Edited version of your written advice

Authorisation Number: 1051206406558

Date of advice: 24 March 2017

Ruling

Subject: Fringe Benefits tax - otherwise deductible rule

Question 1

Does the 'otherwise deductible rule' contained in section 19 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) apply to reduce the taxable value of the loan fringe benefit to nil?

Answer

Yes

This ruling applies for the following periods:

Year ended 31 March 2013,

Year ended 31 March 2014,

Year ended 31 March 2015,

Year ended 31 March 2016,

Year ended 31 March 2017 and

Year ended 31 March 2018.

The scheme commences on:

1 July 2017

Relevant facts and circumstances

The taxpayer (the Company) is an Australian Company that was incorporated in 20XX. The Company develops mobile solutions for safety in the workplace.

In 20YY, the Company started an employee share scheme (ESS) for new employees.

Under the terms of the ESS, employees acquire shares in the Company at market value. The share acquisition is financed through a loan by the taxpayer, which is provided to employees on an interest-free and non-recourse basis (ESS Loan).

The Company is projected to reach sufficient revenue within 3-5 years period and to be sustainably profit-making to have the ability to pay dividends.

The Employee Share Plan Rules

The Employee Share Plan Rules (the Plan Rules) provides that the share acquisition could be financed through a loan by the Company, one of the Rules states:

Manner of Subscription

A Participant must subscribe for Plan Shares by completing and signing the prescribed form of subscription and lodging it with the Company (or as otherwise determined from time to time by the Board), together with payment to the Company (either by cheque marked “Not Negotiable” or electronic funds transfer in an amount equal to the Subscription Price) or a notice to the Board that the Participant wishes to accept a Loan from the Company in the amount of the Subscription Price and on the terms contained in the specimen Loan Agreement attached as Schedule 1. Subject to the terms and conditions of this Plan, upon subscribing in the manner set out above, the Company must allot and issue to the Participant the relevant number of Plan Shares which upon issue and in respect of each class of Shares, will each:

(a) be credited as fully paid; and

(b) rank pari passu in all respects with all other issued Shares of that class.

According to the Plan Rules, the Participants have to sell the shares if they leave the company and if the Loan has not been paid in full, the capital proceeds of the sale must be applied to the loan.

The Loan Agreement

The terms and conditions of the loan are governed by the Loan Agreement attached as Schedule 1 of the Plan Rules.

The following clauses are relevant:

Purpose and Drawdown of Loan and Acknowledgement:

(a) The objective of the Plan is to provide an incentive to Employees to gain a proprietary interest and share in the performance of the Group by subscribing for Plan Shares under the Plan.

(b) The amount payable per Plan Share will be financed by the Loan.

(c) The participant acknowledges that the sole purpose of the Loan is to enable the Participant to subscribe for Plan Shares if the Participant accepts an Invitation.

(d) The Participant is not entitled to utilise the Loan Amount for any purpose other than in accordance with this Clause.

Interest:

No interest or other charges shall be payable by the Participant on the Loan Amount or on amount outstanding under the Loan.

Payment at Participant's option:

Without limiting any other provision of this Agreement but subject to the rules of the Plan and the Invitation to the Participant, the Participant may, at any time, repay part or all of the Loan Amount.

Repayment form Distributions

(a) Subject to paragraph (b), whilst any portion of the Loan Amount remains outstanding the Participant must apply all Distributions received on the Plan Shares in repayment of the Loan Amount.

(b) Such portion of the Distributions to be paid on the Plan shares as is equal to the estimated tax payable by the Participant on the Distributions will not be used to repay the loan Amount under paragraph (a) and may be used by the Participant to pay the tax liability of the Participant in respect of the Distributions on the Plan Shares.

Repayment on ceasing to render Services

(a) Subject to Clause 3, the Loan becomes due and payable without the necessity for any demand or notice to the Participant if the Participant (or any personal services company of the Participants) ceases to render Services and the Participant must repay the Loan Amount in full to the Company within 30 days of the date he (or his personal services company) ceases to render Services.

(b) Subject to clause 3, full repayment of the Loan Amount will be constituted by surrender to the Company of unvested Plan Shares subscribed for via the proceeds of the Loan Amount, less that number of Plan Shares (Calculated at the Subscription Price) equal in value to the aggregate of all Repayments. The Participant will sign any documents to effect the surrender of the Plan Shares and Payment of the Loan pursuant to clause (a) above.

Loan is Limited Recourse

The Company acknowledges that in the event of non-repayment of the Loan Amount, its only recourse is to accept the surrender of the Plan Shares as contemplated in this Agreement in satisfaction of the outstanding balance of the Loan. In exercising its rights, the Company may do whatsoever may be necessary to affect the surrender of the Plan shares and the Participant undertakes to comply with any such procedure.

No deduction

The participant must pay all amounts payable to the Company under this Agreement without any deduction, withholding, set-off or counterclaim which is alleged to exist in favour of the Participant as against the Company in any capacity whatsoever or the Trust.

Time and Place of Payment

All payments to be made under this Agreement by the Participant to, or at the direction of, the Company, must, unless otherwise specified or agreed by the Company, be made in Australian dollars in immediately available funds not later than 3.00pm on the due date at the registered office of the Company or at such other place as the Company may from time to time direct in writing.

No set-off or counterclaim

Notwithstanding any term, whether express or implied , in this Agreement or any rule of law or course of conduct to the contrary, payments under this Agreement must be made by the Participant without set-off or counterclaim and free and clear of, and without, any deductions whatsoever.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 section 16

Fringe benefit Tax Assessment Act 1986 section 19

Fringe benefit Tax Assessment Act 1986 section 18

Fringe benefit Tax Assessment Act 1986 section 136(1)

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

In general, a loan fringe benefit will arise where a loan is made to an employee and the amount of interest charged (if any interest is charged), on the loan is less than the statutory (or benchmark) interest rate.

In the private ruling application the taxpayer requested the Commissioner to assume that the ESS loan is a loan fringe benefit for the purpose of the private ruling application. The Commissioner considers that it is reasonable to make such an assumption since the ESS loan is being made to your employee at a nil rate of interest.

Please note the Commissioner has not fully considered if the definition of a loan fringe benefit under section 16 of the FBTAA has been satisfied.

The taxable value of the loan fringe benefit is calculated as per section 18 of the FBTAA. Section 18 of the FBTAA states:

Subject to this Part, the taxable value, in relation to a year of tax, of a loan fringe benefit provided in respect of the year of tax is the amount (if any) by which the notional amount of interest in relation to the loan in respect of the year of tax exceeds the amount of interest that has accrued on the loan in respect of the year of tax.

The taxable value of the loan fringe benefit could be reduced if the otherwise deductible rule contained in section 19 of the FBTAA applies.

Generally, the 'otherwise deductible rule' operates to reduce the taxable value of the loan fringe benefit to the extent to which interest payable on the loan is, or would have been, allowable as a once-only income tax deduction to an employee.

Paragraphs 19(1)(a), 19(1)(b) and 19(1)(ba) of the FBTAA 1986 state:

(a) the recipient of a loan fringe benefit in relation to an employer in relation to a year of tax is an employee of the employer; and

(b) if the recipient had, on the last day of the period (in this subsection called the loan period) during the year of tax when the recipient was under an obligation to repay the whole or any part of the loan, incurred and paid unreimbursed interest (in this subsection called the gross interest), in respect of the loan, in respect of the loan period, equal to the notional amount of interest in relation to the loan in relation to the year of tax - a once-only deduction (in this subsection called the gross deduction) would, or would if not for section 82A of the Income Tax Assessment Act 1936, and Divisions 28 and 900 of the Income Tax Assessment Act 1997, have been allowable to the recipient under either of those Acts in respect of the gross interest; and

(ba) the amount (in this subsection called the notional deduction) calculated in accordance with the formula:

GD - RD

Where:

GD is the gross deduction; and

RD is:

(i) if no interest accrued on the loan in respect of the loan period - nil; or

(ii) if interest accrued on the loan in respect of the loan period - the amount (if any) that would, or that would but for section 82A of the Income Tax Assessment Act 1936, and Divisions 28 and 900 of the Income Tax Assessment Act 1997, have been allowable as a once-only deduction to the recipient under the Income Tax Assessment Act 1936 or the Income Tax Assessment Act 1997 in respect of that interest if that interest had been incurred and paid by the recipient on the last day of the loan period;
exceeds nil;

The deductibility of interest expense on loans to acquire shares has been considered in Taxation Ruling IT 2606 Income Tax: Deductions for Interest on Borrowing to Fund Share Acquisitions (IT2606). Paragraph 9 of IT 2606 states:

As a general rule, interest on money borrowed to acquire shares will be deductible under the first limb of subsection 51(1) (now section 8-1 of the ITAA 1997) where it is expected that dividends or other assessable income will be derived from the investment. Such an expectation will usually exist as shares by their very nature are inherently capable of generating dividends, whether in the short or long term. However, such an expectation must be reasonable and not a mere theoretical possibility; there must be a prospect of dividends or other assessable income being received.

Based on the information the taxpayer provided, the Commissioner considers that an expectation of dividends and other assessable income is reasonable.

Therefore, the interest payable on the loan would have been an allowable deduction under section 8-1 of the ITAA 1997.

Provide that the substantiation requirements are met, the otherwise deductible rule in section 19 FBTAA will apply.

Paragraph 19(1)(c) of the FBTAA requires that the recipient gives a declaration to the extent that the interest would have been otherwise deductible except where the fringe benefit is an employee credit loan or employee share loan fringe benefit, Paragraph 19(1)(c) states:

(c) except where the fringe benefit is:

(i) an employee credit loan benefit in relation to the year of tax; or

(ii) an employee share loan benefit in relation to the year of tax;

the recipient gives to the employer, before the declaration date, a declaration, in a form approved by the Commissioner, in respect of the loan concerned; and

Sub-paragraph 19(1)(c)(ii) is relevant in your situation.

An employee share loan benefit is defined in subsection 136(1) of the FBTAA as:

employee share loan benefit , in relation to a year of tax, means a loan fringe benefit in relation to an employee in relation to an employer in relation to the year of tax where:

(c)  the sole purpose of the making of the loan is to enable the employee to acquire shares, or rights to acquire shares, in a company, being:

(i) the employer; or

(j) an associate of the employer; and

(d) the shares or rights were beneficially owned by the employee at all times during the period during the year of tax when the employee was under an obligation to repay the whole any part of the loan.

In considering the Loan Agreement and the Plan Rules, it is accepted that the sole purpose of the loan is to enable your eligible employees to subscribe for shares in the Company. The participant is not allowed to use the Loan for any other purpose.

In relation to the beneficial ownership, the shares are owned by the employees. According to the Plan Rules and Loan Agreement, if the shares are required to be disposed of (in the event of ceasing employment) before the loan has been repaid, the capital proceeds of the disposal must be applied to the loan. Furthermore, as per the Loan Agreement, any distributions from the shares (i.e. dividends) must be applied to the loan before it has been repaid. Therefore, the employees will be the beneficial owners of the share while under an obligation to repay the loan.

As such, the loan is an employee share loan benefit and there is no need for the employee to provide a declaration for the purpose of section 19 of the FBTAA.

Conclusion

Substantiation requirements of section 19 of the FBTAA are not required. Section 19 of the FBTAA will apply to reduce the taxable value of the loan benefit to nil.