Edited version of your written advice

Authorisation Number: 1051197076202

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Date of advice: 28 February 2017

Ruling

Subject: Employee share scheme and loan arrangement

Questions and answers

Question 1

Will the share scheme be considered an Employee Share Scheme under Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the loan constitute a deemed dividend assessable to X (the Individual) under section 109D of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 3

Will there be any deemed dividend assessable to the Individual under section 109C of the ITAA 1936 in relation to a transfer of all shares held by the Individual to the lender?

Answer

No.

Question 3

Should any deemed dividend be assessable to the Individual under section 109C of the ITAA 1936 in relation to a transfer of all shares held by the Individual to the lender, would the dividend amount be nil?

Answer

Not applicable

Question 4

Will there be any deemed dividend assessable to the Individual under section 109F of the ITAA 1936 in relation to a transfer of all shares held by the Individual?

Answer

No.

Question 5

Will any other provisions of Division 7A of Part III of the ITAA 1936 (Division 7A) apply to the share scheme and loan arrangement between the Individual and the Company?

Answer

No.

Question 6

Will any commercial debt forgiveness under Division 245 of the ITAA 1997 apply the Individual in relation to a transfer of all shares held by the Individual?

Answer

No.

Question 6

Will the Individual have any liability under either the ITAA 1936, or the ITAA 1997, in relation to the scheme or circumstance except for the following:

a) Personal income tax assessable to the Individual on any dividends received from the shares, or

b) Capital gains tax (CGT) payable by the Individual should he dispose of the shares in the future.

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The Individual is an employee of Company X (the Company).

The Individual is not currently, nor have they previously been, either, a shareholder of the Company, or an associate of a shareholder of the Company.

The Company proposes to provide the Individual with a limited recourse loan in the amount of $X to acquire X% of the total shareholding in the Company by way of a share issue.

The shares would be legally and beneficially held by the Individual.

The subscription price for the shares is $X, being the market value of the shareholding to be acquired as evidenced by a valuation letter from an accounting firm.

Clause X of the Loan Deed specifies that no interest will be payable on the loan.

Clause Y of the Loan Deed specifies that the annual loan repayments will be the greater of:

● $1.00; and

● the amount of any dividends from the Company to the Individual in respect of the shares, net of any tax payable on the dividends after allowance for any franking credits.

Clause Z of the Loan Deed specifies that:

● recourse for the recovery of the loan will be limited to the shares held by the Individual;

● until the loan has been repaid or satisfied in full, the Individual shall not transfer any shares held by them to an affiliate or relative of theirs;

● on any disposal of the shares held by the Individual, the net consideration received will be applied to reduce or repay the outstanding loan balance;

● where the net consideration received on disposal of the shares is greater than the outstanding loan balance, the surplus amount will be paid to the Individual by the Company;

● where the net consideration received on disposal of the shares is less that the outstanding loan balance, the amount will be applied in full and final satisfaction of the obligation of the Individual to repay the full amount owing and the Company will have no further recourse against the Individual in respect of any outstanding loan balance.

The Loan Deed does not specify a maximum loan term.

Clause X of the Shareholder's Deed specifies that the Individual may dispose of the shares to a third party subject to notice being provided to the Company in writing.

Clause Y of the Shareholder's Deed specifies that in the event of the Individual employment being terminated by them or the Company, the Company must conduct a buy-back, or selective reduction, of all the Individual's shares equal to the market value at that time.

Clause Z of the Shareholder's Deed specifies that in the event of the Individual being in default of the agreement, the Company may conduct a buy-back, or selective reduction, of all the Individual's shares equal to the market value at that time.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A of Part III

Income Tax Assessment Act 1936 Subsection 109C(1)

Income Tax Assessment Act 1936 Subsection 109C(4)

Income Tax Assessment Act 1936 Section 109D

Income Tax Assessment Act 1936 Subsection 109D(1)

Income Tax Assessment Act 1936 Subsection 109F(1)

Income Tax Assessment Act 1936 Subsection 109F(4)

Income Tax Assessment Act 1936 Section 109N

Income Tax Assessment Act 1936 Section 109NB

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 Section 245-10

Income Tax Assessment Act 1997 Paragraph 245-35(a)

Income Tax Assessment Act 1997 Section 245-50

Income Tax Assessment Act 1997 Section 245-60

Income Tax Assessment Act 1997 Subsection 245-60(1)

Income Tax Assessment Act 1997 Subsection 245-60(2)

Income Tax Assessment Act 1997 Subsection 245-60(3)

Income Tax Assessment Act 1997 Section 245-65

Income Tax Assessment Act 1997 Subsection 245-65(1)

Reasons for decision

Question 1

Division 83A of the ITAA 1997 provides that a discount received on shares, rights or stapled securities acquired under an employee share scheme is included in assessable income when the beneficial interest in those shares, rights or securities is acquired.

An employee share scheme is a scheme under which ESS interests in a company are provided to its employees (including current, past or prospective employees and their associates) in relation to their employment.

An ESS interest in a company is a beneficial interest in a share in the company or a right to acquire a beneficial interest in a share in the company.

The assessable income of the employee for the income year in which the ESS interest is acquired includes the discount given in relation to the scheme.

In this case, the ESS interest will not be acquired at a discount; it will be acquired at market value.

Consequently, Division 83A of the ITAA 1997 will not apply in relation to the share scheme.

Question 2

Division 7A is an integrity measure aimed at preventing private companies from making tax-free distributions of profits to shareholders (or their associates). In particular, advances, loans and other payments or credits to shareholders (or their associates) are, unless they come within specified exclusions, treated as assessable dividends to the extent that the private company has a distributable surplus.

Section 109D of the ITAA 1936

Subsection 109D(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity at the end of one of the private company's years of income if:

a)  the private company makes a loan to the entity during the year; and

b)  the loan is not fully repaid before the lodgment day for the year; and

c) Subdivision D does not apply to prevent the company from being taken to pay a dividend because of the loan at the end of the year; and

d) either:

(i)  the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or

(ii) a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time.

Section 109NB of the ITAA 1936

Section 109NB of the ITAA 1936 provides that a private company is not taken under section 109D of the ITAA 1936 to pay a dividend because of a loan made solely for the purpose of enabling the shareholder, or an associate of the shareholder, to acquire an ESS interest under an employee share scheme to which certain provisions of Division 83A of the ITAA 1997 would apply.

As stated above, Division 83A of the ITAA 1997 will apply to an ESS interest if the interest is acquired under an employee share scheme at a discount.

However, in this case, the ESS interest will not be acquired at a discount; it will be acquired at market value.

Consequently, section 109NB of the ITAA 1936 will not apply to prevent the Company from being taken to pay a dividend under section 109D of the ITAA 1936.

Section 109N of the ITAA 1936

Section 109N of Subdivision D of the ITAA 1936 prevents a private company from being taken to pay a dividend under section 109D of the ITAA 1936 if the loan is put under a written agreement before the private company's lodgment day for the income year in which the loan is made, the rate of interest payable on the loan equals or exceeds the benchmark interest rate, and the term of the loan does not exceed seven years for unsecured loans or 25 years for secured loans.

In this case, the loan agreement does not allow for interest to be charged and does not specify a maximum loan term. Consequently, the loan does not meet the requirements of section 109N and therefore, the Company would normally be taken to pay a dividend in these circumstances.

However, we note that the Individual is not currently a shareholder of the Company and is being offered a loan to acquire an initial shareholding in the Company.

In circumstances such as these, it is the Commissioner's view that where the borrower is not a shareholder at the time the loan is made; the loan arrangement will fall outside section 109D of the ITAA 1936 and the company will not be taken to pay a dividend.

Summary

As the Individual will not be a shareholder at the time the loan is made, the loan arrangement will fall outside section 109D of the ITAA 1936 and the Company will not be taken to pay a dividend to the Individual.

However, any subsequent loan made to the Individual to purchase additional shares in the Company will be subject to section 109D of the ITAA 1936 and the requirements of section 109N of the ITAA 1936.

Question 3

Subsection 109C(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if the private company pays an amount to the entity during the year and either:

a) the payment is made when the entity is a shareholder in the private company or an associate of such a shareholder; or

b) a reasonable person would conclude (having regard to all the circumstances) that the payment is made because the entity has been such a shareholder or associate at some time.

The amount of a payment by a private company consisting of a transfer of property is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer. The amount of a payment is nil if the consideration given by the transferee equals or exceeds the amount that would have been paid at arm's length for the transfer (subsection 109C(4) of the ITAA 1936).

In this case, should the Individual transfer their shares to the Company, the Company will pay the Individual a consideration amounting to the market value of the shares at the time of transfer. These funds will then be applied to repay the outstanding loan balance. In the event of the value of the shares exceeding the amount of the loan, the Individual will receive a payment of the surplus amount.

In the above situation, any payment by the Company to the Individual will be in exchange for the transfer of the shares to the Company under the terms of the Loan Deed. A payment in these circumstances can be differentiated from an arbitrary payment made by a Company to a shareholder that is in exchange for nothing and constitutes the tax free distribution of Company profits.

Consequently, should the Individual transfer all their shares to the Company in exchange for payment, the Company will not be taken to pay a dividend to the Individual under subsection 109C(1) of the ITAA 1936.

Question 4

Not applicable

Question 5

Subsection 109F(1) of the ITAA 1936 provides that a private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either:

a) the amount is forgiven when the entity is a shareholder in the private company, or an associate of such a shareholder; or

b) a reasonable person would conclude (having regard to all the circumstances) that the amount is forgiven because the entity has been such a shareholder or associate at some time.

However, an amount of debt is not forgiven for the purposes of Division 7A if the obligation to pay the amount is discharged by a payment to the creditor consisting of a transfer of property (subsection 109F(4) of the ITAA 1936).

In this case, should the Individual transfer all their shares to the Company in exchange for a net consideration, the loan debt will be fully discharged under the terms of the non-recourse Loan Deed. Even where the net consideration received on disposal of the shares is less that the outstanding loan balance, the amount will be applied in full and final satisfaction of the obligation of the Individual to repay the full amount owing and the Company will have no further recourse against the Individual in respect of any outstanding loan balance.

Alternatively, should the Individual dispose of their shares to an entity other than the Company, they will still be obligated to pay the net consideration received to the Company so that their loan debt will be fully discharged under the terms of the Loan Deed.

Consequently, it is considered that there will not be any debt forgiveness for the purposes of Division 7A in these situations as the debt will be fully discharged under the terms of the Loan Deed.

Therefore, subsection 109F(1) of the ITAA 1936 will not apply in the event of the Individual disposing of their shares either to the Company or to an entity other than the Company.

Question 6

No other provisions of Division 7A will apply to the share scheme and loan arrangement between the Individual and the Company.

Question 7

Division 245 of the ITAA 1997 contains the rules that apply in relation to the forgiveness of commercial debts.

Section 245-10 of the ITAA 1997 states (in part) that a debt will be considered to be a commercial debt if:

● the whole or any part of the interest payable in respect of the debt can be deducted by the borrower, or

● where interest is not payable, but had interest been payable, the whole or any part of the interest payable could have been deducted by the borrower.

In this case, an interest free non-recourse loan will be provided to the Individual to enable the purchase of shares in the Company and the shares will be expected to generate dividend income. Accordingly, if interest were payable on the loan it would be able to be deducted by the Individual.

Therefore, the loan from the Company to the Individual constitutes a commercial debt.

A debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full (paragraph 245-35(a) of the ITAA 1997).

In this case, in the event of the market value of the shares on disposal to the Company being less that the outstanding loan balance, the net consideration received will be applied in full and final satisfaction of the obligation of the Individual to repay the amount owing and the Company will have no further recourse against the Individual in respect of the outstanding loan balance.

Therefore, in this situation, the debt will be considered to be extinguished other than by repayment of the debt in full.

Section 245-50 of the ITAA 1997 relates to the extent of debt forgiveness when consideration is given and states that if any consideration is paid or given in respect of the forgiveness of a debt, the debt that is forgiven is:

● the obligation that existed before the forgiveness to pay so much of the debt as is expressed, or is taken, to be forgiven; and

● the obligation that existed before the forgiveness to pay any part of the debt to which paragraph (a) does not apply but which ceases to be payable as a result of the payment or giving of the consideration.

There is a general rule for working out the value of a debt; however, there are special rules in section 245-60 of the ITAA 1997 for working out the value of a non-recourse debt.

The rules cover debts including those incurred to finance the acquisition of property where the creditor's rights against the borrower in the event of default in the payment of the debt or interest were, just before the debt was forgiven, limited to rights (including the right to money payable) in relation to:

● the property or the use of the property;

● goods produced, supplied, carried, transmitted or delivered by means of the property;

● services provided by means of the property;

● the loss or disposal of the whole or a part of the property or of your interest in the property (subsections 245-60(2) and (3) of the ITAA 1997).

Subsection 245-60(1) of the ITAA 1997 states that the value of a debt when it is forgiven is the lesser of:

● the amount of the debt outstanding at that time; and

● the market value at that time of the creditor's rights.

In this case, should the market value of the shares on transfer/disposal to the Company or another entity be less than the amount of the loan, the value of the debt when it is forgiven will be the market value of the creditor's rights; that is, the market value of the shares.

The rules to determine the amount that can be offset against the value of a debt are set out in section 245-65 of the ITAA 1997. In this case, item 2 of the table in subsection 245-65(1) of the ITAA 1997 will apply as:

● the debt is not a moneylending debt; and

● items 3, 4, 5 and 6 do not apply (as the conditions in subsection (2) are not met, the debt is not assigned and the debt is not forgiven by subscribing for shares in a company).

Consequently, the amount offset against the value of the debt will be the market value of the shares at the time of the debt forgiveness which will result in a nil amount.

Therefore, there will not be any amount of debt forgiveness under Division 245 of the ITAA 1997.

Question 8

Further to the consideration of the income tax issues detailed above, the Individual will also not have any liability under any other provision of the ITAA 1936 or the ITAA 1997 in relation to the share scheme except for:

● personal income tax assessable to the Individual on any dividends received from the shares, or

● capital gains tax (CGT) payable by the Individual should he dispose of the shares in the future.