Edited version of your written advice

Authorisation Number: 1013113126007

Date of advice: 28 October 2016

Ruling

Subject: Employee share scheme, Fringe benefit tax

Question 1:

Will the issue of options to employees of Company A under the Employee Incentive Plan document, pursuant to the letter of offer, be subject to Division 83A of the Income Tax Assessment Act 1997?

Answer:

No

Question 2

Will Company A be liable to pay tax imposed by the Fringe Benefits Tax Act 1986 in relation to the issue of options to employees of Company A under the Employee Incentive Plan document, pursuant to the letter of offer?

Answer:

No

Question 3

Will the removal of exercise restrictions and subsequent exercise of options be considered fringe benefits provided by Company A pursuant to the Fringe Benefits Tax Assessment Act 1986?

Answer

No

This ruling applies for the following period

1 July 201X to 30 June 201Y

The scheme commences on

1 July 201X

Relevant facts and circumstances

1. Company A is an Australian resident private company.

2. The Company A Employee Incentive Plan ('Plan') was approved by the Company A Board.

3. By way of letter dated late 201X, Company A offered its employees the opportunity to acquire 'Incentive Options' pursuant to the Plan, with the following terms and conditions:

a. each option enables the holder to acquire ordinary shares in Company A

b. the issue price of the option is nil

c. the exercise price of the option is nil

d. the date of issue of the options is late 201X

e. vesting conditions: The options granted under the Plan are restricted from being exercised unless certain vesting conditions had been met, being:

i. the first XX% of options will vest X months after the date of grant of the options, and

ii. the remaining YY% of options will vest equally on a monthly basis over the following XX months

f. the expiry date of the options is X years from the date of grant, or, X months after a 'change of control', and

g. options which have not vested will lapse if the employee resigns from or terminates their position with Company A, unless the Board determines otherwise (clause 5.5 of the Plan).

4. The vesting schedule for Incentive Options issued to X employees commences XX months earlier than all other options issued to employees.

5. One recipient of the Incentive Options holds greater than X% of the Company A ordinary shares on issue, meaning they will not be eligible for deferred taxation under Subdivision 83A-C of the Income Tax Assessment Act 1997 (ITAA 1997).

6. In accordance with Clause 4.1 of the Plan, when Company A has received an employee's acceptance of the invitation letter, the Board may, in its complete discretion and only where the employee remains an employee of Company A, grant the Incentive Options to the employee with effect from the grant date in late 201X.

7. The date of issue of the options, in late 201X, is different to the date of the invitation letter, late 201X. This timing difference was to align the issuing of options with the employees annual performance review. Upon acceptance, employees were taken to have commenced participation in the scheme from late 201X. There were no events that occurred between late 201X and late 201X that would have materially affected Company A's market value.

8. The options provided pursuant to the letter of offer dated late 201X were provided to the employees in respect of their employment.

9. On a date in late 201X, at the time of issue of the options, Company A had the following shares on issue:

a. Ordinary Shares

b. Series Preference 'A' Shares

c. Series Preference 'B' Shares

d. Series Preference 'C1' Shares

Additionally, an option had been granted for the issue of Series Preference 'C2' Shares.

10. Company A's share classes are entitled to participate in a return of capital in the following order:

a. Preference C1 Shares (invested amount) and Preference C2 Shares (not on issue) ranking equally; followed by

b. Preference B Shares (invested amount); followed by

c. Preference A Shares (issue price then the preference coupon on the Preference A Shares); followed by

d. Ordinary Shares.

Independent Valuation Report

11. Company A received an independent valuation of the ordinary shares in the company. You have provided a copy of this valuation report.

12. This valuation report valued the ordinary shares of Company A as having a market value of nil on a 'Net Asset Backing' valuation methodology basis. This conclusion was primarily based upon Company A's negative net equity position at the time, along with the Preference Share Classes ranking higher than ordinary shares for rights to surplus assets in the event of a liquidity event.

13. The valuation report considered that other valuation methodologies, including market based, discounted cash flow, takeover bid and capitalisation of future maintainable earnings methodologies, were not appropriate given the stage that the company is at in its business life cycle.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 section 136

Fringe Benefits Tax Assessment Act 1986 section 40

Fringe Benefits Tax Assessment Act 1986 section 43

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 83A-20

Income Tax Assessment Act 1997 section 83A-105

Income Tax Assessment Act 1997 section 83A-315

Income Tax Assessment Regulations 1997

Taxation Administration Act 1953 Division 392

Taxation Administration Act 1953 section 392-5

Reasons for Decision

Question 1:

Detailed Reasoning

Record keeping obligations - Employee Share Schemes

14. 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.

15. In order for a company to fulfil its ESS reporting requirements outlined within Division 392 of the TAA, the company is required to know whether employees participated in an ESS and received ESS interests subject to Division 83A of the ITAA 1997.

Employee share schemes

16. Division 83A of the ITAA 1997 provides for the taxation of ESS interests acquired under an ESS at a discount.

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

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

19. Generally, the discount given in relation to an ESS interest acquired under an ESS is included in an employee's assessable income in the income year in which the interest is acquired under Subdivision 83A-B of the ITAA 1997, unless Subdivision 83A-C applies.

20. If Subdivision 83A-C of the ITAA 1997 applies to the ESS interest, the employee will include an amount in the income year in which the ESS deferred taxing point for the ESS interest occurs.

Discount

21. From sections 83A-20 and 83A-105 of the ITAA 1997 it is ascertained that Subdivision 83A-B or 83A-C cannot apply to an ESS interest acquired under an employee share scheme on or after 1 July 2009 unless that interest is acquired at a discount.

22. The term 'discount' is not defined for the purposes of Division 83A of the ITAA 1997. However, the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 ('2009 EM') states at paragraph 1.102 that the term 'discount' is:

   ... the market value of the ESS interest less any consideration paid, or to be paid, by the employee.

Market value

23. The ESS rules in Division 83A of the ITAA 1997 generally use the ordinary meaning of market value.

24. Section 83A-315 of the ITAA 1997 provides that the method for calculating the value of an ESS interest can also be specified by regulation in the Income Tax Assessment Regulations 1997 ('the Regulations'). If the Regulations specify an amount, taxpayers must use this amount instead of the market value in relation to the interest, unless the Regulations give a choice between using market value and a specified amount.

25. Subsection 83A-315(1) of the ITAA 1997 states:

Whenever this Division (other than section 83A-20) uses the *market value of an *ESS interest, instead use the amount specified in the regulations for the purposes of this section in relation to the interest, if the regulations specify such an amount.

26. Subsection 83A-315(1) of the ITAA 1997 was amended by the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 by inserting the words “(other than section 83A-20)” immediately after “Whenever this Division”.

27. The reason for this amendment was to fix a technical defect affecting the interaction of ESS rules and fringe benefits tax. This is explained in the Explanatory Memorandum to the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015, at paragraphs 1.105 and 1.106:

1.105 A technical defect in Division 83A has been identified where certain ESS interests that are issued at a discount to market value, are for the purposes of reducing compliance costs, deemed to have a market value which results in the discount for Division 83A purposes being nil. However, the unintended effect of such a deeming is for the ESS interest to then fall outside the scope of Division 83A and instead be subject to fringe benefits tax where the deemed value does not apply.

1.106 Schedule 1 to this Bill, amends Division 83A to ensure that such an ESS interest remains within the scope of Division 83A. However, because of the deemed market value and resulting nil discount, Division 83A will not include any amount in the assessable income of any employee, and will simply operate to set the cost base of the interest for capital gains tax purposes, which will generally remain the primary taxing code for these interests

28. As per schedule 1, item 51 of the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015, this technical amendment applies to assessments for the 2011-12 income year and later income years.

29. Therefore, for the purposes of applying section 83A-20 of the ITAA 1997 to determine whether Subdivision 83A-B applies to the ESS interests, subsection 83A-315(1) excludes the market value amount specified by the Regulations from being used to determine whether an ESS interest is acquired under an ESS at a discount. The ordinary meaning of market value is used for the determining the discount under section 83A-20 for calculations that affect assessments for the 2011-12 income year and later years.

Application to your circumstances

30. Under the Company A Employee Incentive Plan ('Plan'), Company A offered its employees the opportunity to acquire Incentive Options through an unlisted option acquisition scheme. The options provided under this scheme were provided to the employees in respect of their employment. In accordance with Clause 4.1 of the Plan, when Company A has received an employee's acceptance of the invitation letter dated late 201X, the Company A Board may, in its complete discretion and only where the employee remains an employee of Company A, grant the Incentive Options to the employee with effect from the grant date, late 201X.

31. The options issued under the Plan satisfy the definition of an ESS interest per paragraph 83A-10(1)(b) of the ITAA 1997.

32. The Plan is a scheme under which ESS interests in Company A are provided to employees of Company A in relation to their employment. Therefore, the Company A Plan qualifies as an ESS under subsection 83A-10(2) of the ITAA 1997.

33. Section 83A-20 of the ITAA 1997 provides that Subdivision 83A-B will apply if the options issued under the Plan are issued at a discount. The discount is calculated as the difference between the market value of the Company A option upon issue, less any consideration paid by the employee. Company A employees did not pay any consideration for the acquisition of the options.

Market value

34. The options were issued effective late 201X. For an assessment post the 2011-12 income year, the amended subsection 83A-315(1) of the ITAA 1997 excludes the market value amount specified by the Regulations from being used to determine whether the options are acquired at a discount under section 83A-20. The ordinary meaning of market value is used for the determining the discount under section 83A-20.

35. The Australian Taxation Office (ATO) has undertaken a valuation review of the independent valuation report you have provided and accepts that, for tax purposes, the options over ordinary shares acquired by the Company A employees effective late 201X will have a market value of nil at the time of acquisition.

36. As the consideration for the acquisition of the options (that is nil) is equal to, or more than, the market value of the options on acquisition, the options were not acquired at a discount. Therefore, subsection 83A-20(1) of the ITAA 1997 is not satisfied and Subdivision 83A-B does not apply to the options.

37. It follows that Subdivision 83A-C of the ITAA 1997 does not apply to the options, as paragraph 83A-105(1)(a) is not satisfied.

38. The issue of options to employees of Company A under the Employee Incentive Plan document, pursuant to the letter of offer dated late 201X, will not be subject to Division 83A of the ITAA 1997 on the basis that the options were not acquired by the employees at a discount to market value.

Question 2:

Detailed Reasoning

39. Fringe benefits tax (FBT) is defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) as tax imposed by the Fringe Benefits Tax Act 1986. An employer is liable to pay FBT on a fringe benefit they provide to an employee if the benefit has a taxable value.

40. A 'fringe benefit' includes a benefit provided by an employer to an employee in respect of the employment of the employee, in accordance with the definition in subsection 136(1) of the FBTAA.

41. Paragraph (h) of the definition of fringe benefit in subsection 136(1) of the FBTAA specifically excludes as a fringe benefit a benefit constituted by the acquisition of an ESS interest to which either Subdivision 83A-B or Subdivision 83A-C of the ITAA 1997 applies.

42. Relevantly for this ruling, section 136 of the FBTAA defines the following:

a. The term 'employer' includes a current employer.

b. The term 'current employer' means a person who pays or is liable to pay salary or wages.

c. The term 'employee' includes a current employee.

d. The term 'current employee' means a person who receives or is entitled to receive salary or wages.

e. The term 'employment' in relation to a person, means the holding of any office or appointment, the performance of any functions or duties, the engaging in of any work, or the doing of any acts or things that results, will result or has resulted in the person being treated as an employee.

f. The term 'property' means intangible property and tangible property.

g. The term 'intangible property' means:

i. real property;

ii. a chose in action; and

iii. any other kind of property other than tangible property;

but does not include:

iv. a right arising under a contract of insurance; or

v. a lease or licence in respect of real property or tangible property.

h. The term 'tangible property' means goods.

i. The term 'property benefit' means a benefit referred to in section 40.

j. A 'property fringe benefit' means a fringe benefit that is a property benefit.

k. An 'external property fringe benefit' means a property fringe benefit other than an in-house property fringe benefit.

l. An 'in-house property fringe benefit' means a property fringe benefit in respect of tangible property where other conditions are satisfied

m. The term 'notional value' in relation to the provision of property to a person means the amount that the person could reasonably be expected to have been required to pay to obtain the property from the provider under an arm's length transaction.

n. The term 'recipients contribution' in relation to a property fringe benefit means the amount of any consideration paid to the provider or to the employer by the recipient or by the employee in respect of the provision of the property, reduced by the amount of any reimbursement paid to the recipient in respect of that consideration.

43. Section 40 of the FBTAA provides that where, at a particular time, a person (the provider) provides property to another person (the recipient), the provision of the property shall be taken to constitute a benefit provided by the provider to the recipient at that time.

44. Section 43 of the FBTAA provides that the taxable value of an external property fringe benefit is:

a. where the provider was the employer and the recipient's property was purchased by the provider under an arm's length transaction at or about the provision time - the cost price of the recipient's property to the provider;

b. where the provider was not the employer and the employer incurred expenditure to the provider under an arm's length transaction in respect of the provision of the property - the amount of that expenditure; or

c. in any other case - the notional value of the recipient's property at the provision time;

reduced by the amount of the recipients contribution.

Application to your circumstances

45. Company A will be liable to pay FBT in relation to the options issued under the Plan if they constitute a fringe benefit that has a taxable value.

46. As concluded in question 1, the options were not acquired by the Company A employees at a discount, and therefore, neither Subdivisions 83A-B or 83A-C of the ITAA 1997 can apply. Thus the options acquired by the Company A employees are not excluded from being fringe benefits under paragraph (h) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA.

Fringe benefit

47. Each individual who participated in the Plan was an employee of Company A. The options were issued in respect of the employment of each individual. The options constitute a benefit provided by an employer to an employee in respect of the employment of the employee. The options constitute a fringe benefit for the purposes of the FBTAA.

Category of fringe benefit

48. There are different categories of a fringe benefit. In your circumstances, the options provide the employee with the right to acquire shares in Company A. Shares are considered to be 'intangible property' and a right to property is considered to be property for FBT purposes. A property fringe benefit therefore arises under section 40 of the FBTAA.

49. The options are characterised as 'external property fringe benefits' per the definition in subsection 136(1) of the FBTAA, as they do not fall within the definition of an 'in-house property fringe benefit'.

Taxable value of the fringe benefit

50. The taxable value of external property fringe benefits is set out in section 43 of the FBTAA. Given Company A is the employer and provider of the options, and the options were not purchased by Company A, neither subsection 43(a) or 43(b) can apply to the options.

51. The taxable value of the options, pursuant to paragraph 43(c) of the FBTAA, is the 'notional value' of the options at the time they were granted, reduced by any contribution from the employee. The recipient contribution in respect of the Company A options will be nil, as the employees are not paying anything to acquire the options. Therefore, the taxable value is the 'notional value' of the options.

52. The notional value of the options is the amount that the person could reasonably be expected to have been required to pay to obtain the options from Company A in an arm's length transaction.

53. You have provided an independent valuation report which concludes the options over ordinary shares acquired by the Company A employees effective late 201X will have a market value of nil. The ATO has reviewed this valuation report and accepts for tax purposes, the market value of the options is nil at the time of issue. This nil value represents the notional value, and hence the taxable value, of the options for FBT purposes.

Conclusion

54. The options issued under the Plan constitute a fringe benefit. However, the taxable value of the options for FBT purposes is nil. Company A will not be liable to pay any FBT imposed by the Fringe Benefits Tax Act 1986 as no value in relation to the options will be included in the fringe benefit taxable amount for Company A.

Question 3

Detailed Reasoning

55. For a benefit to be a 'fringe benefit' under subsection 136(1) of the FBTAA, it must be provided 'in respect of' the employment of the employee.

56. Whilst the expression 'in respect of' has no fixed meaning, it has been considered by the courts in various statutory contexts.

57. The full Federal Court in J and G Knowles v FC of T (2000) 96 FCR 402; 2000 ATC 4151; (2000) 44 ATR 22 examined the meaning of 'in respect of' in relation to fringe benefits tax and noted that: 

… what must be established is whether there is a sufficient or material, rather than a causal connection or relationship between the benefit and the employment… 

58. The Court also suggested that it would be useful to ask 'whether the benefit is a product or incident of the employment'.

Application to your circumstances

59. Under the Plan and pursuant to the letter of offer dated late 201X, certain Company A employees were granted incentive options effective late 201X. The options granted were restricted from being exercised unless certain vesting conditions had been met.

60. The exercise of the options is conditional on completion of a specific period of employment. Upon completion of the specific period of employment, the vesting conditions are satisfied and the employee is entitled to exercise the options. The first XX% of options will vest X months after the date of grant of the options. The remaining YY% of options will vest equally on a monthly basis over the following XX months.

61. When the vesting conditions are satisfied, Company A employees can exercise their options to acquire Company A ordinary shares at no cost.

62. As discussed in question 2, when the options are granted to the Company A employee they are considered to be a fringe benefit. The employee holds the options upon issue and the vesting conditions merely restrict their entitlement to exercise the options until the conditions are met. The removal of exercise restrictions, through the satisfaction of the vesting conditions, will not be considered a fringe benefit as no additional benefit is provided to the employee from Company A.

63. When options granted under an employee share scheme are exercised, and shares are allocated by the employer, it is considered that the benefit that arises comes as a consequence of the employee exercising the rights previously obtained under the scheme, and not in respect of employment.

64. Where the Company A employee has received shares by exercising their options, the acquisition of the shares is a product or incident of the exercise of the options. On the basis that the Company A employees were option holders, there is not a material connection between the shares and the employment of the Company A employee.

65. The removal of exercise restrictions and subsequent exercise of options are not considered to be a fringe benefit under subsection 136(1) of the FBTAA, as no benefit has been provided to the Company A employee in respect of an employment relationship.