Edited version of your written advice

Authorisation Number: 1051304967903

Date of advice: 7 November 2017

Ruling

Subject: Employee Share Scheme

Question 1

Will the irretrievable cash contributions by the Company or any subsidiary member of the tax consolidated group to the Trustee to fund the acquisition of shares in the Company by the Trust for purposes of the Option Plan be 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 arises for the Trustee at the time when the employees become absolutely entitled to the Company shares 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 hands of the Trustee?

Answer

Yes.

Question 3

Will contributions by the Company or any subsidiary member of the tax consolidated group to the Trustee to fund the acquisition of shares in the Company by the Trust for purposes of the Option Plan be treated as a deemed dividend within the meaning of Division 7A of the of the Income Tax Assessment Act 1936 (‘ITAA 1936’)?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2017

Year ended 30 June 2018

Year ended 30 June 2019

Year ended 30 June 2020

Year ended 30 June 2021

Year ended 30 June 2022

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The Company is a private company for the purposes of the ITAA 1936. The company is the head company in a tax consolidated group.

The Company’s remuneration strategy is designed to attract, retain and motivate appropriately qualified and experienced employees whilst balancing the expectations of shareholders. As part of its remuneration strategy, the Company operates the Option Plan and may operate other long term equity incentive plans from time to time.

The Option Plan

The Company’s Option Plan broadly operates as follows:

● Options issued by the Company will be subject to the terms specified in the Invitation Letter accompanying the offer of Options. It is anticipated that the terms of the initial tranche of Options being offered to Participants under the Option Plan rules will be fully vested and will not be subject to any vesting conditions or performance hurdles.

● Options are not transferrable without the consent of the Board pursuant to the Option Plan rules.

● The Options may be exercised at certain times as specified in the Invitation Letter or immediately prior to an Exit Event, such as the Company listing on a stock exchange.

● For the initial tranche of Options, the Options will entitle Participants to either Class B or Class C shares of the Company, as follows:

● Class B and C shares will convert into Ordinary shares in the Company on a one for one basis if, at any time between the Grant Date and the Expiry Date, an Exit Event has occurred, or the Board, acting in its sole and absolute discretion, has determined that the an Exit Event is likely to occur.

● A Change of Control Event means:

● Where a person or entity and its respective associates become entitled to, acquires, holds or has a beneficial interest in more than 50% of the issued share capital of the Company;

● The Company passes a resolution for the voluntary winding-up of the Company;

● An order is made for the compulsory winding up of the Company; or

● The sale of substantially all of the business and assets of the Group;

● But does not include any internal reorganisation of the structure, business and/or assets of the Group.

● An Exit Event means a Change of Control Event or the Company becoming listed on the ASX or another stock exchange.

● The Class B and Class C shares will be subject to a disposal restriction until the earlier of an Exit Event, 15 years from the date of grant of the options, or if a Participant leaves the employment of the Company.

● The Class B and Class C shares will be compulsory divested in accordance with the Plan Rules upon a Participant ceasing employment with the Company.

● The Class B and Class C shares will be automatically forfeited if an Exit Event does not occur within 15 years from the Grant Date of the Options, unless a Participant has given written notice to the Company prior to this date that the Participant wishes to retain some or all of the Class B and Class C shares.

Class B and C Share Rights

Both Class B and C shares in the capital of the Company have the following features:

● (Dividends) Both Class B and Class C shares confer on their holders the right to receive dividends on a pari passu basis with ordinary shares in the capital of the Company. Therefore, should the Board in its sole and absolute discretion, declare or determine a dividend on the ordinary shares of the Company, the Board will be deemed to have declared or determined (as the case may be) on the same date a dividend on the same class of shares (to which they hold) of the same amount per share with the same level of franking as the ordinary share dividend.

● (Voting Rights) Holders of Class B or Class C shares have the right to receive notice of and to attend any general meeting of members of the Company, and to vote on any resolution to be passed at that general meeting of members. They are entitled to on a show of hands, to one vote; and on a poll, to one vote for each class share held. The holder of either Class B or Class C may vote in person or by proxy or attorney.

● (Conversion to ordinary shares) Each shares of either Class B or Class C will, on a date determined by the Board, be automatically varied and converted into one ordinary share in the capital of the Company if, at any time after the Grant Date, an Exit Event has occurred, or the Board, acting in its sole and absolute discretion, has determined that an Exit Event is likely to occurred.

● Prior to such conversion and resulting variation, the Board must resolve for such Conversion to occur and to set out the relevant date of Conversion.

● The rights attaching to each class of shares will, upon conversion, be automatically varied so that each class of shares has identical rights to one fully paid ordinary share and is considered to be one fully paid ordinary share from the date of conversation

● Each share whose rights have been varied and converted under this schedule will rank pari passu with each other fully paid ordinary share in the capital of the Company on and from the date of Conversion.

● (Winding Up) Both Class B and Class C shares confer on their holders the right to participate on a winding up in respect to paid-up capital and surplus assets on a pari passu basis as holders of ordinary shares in the capital of the Company.

● (Variation of Class Rights) For the purposes of the Constitution and the Corporations Act: any issue of Class B share, Class C shares or ordinary shares in accordance with the Constitution and the Company’s shareholders agreement; any variation and conversion of either Class B or Class C shares; and any issue of preference shares ranking equally with or in preference to the either Class B or Class C shares, will not be regarded as a variation or abrogation of the rights of the holders of either class of shares

The Employee Incentive Trust

The Company established an Employee Incentive Trust (‘Trust’) in accordance with the Company Employee Incentive Trust Deed (‘Trust Deed’), in order to facilitate and administer the current and future employee incentive plans. The Trust was set up for the sole purpose of obtaining shares for the benefit of employees and executives of the Company.

It is intended that the Trust will be used to acquire shares for employees of the Company and its employing entities pursuant to the Option Plan and other equity incentive plans the Company may implement from time to time. The Trust provides capital management flexibility for the Company, in that it has the ability to use the contributions made by the Company either to acquire shares in the Company from existing shareholders, on-market if the Company becomes listed, or alternatively to subscribe for new shares in the Company. Similarly, it provides an arm’s-length vehicle through which shares in the Company can be acquired and held on behalf of employees providing the liquidity of employee shares in a simple flexible manner compared to the employer buying back shares from employees. In effect, this aspect allows the Company to satisfy corporate law requirements relating to companies dealing in their own shares.

The Trustee is an independent third party.

The Trust operates as follows:

● The Trust will be funded by contributions from the Company or a subsidiary member of the tax consolidated group (e.g. for the purchase of shares in accordance with the Option Plan).

● These funds will be used by the Trustee to acquire shares in the Company either from an existing shareholder, on-market to the extent the Company becomes listed, or via a subscription for new shares in the Company.

● Shares acquired by the Trustee will be allocated to the relevant employees following instructions from the Company.

● The Trustee can sell shares on behalf of an employee where permitted to do so by the employee, subject to any disposal restrictions set out in the Option Plan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 10-5

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 104-75

Income Tax Assessment Act 1997 Section 104-85

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 Subdivision 115-C

Income Tax Assessment Act 1997 Subdivision 130-D

Income Tax Assessment Act 1997 Section 130-75

Income Tax Assessment Act 1997 Section 130-85

Income Tax Assessment Act 1997 Section 130-90

Income Tax Assessment Act 1997 Section 995

Income Tax Assessment Act 1936 Part III of Division 6

Income Tax Assessment Act 1936 Section 95

Reasons for decision

Question 1

Summary

The contributions of the funds by the Company to the Trustee will not be assessable income of the Trust pursuant to sections 6-5 or 6-10, and Division 6 of the ITAA 1936.

Detailed reasoning

The basic trust assessing provisions are contained in Division 6 in Part III of the ITAA 1936. In general terms, it is the beneficiaries of a trust who are ultimately entitled to receive and retain the income of a trust and are taxable on that income. The trustee is generally taxed on the balance of the net income defined for tax purposes where no beneficiary is presently entitled to the income.

Subsection 95(1) of the ITAA 1936 defines net income of a trust as the total assessable income of the trust calculated as if the trustee were a resident taxpayer in respect of that income, less all allowable deductions.

Subsection 6-5(1) provides that the assessable income includes income according to ordinary concepts, which is also called ordinary income.

Subsection 6-10(1) provides that assessable income also includes some amounts that are not ordinary income.

Subsection 6-10(2) details that amounts that are not ordinary income, but are included in your assessable income by provisions about assessable income are called statutory income.

ATO Interpretive Decision ATO ID 2002/965 – Income Tax – Trustee not assessable on employer contributions made to it under the employer’s employee share scheme provides the Commissioner’s view on whether the Trustee of an employee share trust will be assessed under sections 6-5 or 6-10 on contributions made to it by an employer for the purpose of and under the employer’s employee share scheme. In the reasons for decision, ATO ID 2002/965 states that when the funds provided to the Trustee are used in accordance with the Trust Deed and the Plan Rules for the sole purpose of and under the employee share scheme, the contributions constitute capital receipts to the Trustee and are not assessable under sections 6-5 or 6-10.

An employee share trust is defined in subsection 130-85(4) as 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)

An ESS interest, in a company, is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company or the right to acquire a beneficial interest in a share in the company. In this case, the ESS interests are the Options granted to the Participants of the Plan.

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. For the purposes of this subsection, section 995 defines the term 'scheme' as any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

On the facts, the Company has established the Trust (under the Trust Deed) to facilitate the Plan by acquiring Shares and allocating those Shares to Participants, in order to satisfy the Options acquired under the employee share scheme. The right to acquire beneficial interest (Options to acquire) in the Company’s shares is provided under an employee share scheme to the Participant in relation to the Participant’s employment, as defined in subsection 83A-10(2).

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 paragraph 130-85(4)(a) and paragraph 130-85(4)(b).

The Trustee also undertakes some incidental activities to operate and administer the Trust, such as clerical and administrative functions. They are however, merely incidental and in accordance with subsection 130-85(4)(c) and 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.

The Commissioner is also satisfied that the irretrievable cash contributions made by the Company to the Trustee are for the sole purpose of procuring the Company’s shares for the benefit of Participants in accordance with the Trust Deed and the Company’s employee incentive plans. The reasons are:

● The Trust Deed provides that the trust was established for the purpose of subscribing for or acquiring, allocating, holding and delivering the Company’s shares under the Plans;

● The Trust Deed indicates that the Trust’s sole activities are to acquire shares and to hold these shares until they vest in the employee and then transferring them to the employee;

● The Trust Deed provides that the Trust must, at all times, be managed and administered so as to satisfy the Sole Activities Test or the requirements to satisfy the definition of ‘employee share trust’ for the purposes of subsection 130-85(4);

● The general powers granted to the Trustee pursuant to the Trust Deed are restricted. These powers must be exercised only for the purposes of the Trust and only to give effect to the employee incentive plans which the Trust supports. To this end, the contributions received from the Company must, therefore, be used for the sole purpose of enabling the Trustee to acquire Shares in accordance with the terms of the Trust Deed and the Plan Rules;

● The Trust Deed provides that all contributions by the Company to the Trustee constitute accretions to the corpus of the Trust.

Further, the irretrievable cash contributions made by the Company to the Trust do not fall into one of the categories listed in section 10-5, and therefore will not be assessable income under section 6-10.

Consequently, these contributions constitute capital receipts to the Trust and are not assessable under section 6-5 (ordinary income) or section 6-10 (statutory income).

Question 2

Summary

A capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to 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 if the employees acquire the Shares for the same 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.

The conditions in subsection 130-90(1) are that CGT event E5 or E7 happens in relation to a beneficial interest in a share and it was acquired by the beneficiary by exercising a right and 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.

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

In order for the Trustee to be able to disregard any capital gain or capital loss made under CGT event E5 or E7 under section 130-90, it is necessary for the Trust to satisfy the definition of an ‘employee share trust’ as defined in subsection 130-90(1).

As detailed in Question 1, the Trust is an 'employee share trust' under subsection 130-85(4) and the Plan is an ‘employee share scheme’ under subsection 83A-10(2). The Option is an ESS interest under subsection 83A-10(1) as it is a right to acquire a beneficial interest in a share in the Company.

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 that market value is less than the asset’s reduced cost base.

In determining whether a beneficiary is absolutely entitled to the asset, any legal disability is ignored. In Draft Taxation Ruling TR 2004/D25 - Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 the Commissioner stated his view that the core principle underlying the concept of absolute entitlement in the CGT rules is the ability of a beneficiary who has a vested and indefeasible interest in the entire trust asset to be transferred to them or as they so direct.

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

In the present case, the Trust Deed provides that each Participant will be the beneficial owner of and absolutely entitled to their Allocated Share and all benefits and privileges attached to, or resulting from holding, those Allocated Shares. However, the Trust Shares must be dealt with in accordance with the terms of the Trust Deed, the relevant Plan Rules and the Participant’s relevant Terms of Participation.

Pursuant to subsection 104-75(3), where a Participant becomes absolutely entitled to Shares as against the Trustee, CGT event E5 will occur (under the terms of the Plan), and the Trustee will make a capital gain or loss.

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.

Relevantly, the Trust Deed deals with sale of Trust Shares by the Trustee. Pursuant to the Trust Deed, the Trustee may, at the Participant’s direction, sell Trust Shares to which the Participant is entitled after the expiry of the Restriction Period. It is subject to administrative guideline established by the Board (including securities trading policy), the relevant Plan Rules and the relevant Terms of Participation. The sale proceeds would be distributed to relevant Participants, after paying any brokerage and expenses of the sale incurred by the Trustee (including tax liability incurred by the Trustee resulting from that sale (of the Trust Deed).

The Trust Deed also deals with the transfer of the Trust Shares and provides that the Trustee must do all things required to transfer Trust Shares to the relevant recipient.

Upon transfer of the legal title in those Trust Shares, in accordance with the relevant Plan rules and the relevant Terms of Participation, CGT event E7 will occur at the time legal title in the shares is transferred to either the Participant, or a third party as directed by the Participant.

Paragraph 130-90(1)(b)

Subsection 995-1(1) defines a share to mean a share in the capital of a company. A share in the Company held by the Trustee and to which a Participant is entitled to upon exercising an Option is a share in the capital of the Company. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 or E7 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 the Company by exercising an option granted under the Plan.

Paragraph 130-90(1)(d)

Pursuant to subsection 83A-20(1), subdivision 83A-B applies to an ESS interest acquired under an employee share scheme at a discount.

As discussed in Question 1, ‘employee share scheme’ is defined in subsection 83A-10(2), and 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 share or the right to acquire a beneficial interest in a share in the Company) is provided to Participants in relation to their employment in Company in accordance with the Trust Deed.

The Options are issued under the Plan at a discount as they are issued for no consideration and the exercise price will be either nil or will not exceed the share price paid by the Trust to acquire those Shares (Options). Shares will be acquired by the Trust under the Plan on behalf of employees, using contributions from the Company.

Accordingly, prima facie, Subdivision 83A-B will apply to Options acquired under the Plan as pursuant to subsection 83A-20(1), the ESS interest (i.e. Options issued under the Plan) will be acquired under an employee share scheme at a discount.

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 Subdivisions 83A-B or 83A-C have been satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

Section 130-90(2)

Question 2 has been framed on the assumption that the Participants will acquire the shares for the same or less than the cost base of the shares in the hands of the Trust.

Given that the Options will be acquired for nil consideration and will have either no exercise price or one that does not exceed the cost paid by the Trustee it is reasonable for the Commissioner to assume that the Participants will acquire the shares for less than the cost base for the shares in the hands of the Trust.

Provided that the beneficiary does not acquire the beneficial interest in the share for more than its cost base in the hands of the Trust at the time that CGT event E5 or E7 happens, subsection 130-90(2) is also satisfied.

Conclusion

Accordingly, section 130-90 operates to disregard a CGT event E5 or E7 capital gain or loss made by the Trustee on the Shares.

Question 3

Summary

The contributions by the Company or any subsidiary member of the tax consolidated group headed by the Company to the Trustee to fund the acquisition of shares in the Company by the Trust for purposes of the Option Plan will not be treated as a deemed dividend within the meaning of Division 7A of the ITAA 1936.

Detailed reasoning

Subdivision B of Division 7A of Part III of the ITAA 1936 (‘Division 7A’) treats certain payments, loans and debt forgiveness made by a private company to a shareholder (or their associate) as a dividend paid by the company.

Subsection 109C(1) of the ITAA 1936 states 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

Subsection 109C(2) of the ITAA 1936 provides that the amount of the dividend is the amount paid, subject to the private company's distributable surplus calculated under section 109Y of the ITAA 1936.

Subdivision D of Division 7A sets out certain payments and loans that are not treated as dividends under Subdivision B.

‘Entity’ is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by subsection 960-100(1). An entity includes the trustee of a trust (subsection 960-100(2)).

Therefore, the contributions made to the Trustee of the Trust would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Shares at the time the contribution is made.

However, Division 7A does not apply to a payment made to a shareholder, or an associate of a shareholder, in their capacity as an employee (as defined in the FBTAA) or an associate of such an employee by virtue of subsection 109ZB(3) of the ITAA 1936.

‘Associate' is defined in subsection 109ZD of the ITAA 1936 and has the meaning given by section 318 of the ITAA 1936. An 'associate' of a natural person (other than in the capacity of trustee) includes a trustee of a trust where the individual benefits under the trust.

The Trustee of the Trust is an associate of any employees of the taxpayer that are Participants in the Option Plan as they are beneficiaries under the Trust.

Contributions are made to the Trust when the employer directs the Trustee to purchase Shares to hold for the purposes of exercising its obligations under the Plan to allocate Shares to Participants, as directed by the employer, to satisfy the exercise of Options. Having regard to the operation of the Plan and the Trust Deed, the Commissioner accepts that the payments are made to the Trustee shareholder in its capacity as an associate of an employee being the relevant Participant in the Plan, under the operation of section 109ZB of the ITAA 1936.

As such, the contributions made by the Company to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936.