Edited version of your written advice

Authorisation Number: 1013072679889

Date of advice: 29 August 2016

Ruling

Subject: Employee Share Scheme

Question 1

Will the irretrievable cash contributions by Company A Limited (Company A) or any subsidiary member of the Company A tax consolidated group headed by Company A to Company B Pty Ltd (the Trustee) as trustee for the Company A Employee Share Trust (the Trust) to fund the acquisition of Company A shares by the Trustee for the purposes of the Performance Rights Plan (PRP) be assessable income of the Trust under section 6-5 or 6-10?

Answer

No.

Question 2

Will a capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to Company A shares (capital gains tax (CGT) event E5), or when the Trustee disposes of the shares to the employees (CGT event E7), be disregarded under section 130-90 if the employees acquire the shares for the same or less than the cost base of the shares in the hand 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

Year ending 30 June 2021

Year ending 30 June 2022

Relevant facts and circumstances

Company A is an Australian company.

Company A's stated purpose in establishing and funding its PRP is to maintain a productive and motivated work environment including:

• to act as a key retention tool, and

• to focus attention on future Shareholder value generation.

Company A's remuneration strategy adopts the use of fixed remuneration, short term incentives and long term incentives such as the PRP.

Performance Rights Plans

The PRP is governed by Company A's Performance Rights Plans Rules (PRPR).

Company A PRP under the PRPR

The PRP is governed by the PRPR, they operate as follows:

• Eligible Participants are issued Invitations by the Board to apply for up to a specified number of Performance Rights, which vest according to performance criteria (also referred to as "Vesting Conditions"). The Performance Rights will be issued to Participants for nil consideration.

• Amongst other things, the Invitation will outline the maximum number of Performance Rights offered that the Eligible Participant may apply for, the maximum number of Shares that the Participant is entitled to be issued on the exercise of each Performance Right, whether the exercise on Vesting is automatic or manual and the applicable Vesting Conditions.

• Once the Eligible Participant has received the Invitation, the Eligible Participant or a Nominee may apply for Performance Rights described in that Invitation, in accordance with the instructions accompanying the Invitation. The Board may accept or reject any application in its absolute discretion.

• Once the Board has received and accepted a duly signed application form for Performance Rights, the Company must promptly grant Performance Rights to the applicant.

• The satisfaction of the Vesting Conditions shall determine the proportion of Performance Rights which vest and become exercisable to the Participant.

• Once exercised, Company A must issue to the Participant or instruct the Trustee to subscribe for, acquire and/or allocate for the benefit of the Participant the number of shares.

• The Trustee will hold the shares that were subscribed for and/or acquired on-market in accordance with the terms of the Trust Deed.

• The Performance Rights will vest at the end of the performance period, subject to the satisfaction of all or some of the PRPR.

• Once allotted, the Shares will be held in the Trust on behalf of the Participant subject to conditions as specified in the Plan Rules.

Company A's PRP

The PRP is a key part of Company A's remuneration framework for key management personnel.

As set out in the PRPR the purpose of the PRP is to:

(a) assist in the reward, retention and motivation of Eligible Participants

(b) link the reward of Eligible Participants to performance and the creation of Shareholder value

(c) align the interests of Eligible Participants more closely with the interests of Shareholders by providing an opportunity for Eligible Participants to receive Shares

(d) provide Eligible Participants with the opportunity to share in any future growth in value of the Company, and

(e) provide greater incentive for Eligible Participants to focus on the Company's longer term goals.

Participants in the PRP are Directors and key management personnel of the Company A Employer Entities.

The grant of Performance Rights does not automatically entitle a Participant to a Share. The actual number of Shares to which the Participant may become entitled will depend on:

• the degree to which the PRP performance measures are satisfied over the PRP performance period

• the satisfaction of one or more of the Vesting Conditions (as determined by the Board), during the relevant performance period, and

• the operation of the PRPR.

Company A Employee Share Trust

The Trust will be set up for the sole purpose of obtaining shares for the benefit of employees of Company A.

The Trust operates as follows:

• The Trust will be managed and administered so that is satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the ITAA 1997.

• The Trust will be funded by contributions from Company A's Employer Entities

• These funds will be used by the Trustee of the Trust to acquire the shares in Company A either on-market or via a subscription for new shares in Company A.

The Trustee is an external trustee acting in an independent capacity on behalf of the beneficiaries of the Trust.

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 subsection 83A-20(1)

Income Tax Assessment Act 1997 section 83A-105

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 section 130-90

Income Tax Assessment Act 1997 subsections 130-90(1A)

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

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

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

Reasons for decision

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

Question 1

Summary

The irretrievable cash contributions by Company A or any subsidiary member of the Company A tax consolidated group headed by Company A to Company B (the Trustee) to fund the acquisition of Company A shares by the Company A Employee Share Trust (the Trust) for the purposes of the Performance Rights Plan (PRP) will not be 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.

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 of these provisions, see section 10-5.

Section 6-5 provides that your assessable income includes income according to ordinary concepts which is also called ordinary income. The classic definition in Australian law was given by Chief Justice Jordan in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215. 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). 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 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.

ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme provides that the trustee of an employee share scheme (ESS) trust will not be assessed under section 6-5 on contributions made to the trust by an employer for the purpose of, and under, the employer's employee share scheme as the contributions constitute capital receipts to the trustee.

The Company A Trust Deed states that Trust Shares held by the Trustee on behalf of participants will be held by the Trustee on trust for and on behalf of that Participant on the terms of this Deed and subject to the relevant Plan Rules and relevant Terms of Participation.

The Company A Trust Deed states that all funds received by the Trustee from Company A or a subsidiary of Company A will constitute accretions to the corpus of the Trust and will not be repayable by the Trustee. Furthermore, pursuant to the terms of the Trust Deed, The Trustee must, when directed by Company A subscribe for or acquire Company A shares on behalf of Participants and use the contributions made by Company A to do so.

The general powers granted to the Trustee of the Trust pursuant to the Trust Deed must be exercised only for the purposes of the Trust and only to give effect to the PRP which the Trust supports. The contributions by Company A to the Trust will be to procure shares to satisfy awards made to employees of Company A under the PRP.

Accordingly, the irretrievable and non-refundable contributions made by Company A to the Trustee to subscribe for or acquire Company A shares will not be included in the assessable income of the Trust under section 6-5 but will constitute capital receipts to the trustee.

None of the provisions listed in section 10-5 are relevant in the present circumstances. Therefore, the irretrievable and non-refundable contributions made by Company A to the Trustee for the Trust to fund the subscription for, or acquisition on-market of, Company A shares under the PRP will not be included in the assessable income of the Trust under section 6-10.

Question 2

Summary

Capital gain tax (CGT) that arises for the Trustee at the time when the employees become absolutely entitled to Company A shares (CGT event E5), or when the Trustee disposes of the shares to the employees (CGT event E7) will be disregarded under section 130-90 provided the employees acquire the shares for the same or less than the cost base of the shares in the hand of the Trustee.

Detailed reasoning

Section 130-90 applies to disregard any capital gain or capital loss made by an employee share trust where certain criteria are met. Subsections 130-90(1) and (2) state:

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

(a) 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 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).

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

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

Subsection 83A-10(2) defines an ESS 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 PRP is an ESS within the meaning of subsection 83A-10(2) because it is a scheme under which rights to acquire beneficial interests in ordinary shares in Company A are provided to employees in relation to the employees' employment.

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

The Company A Trust Deed states that the Trustee must hold Shares on behalf of a Participant under the terms of the Trust Deed, the relevant Plan Rules and the Participant's relevant Terms of Participation.

The Company A Trust Deed states that the Board may by notice in writing instruct the Trustee to subscribe for, purchase and/or allocate a number of Shares specified in the Dealing Notice to be held by the Trustee in respect of an identified Participant or Participants.

The Trustee will, in accordance with the instructions received by Company A promptly acquire, subscribe for and allocate Company A shares for the benefit of a Participant provided the Trustee receives sufficient funds or having sufficient capital (Clause 5.2 of the Trust Deed).

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 shares of Company A), are provided under an ESS (as defined in subsection 83A-10(2) by allocating those shares to the employees in accordance with the Company A Trust Deed and the PRP.

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 PRP.

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.

The Company A Trust Deed states some specific things that the Trustee has the power to do but they are subject to the terms of the Company A Share Trust Deed and all would be considered incidental for the purposes of paragraph 130-85(4)(c).

The Company A Trust Deed states that Company A and the Trustee agree that the Trust will be managed and administered so that it satisfies the definition of employee share trust (EST) for the purposes of section 130-85(4).

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 Company A Trust Deed, the PRP and the PRPR are merely incidental to operation of the PRP.

The Trust satisfies the definition of an EST 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 shares of Company A), are provided under an ESS (as defined in subsection 83A-10(2) by allocating those shares to the employees in accordance with the Company A Trust Deed, the PRP and the PRPR, and

• the Company A Trust Deed does not provide for the Trustee to participate in any activities which are not considered to be merely incidental to a 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 PRP at the time the Participant become 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 exercise of a Performance Right 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 exercising a right (Performance Right) under the PRP.

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 ESS 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 PRP is an ESS within the meaning of subsection 83A-10(2) because it is a scheme under which rights to acquire beneficial interests in ordinary shares in Company A are provided to employees in relation to the employees' employment. Each Performance Right is acquired for no cost.

Subdivision 83A-B will apply to Performance Rights acquired under the PRP as pursuant to subsection 83A-20(1) the ESS interests (i.e. Performance Rights issued under the PRP) will be acquired under an ESS (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 Company A Share Trust at the time that CGT event E5 happens, subsection 130-90(1) will apply.

Subsection 130-90(1A)

Subsections 130-90(1A) and 130-90(2) state:

130-90(1A)

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

(a) immediately before the event happens, an ESS interest is a CGT asset of the trust; and

(b) either of the following subparagraphs applies:

(i) the event is CGT event E5, and the event happens because a beneficiary of the trust becomes absolutely entitled to the ESS interest as against the trustee;

(ii) the event is CGT event E7, and the event happens because the trustee disposes of the ESS interest to a beneficiary of the trust; and View history reference

(c) Subdivision 83A-B or 83A-C (about employee share schemes) applies to the ESS interest.

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.

Under the PRP, Participants are invited to acquire shares in Company A, which will make contributions to the Trustee in order to allow it to either subscribe for shares from Company A or acquire them on-market to satisfy the offers made to the eligible employees under the PRP.

Subsection 130-90(1A) provides that any capital gain or loss made by an EST is disregarded where it results from a CGT event if immediately before the event happens an ESS interest is a CGT asset of the trust and a beneficiary of the trust becomes absolutely entitled to the ESS interest (CGT event E5), or the trustee disposes of the ESS interest to a beneficiary of the trust (CGT event E7).

For the reasons discussed above the Company A Share Trust satisfies the definition of an EST in subsection 130-85(4).

Paragraph 130-90(1A)(a) is satisfied as the shares held by the Trustee are ESS interests which are CGT assets of the Company A Share Trust.

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

The PRP is an ESS for the purposes of Division 83A as it is an arrangement under which an ESS interest is provided to a Participant in relation to their employment in Company A in accordance with the Company A Trust Deed.

Subdivision 83A-C will apply to Company A shares acquired under the PRP (refer section 83A-105). Accordingly, paragraph 130-90(1A)(c) will be satisfied.

Accordingly, all the conditions in subsection 130-90(1A) 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 Company A Share Trust at the time that CGT event E5 happens, subsection 130-90(1A) will apply.

Conclusion

Under the circumstances of either subsection 130-90(1) or 130-90(1A) applying, 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), 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.

A Participant, on allocation of the Company A shares by the Trustee, becomes absolutely entitled to those shares. In accordance with sub-clause 3.1(b) of the Company A Trust Deed each Participant is absolutely entitled to their Allocated Shares held by the Trustee on their behalf, and is entitled to all other benefits and privileges attached to, or resulting from holding, those Allocated Shares.

Once a Participant is absolutely entitled to the Company A share held on their behalf by the Trust, section 106-50 will deem the disposal of the Company A share 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 PRP (by way of transfer to a Participant), the Trustee will not make a capital gain or capital loss under CGT Event E7.