Edited version of your written advice

Authorisation Number: 1013063381392

Date of advice: 18 August 2016

Ruling

Subject: Employee Share Scheme

Question 1

Will the irretrievable cash contributions made by the Employer to fund the acquisition of Employer shares by the Trust be included in the assessable income of the Trust under section 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 the Trustee makes at the time when an employee becomes absolutely entitled to Employer shares be disregarded under section 130-90 of the ITAA 1997 if the employee acquires the shares for the same amount as, or an amount that is more or less than the amount of the cost base of the shares in the hands of the Trustee?

Answer

Yes

Relevant facts and circumstances

Background

The Employer is a listed Australian company and its subsidiary companies.

Employees of the Employer and its subsidiaries may benefit under the employee share plan (the Plan).

The Plan

The Employer established the Plan for key employees of the business as part of its long-term strategy of creating wealth. The Plan is governed by Plan Rules.

Participants in the Plan are employees of the Employer and of various subsidiaries of the Employer.

The Plan is to reward, motivate, promote and attract senior executives and selected employees who are important to the Employer's long term growth and wealth creation

The Plan enables eligible employees to share in the growth of the Employer through grants of performance rights. The performance rights are capable of exercised into ordinary shares following the satisfaction of certain vesting conditions. Under the current offer, the performance rights will be subject to time-based vesting and performance-based conditions.

The Plan broadly operates as follows:

• It is at the absolute discretion of the Employer to issue written invitations to Eligible Participants to apply for up to a specified number of performance rights

• Subject to the terms attaching to the performance rights, each performance right entitles the Eligible Participant to one fully paid ordinary share in Employer

• A performance right granted under the Plan may not be exercised unless the vesting conditions attaching to that performance right are met

• The Employer will advise the Eligible Participant of the achievement, satisfaction or waiver of a vesting condition

• The price that an Eligible Participant will pay when exercising that performance right is as specified in the relevant invitation

• Once all conditions on the performance rights, as determined by the Employer, have been satisfied, Eligible Participants will be entitled to exercise the performance rights

• The exercise of any performance rights granted under the Plan will be effected in the form and manner determined by the Employer, and will be accompanied by payment of the exercise price

• The performance right is automatically exercised on the satisfaction of the vesting conditions

• After a performance right under the Plan is exercised by an Eligible Participant, the Employer must promptly issue or procure the transfer of the said number of shares

• A performance right will lapse when there is a failure to meet the performance right's vesting condition in the prescribed period

• A performance right that is not exercised will automatically lapse on the 7^th anniversary of its Grant date, unless an earlier lapsing date applies, and

• Performance rights are not transferable without the prior written consent of the Employer.

Employee Scheme Share Trust

The Employer established an employee share scheme trust (the Trust), a sole purpose trust to subscribe for, or acquire, allocate, hold and transfer shares for participating employees pursuant to the Plan and the appointment of a trustee to operate the Trust as Trustee (the Trustee). The establishment of the Trust for such a purpose is specifically allowable under the Plan Rules.

The trust will operate in accordance with the Trust Deed.

The Trustee is not permitted to carry out activities that are neither matters nor things which are necessary or expedient to administer and maintain the Trust. The Trustee must not carry out activities which result in the Participants being provided with additional benefits other than the benefits that arise from the relevant Plan rules and/or relevant terms of Participation.

The Trustee is not entitled to receive from the Trust any fees, commission or remuneration in respect of the performance of its obligations as trustee of the Trust. The Employer may pay to the Trustee from its own resources any fees, commission or remuneration and reimburse any expenses incurred by the Trustee as the Employer and the Trustee may agree from time to time. The Trustee is entitled to retain for its own benefit any such remuneration or reimbursement.

The Trust will be managed and administered so that it satisfies the definition of 'employee share trust' in subsection 130-85(4) of the ITAA 1997.

The Trust will operate as follows:

• The Trust will be funded by contributions from the Employer (for example, for the purchase of shares in accordance with the Plan

• These contributions will be used by the Trustee to purchase shares in the Employer either on-market or via a subscription for new shares in the Employer (or through a combination of both), based on written instructions from Employer

• Shares acquired by the Trustee will be allocated to the Participant following the exercise of the performance rights. The Participant will become absolutely entitled to such shares

• The Trustee can sell shares on behalf of a Participant where permitted to do so by the Participant

• The Trustee will, in accordance with instructions received pursuant to the Plan rules, subscribe for, purchase or allocate the Employer shares for the benefit of Participants provided that the Trustee receives sufficient funds from the Employer to subscribe for or purchase such shares and/or has sufficient unallocated trust shares available

• The Trustee must establish and maintain a separate trust share account or record in respect to each Participant

• While the Employer shares are held in trust, the Participant will be entitled to dividend and voting rights. These shares may be subject to disposal restrictions, including but not limited to imposing a holding lock, and

• All funds received by the Trustee from the Employer will constitute accretions to the corpus of the trust and will not be repaid to the Employer and no Participant shall be entitled to receive such funds. The contributions will not be repaid to the Employer unless they are used to subscribe for shares.

Contributions made by the Employer to the Trust

The Employer will not make cash contributions significantly in excess to the market value of shares that have been and will be acquired for employees. The Trust will use the cash contributions exclusively to purchase shares in the Employer for employees under the Plan and, pending such an acquisition, form part of the Trust's assets.

Shortly after vesting, the Trustee will then allocate shares to the relevant Participants, having subscribed for or acquired on-market sufficient shares to fulfil the obligation as necessary.

The Trustee of the Trust holds or will hold all shares pursuant to the Plan on capital account.

Use of the Trust to facilitate the Plan

All dealings between the parties are conducted according to the rules set out in the Plan and the Trust Deed.

The Employer chose to use an employee share trust for a range of reasons in addition to the Trust being a vehicle for the delivery of shares to employees. In the present case, the Trust:

• is the most effective means to acquire sufficient on-market shares to satisfy the estimated share performance vesting requirements, without the need to dilute current shareholdings or pay excessive prices for on-market acquisitions immediately prior to performance rights vesting

• provides the opportunity to improve cash flow management through the flexibility to control the timing of contributions being made to the trust to enable it to acquire shares

• provides the flexibility to acquire and warehouse shares that will be delivered to employees under its employee share plan

• aligns with the capital management strategy of the company - it enables the shares that will be delivered to employees to be acquired on-market or by subscription

• gives an Eligible Participant the knowledge that the shares, and any incidental dividend income, will be held by a trust, and

• enables easier administration of the Plan because the holding and accounting of the shares are separated from the company.

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 Subdivision 83A

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 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

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

Income Tax Assessment Act 1997 subsection 104-75(3)

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

Income Tax Assessment Act 1997 section 106-50

Income Tax Assessment Act 1997 subsection 106-50(1)

Income Tax Assessment Act 1997 Subdivision 130-D

Income Tax Assessment Act 1997 subsection 130-85(1)

Income Tax Assessment Act 1997 subsection 130-85(2)

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

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

Income Tax Assessment Act 1997 paragraph130-85(4)(b)

Income Tax Assessment Act 1997 paragraph130-85(4)(c)

Income Tax Assessment Act 1997 section 130-90

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

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

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 130-90(2)

Income Tax Assessment Act 1997 section 995-1

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

Reasons for decision

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

Question 1

Summary

The irretrievable cash contributions made by the Employer to fund the acquisition of Employer shares by the Trust will not be included in the assessable income of the Trust under section 6-5 or 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:

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

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.

The irretrievable cash contributions that the Employer makes or will make to the Trust are not addressed by the provisions listed in section 10-5 (with the exception of the matters discussed in the Detailed reasoning for Question 2 below). Therefore the irretrievable cash contributions made by the Employer to the Trust will not be assessable income of the Trust 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.

Pursuant to the Trust Deed, all contributions the Employer makes or will make to the Trust for the purposes of acquiring Employer shares constitute accretions to the corpus of the Trust. Furthermore, to the Trust Deed, the Trustee must, when directed by the Board, acquire Employer shares on behalf of the Participants and use the contributions made by the Employer to do so.

The general powers granted to the Trustee under the Trust Deed require that these powers must be exercised only for the purposes of the Trust and only to give effect to the Plan which the Trust supports. To this end, the contributions received from the Employer and the Participants must, therefore, be used to acquire Employer shares in accordance with the terms of the Trust Deed and the Plan rules.

Accordingly, the irretrievable cash contributions made by the Employer to the Trustee to acquire Employer shares will not be assessable income under section 6-5 but constitute capital receipts of the Trustee.

Therefore, the irretrievable cash contributions made by Employer to the Trustee of the Trust to fund the subscription for or acquisition of Employer shares by the Trust in accordance with Trust Deed will not be assessable income of the Trust pursuant to sections 6-5 or 6-10. This accords with the view set out in ATO Interpretative Decision ATO ID 2002/965: Trustee not assessable on employer contributions made to it under the employer's employee share scheme. Note that clause 4.5 of the Trust Deed provides that Employer may pay from its own resources any fees, commission or remuneration and reimburse any expenses incurred by the Trustee as the Employer and the Trustee may agree from time to time. The clause provides further that the Trustee is entitled to retain for its own benefit any such remuneration or reimbursement. Such receipts will be assessable income of the Trustee in contrast to the irretrievable cash contributions to acquire Employer shares.

Note also that income derived by the employment of the property that is the fund of the corpus of the trust and which the Trustee holds on trust will be income according to ordinary concepts. (See Federal Commissioner of Taxation v Everett (1980) 143 CLR; 440; (1980) 10 ATR 608; 80 ATC 4076 for a discussion of the distinction between the trust income and corpus).

Question 2

Summary

A capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to Employer shares will be disregarded under section 130-90 if the employees acquire the shares for the same amount as, or an amount that is more or less than, the cost base of the shares in the hands of the Trustee.

Detailed reasoning

Section 130-90

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

These conditions are that CGT event E5 or CGT event E7 happens in relation to a beneficial interest in a share acquired by the beneficiary by exercising a right which was an ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

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

Employee share trust

The term 'employee share trust' referred to in subsection 130-90(1) is defined in subsection 995-1 as having the meaning given by subsection 130-85(4).

Subsection 130-85(4) provides that an employee share trust for an employee share scheme (having the meaning given by subsection 83A-10(2)) 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).

The right to acquire a share and the beneficial interest in the share that is acquired pursuant to the exercise of the performance right are both ESS interests within the meaning of subsection 83A-10(1).

An employee share scheme is defined in subsection 83A-10(2) as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) as it is a scheme under which rights to acquire shares in the Employer are provided to employees in relation to their employment.

The Employer established the Trust to facilitate the Plan by acquiring Employer shares and allocating those shares to Participants, in order to satisfy the performance rights acquired under the employee share scheme. The beneficial interest in the Employer shares is itself provided under an employee share scheme as it is provided under the same scheme under which the performance rights to acquire those shares are provided to Participants in relation to the Participant's employment, being an employee share scheme as defined in subsection 83A-10(2).

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

• the Trustee acquires Employer shares, and

• the Trustee ensures that ESS interests as defined in subsection 83A-10(1), being beneficial interests in those shares, are provided under an ESS, as defined in subsection 83A-10(2), by allocating those shares to the Participants in accordance with the governing documents of the scheme.

In undertaking the activities mentioned in paragraphs 130-85(4)(a) and (b), the trustee will be required to undertake incidental activities that are a function of managing the employee share scheme and administering the trust.

For the purposes of paragraph 130-85(4)(c), activities which are merely incidental, as set out in 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, include:

• 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 merely incidental.

The Trust Deed provides that the Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of subsection 130 85(4).

The Trust Deed makes it clear that the Trustee can only use the contributions received from the Employer or any subsidiary members for the acquisition of Employer shares for Participants in accordance with the Plan. To this end, all other duties/general powers listed in the Trust Deed are considered to be merely incidental to the functions of the Trustee in relation to its dealing with the Employer shares to be acquired for Participants of the Plan.

Accordingly, paragraph 130-85(4)(c) is also satisfied because the Trust satisfies the definition of an employee share trust in subsection 130-85(4), as the Trust Deed prevents the Trustee from participating in any activities which are not considered merely incidental to a function of managing the employee share scheme and administering the trust.

Therefore, the Trust is an employee share trust, as defined in subsection 995-1(1), as the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) and its other activities (general powers) are merely incidental to those activities in accordance with paragraph 130-85(4)(c).

Paragraph 130-90(1)(a)

CGT event E5

Subsection 104-75(1) provides that CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies), as against the trustee. Subsection 104-75(3) provides that the trustee will make a capital gain if the market value of the asset (at the time of the event) is more than its cost base, but will make a capital loss if the market value is less than the asset's reduced cost base.

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

Under the Plan, where a Participant becomes absolutely entitled to shares as against the Trustee, CGT event E5 will happen, and pursuant to subsection 104-75(3), the Trustee will make a capital gain or loss.

CGT event E5 will happen under the terms of the Plan at the time when the Participant becomes absolutely entitled to the shares in the Employer as against the Trustee of the EST.

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, subsection 106-50(1) provides:

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

The Participant, on allocation of the Employer shares by the Trustee, becomes absolutely entitled to those shares. In accordance with clause 3.1 of the Trust Deed each Participant is absolutely entitled to any Allocated shares held by the trustee on their behalf, and is entitled to the same rights in those shares as if he or she was the legal owner of the shares.

Once the Participants are absolutely entitled to the Employer shares held on their behalf by the Trust, section 106-50 will operate to treat the disposal of the shares by the Trustee as if the disposal were by the Participants.

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

Paragraph 130-90(1)(b)

Section 995 defines a share to mean a share in the capital of a company. An ordinary share in the Employer held by the Trustee of the Trust and to which a Participant is entitled to upon the exercising of a performance right is a share in the capital of the Employer. Accordingly, paragraph 130-90(1)(b) will be satisfied as CGT event E5 will happen in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) will be satisfied as a Participant will acquire a beneficial interest in a share in the Employer by way of exercising a performance right granted under the Plan.

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.

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

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;….

in relation to the employees' employment.

For the purposes of subsection 83A-10(2), section 995 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 Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest (i.e. a beneficial interest in a right to acquire a beneficial interest in a share of the Employer), is provided to eligible employees in relation to their employment in the Employer in accordance with the Trust Deed. The performance rights are issued under the Plan at nil exercise price. Therefore, the exercise price will not exceed the share price paid by the Trust to acquire those shares. Shares will be acquired by the Trust under the Plan on behalf of employees, using contributions made by the Employer and any subsidiary members.

Accordingly, prima facie, Subdivision 83A-B will apply to performance rights acquired under the Plan as pursuant to subsection 83A-20(1), the ESS interest (i.e. performance rights issued under the Plan) will be acquired under an employee share scheme 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 her or his assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C will be satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

Section 130-90(2)

As the Participant will not acquire the beneficial interest in an Employer share for more than its cost base in the hands of the Trust at the time that CGT event E5 or CGT event E7 happens, subsection 130-90(2) will also be satisfied.

Conclusion

Accordingly, section 130-90 will operate to disregard any capital gain or loss made by the Trustee on CGT event E5 or CGT event E7 happening to the shares.