be noted that section 106-50 affects the operation of section 104-85 such that CGT event E7 may not happen in these circumstances.

Subsection 995-1(1) defines a share in a company to mean a share in the capital of a company. Each Share held by the Trustee is a share in the capital of a company (i.e. xx Limited).

Therefore, both CGT event E5 and CGT event E7 will happen in relation to a share, being a Share of the EST, for the purposes of paragraphs 130-90(1)(b).

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a Share by exercising the Rights granted under the plans.

Paragraph 130-90(1)(d)

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

83A–20 Application of Subdivision

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

Note 1: This Subdivision does not apply if Subdivision 83A–C applies: see section 83A–105…

As established above, the plans are employee share schemes for the purposes of Division 83A and rights granted under the plans are ESS interests that are acquired under those employee share schemes.

In addition, all Rights granted under the plans will be acquired at no cost.

Accordingly, prima facie, Subdivision 83A-B will apply to Rights acquired under the plans because, pursuant to subsection 83A-20(1), the relevant ESS interests will be acquired under an employee share scheme at a discount. However, Subdivision 83A-B will not apply if Subdivision 83A-C applies.

Whether a Participant is ultimately taxed under Subdivision 83A-B or under Subdivision 83A-C will depend on whether additional requirements in those subdivisions have been satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

Conclusion

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

Under these circumstances, subsection 130-90(1) operates to disregard any capital gain or loss made by the EST, or a beneficiary of the EST, on any Share when:

• CGT event E5 happens because a beneficiary (i.e. Participant in the plans) becomes absolutely entitled to that share, or

• CGT event E7 happens because the Trustee disposes of that share to a Participant in satisfaction of that employee's beneficial interest in the Share.