Edited version of your written advice

Authorisation Number: 1051314640866

Date of advice: 15 December 2017

Ruling

Subject: Employee Share scheme

Issue 1- Income Tax

Question 1

Will contributions paid by the Employer to the Share Plan Trust pursuant to the Share Plan Trust Deed be deductible in accordance with section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

When will contributions paid by the Employer to the Share Plan Trust pursuant to the Share Plan Trust Deed be deductible?

Answer

In the income year in which the shares acquired from the contribution are allocated to a Participant.

Issue 2- Fringe Benefits Tax

Question 3

Will the contributions paid by the Employer to the Share Plan Trust constitute a 'fringe benefit' as defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No

Issue 3- Anti-avoidance

Question 4

Will the general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme described?

Answer

No

This ruling applies for the following period<s>:

In respect of issues 1 and 3 the ruling applies for the following Income Tax years:

Income Tax year ending 30 June 2018;

Income Tax year ending 30 June 2019;

Income Tax year ending 30 June 2020;

Income Tax year ending 30 June 2021;

Income Tax year ending 30 June 2022.

In respect of issue 2 the ruling applies for the following Fringe Benefits Tax years

Fringe Benefits Tax year ending 31 March 2018;

Fringe Benefits Tax year ending 31 March 2019;

Fringe Benefits Tax year ending 31 March 2020;

Fringe Benefits Tax year ending 31 March 2021;

Fringe Benefits Tax year ending 31 March 2022.

The scheme commences on:

The scheme commences in the income year ending 30 June 2018.

Relevant facts and circumstances

The Employer Group is an Australian based company group which currently has over 100 employees nationally.

The Employer group consists of a Group Holdings company and X wholly owned subsidiary companies, one of which operates as trustee for the Group’s wholly owned unit trust.

The Employer has decided to introduce the Employee Share Plan (the Plan) as a mechanism for rewarding, retaining and motivating its employees.

The Employer has the following reasons for introducing the Plan:

● Provide a mechanism for rewarding staff for their loyalty and effort in a structured, equitable and transparent manner;

● Provide benefits for existing employees and attract new employees;

● Assist to engender responsibility for the performance of our business throughout our employees and provide a mechanism that rewards staff for our collective and individual contributions.

The Employer will operate the Plan through a trust (the Trust). The Trustee Company is owned by X of the current owners and directors of the Group Holdings Company. They also act as directors of the Trustee Company.

It is intended that the Trust will be used to acquire fully paid ordinary shares in the capital of the Employer (Shares) for employees pursuant to the Plan. The Trust provides an arm’s-length vehicle through which Shares can be acquired and held on behalf of employees providing the liquidity of employee held Shares in a simple flexible manner compared to the Employer buying back Shares from employees. In effect, this aspect allows the Employer to satisfy corporate law requirements relating to companies dealing in their own shares. The Trust provides the following benefits to the Employer:

1. Allows key shareholders to keep control over company ownership.

2. Registration of shares in the Trustee’s name provides control over identity of shareholders, preventing a sale to unrelated persons.

3. If the Employer is sold, it is easier to “mop-up” employee shareholders.

4. Enables the disqualification event and disqualification discount provisions to be enforced in a simple manner through the Trust.

An initial contribution to the Trust consisting of X% of the Employer has been made by the directors of the Group Holdings Company. Further annual contributions will be made to the Trust by the Employer in accordance with a formula established by the Employer.

The Trustee will at the direction of the Employer use any money contributed by the Employer and any residual amounts to purchase Shares from the existing shareholders of the Employer, although a small amount will be retained to provide for the administration of the Plan. The Trust Deed allows for the Employer to direct the Trustee to subscribe for Shares, but it is not the Employer’s current intention for the Trustee to use this method to acquire Shares.

Shares will be held by the Trustee as Unallocated Shares until such Shares are allocated to Eligible Employees who become Participants in the Plan.

The Employer will be entitled under the Trust Deed to nominate and invite Eligible Employees to participate in the Plan; however, it will not have any right to the income or capital of the trust.

Eligibility to participate in the Plan is based upon two independently assessed set of criteria.

Initial eligibility applies only during the first year of operation of the Plan and entitles Eligible Employees to benefit from both the initial contribution and the annual contributions (including any residual amounts of capital after the application of disqualify events or disqualifying discounts).

To be eligible to benefit from the initial contribution an employee must have been continuously employed as a permanent employee of the Employer for three years excluding any breaks in employment (e.g. leave without pay). This includes full time and part time permanent employees.

To be eligible to benefit from any subsequent contributions (and any residual amounts of capital after the application of disqualifying events or disqualifying discounts) an employee must have been continuously employed as a permanent employee of the Employer for two years excluding any breaks in employment (e.g. leave without pay). This includes full time and part time permanent employees.

The beneficial interest of the Shares in the Trust Fund shall be divided into Units.

Subject to a demonstrated commitment to the Employer (determined by the exercise of the Directors discretion) and meeting the expectations of their current role (demonstrated by having no significant performance issues), the Employer will invite Eligible Employees to participate in the Plan by owning Employee Units.

The invitation will include the terms and conditions upon which the Units will be issued. Following receipt of an invitation, an Eligible Employee who wishes to participate in the Plan will return the completed application form. Upon acceptance of the application by the Employer, Eligible Employees become Participants in the Plan. The Employer will then instruct the Trustee to allocate a specific number of Units to the Eligible Employee and to designate one Share to each Unit (Allocated Share). The Trustee shall ensure such designation is recorded in the books and records of the Trust.

Eligible Employees may make a contribution toward the acquisition of an Employee Unit.

The Employee Units provided to the Participants are substantially the same rights in respect of the Shares which are allocated to the Units as if the Participants were the legal owners of the Shares. Subject to the provisions of the Trust Deed, a Unit entitles the Participants to:

● receive the income deriving from the Allocated Shares including dividends declared by the Directors at their discretion in respect of the Shares;

● to the extent that voting rights are attached to the Shares, direct the Trustee on how it should be exercised;

● receive the Redemption Entitlement on redemption.

● to request the Trustee to pass a resolution allowing for the redemption of Units.

The Units may be issued to an associate of an Eligible Employee (and the associate will be a Participant under the Plan).

The number of Employee Units issued to a Participant will be determined by the Trustee with reference to the following factors:

● Length of Service (pro rata for permanent part time) and excludes any breaks in employment (i.e. leave without pay) but includes all paid leave periods in accordance with standard leave entitlements for employees;

● Role/responsibility– reflected by consideration of current role, with key metric including current base salary level (FTE) ; and

● Performance.

No Eligible Employee may acquire Units, by way of an Invitation or otherwise, if, immediately after the acquisition of those Units, the Eligible Employee would directly or indirectly hold or control a legal or beneficial interest in X% or more of the issued capital of the Employer (including the voting rights that relate to those shares).

The Trustee shall keep and maintain an up-to-date register of all Unit Holders.

Subject to receiving written consent from the Employer a Participant may transfer his or her Units to an Associate, otherwise Units cannot be transferred or assigned or otherwise dealt with in favour of any person nor can any equitable, contingent, future or partial interest or other security interest be created in a Unit.

Where the Shares are allocated to a particular Participant, any dividends that the Trustee receives as the result of holding those Shares in the Trust will flow-through to the relevant Participant. Where Shares remain unallocated in the Trust any dividends that the Trustee receives as the result of holding those Shares in the Trust will be retained as part of the capital of the Trust.

If a Disqualifying Event occurs, the relevant Participant will forfeit any right or interest in the Units acquired for the benefit of the Participant under the Plan. “Disqualifying Event” includes (but is not limited to) the employment of the relevant Participant ceasing because of Termination or Termination for Cause. ‘Termination’ means termination of employment of the relevant employee by the Company other than in Special Circumstances, Resignation and Termination for Cause’. ‘Termination for Cause’ means termination of the relevant Eligible Employee without notice by the Employer due to fraud or gross misconduct; fraud and other similarly serious events.

The Trustee may by resolution redeem all or a specified number of Units registered in a Participant’s name on the happening of any of the following events:

● upon the Trustee’s determination to redeem any or all at the Trustee’s absolute unfettered discretion;

● notification by the Employer to the Trustee that the employment of the Participant (or the relevant Eligible Employee) has ceased because of Resignation or Special Circumstances;

● receipt by the Trustee of a request in writing from the Participant to cancel one or more Units provided that request is:

● made while the Participant (or their associate) is an Employee; and

● made with the written approval of the Board.

Subject to the terms of the Trust Deed the relevant Disqualification Discounts (if any) as set out below will apply to the Units redeemed, rounded up to the nearest whole number. The Participant will be entitled to the rights and interests in the Remaining Units (i.e. the interest in the Allocated Shares referable to those Remaining Units), and will forfeit any rights or interests in the Units that the Participant would, but for the application of the Disqualification Discounts, have been entitled to, but provided that no Disqualification Discounts shall be applicable to any Unit whose issue has been funded by the Participant (or the relevant Eligible Employee) entirely by the contribution of funds to the Trustee by the Eligible Employee, or upon the occurrence of Special Circumstances; and

“Disqualification Discounts” means the percentage of Units a Participant is entitled to redeem as set out in Item 2 of the table below, determined by reference to the duration each individual Unit is held for, but provided that if the relevant Eligible Employee has completed 10 years of service when they (or their associate) first become a Participant, then Item 3 of the table will apply as the Disqualification Discounts:

“Special Circumstance” means the cessation of employment due to Redundancy, where the Eligible Employee dies, or where the employment relationship ends because of Retirement, including for reasons of trauma or total and permanent disability;

The Participant who holds Remaining Units shall be entitled to direct the Trustee to sell the Allocated Shares and receive from the Trustee the cash value of the Shares sold net of any selling costs or to transfer to them the Allocated Shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-35

Income Tax Assessment Act 1997 Section 83A-205

Income Tax Assessment Act 1997 Section 83A-210

Income Tax Assessment Act 1997 Subsection 130-85(4)

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Reasons for decision

Question 1

Summary

Contributions paid by the Employer to the Trust pursuant to the Employee Share Plan Trust Deed will be deductible in accordance with section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)

Detailed reasoning

An employer is entitled to a deduction under section 8-1 for a contribution paid to the trustee of a Trust that is either incurred in gaining or producing the Employer’s assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing the Employer’s assessable income (‘positive limbs’).

However subsection 8-1(2) prevents such a deduction to the extent that it is a loss or outgoing of capital, or of a capital nature, is a loss or outgoing of a private or a domestic nature, is incurred in gaining or producing exempt income or non-assessable non-exempt income, or is prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936 (‘negative limbs’).

First positive limb - incurred

To qualify for a deduction under section 8-1, a loss or outgoing must be incurred.

Although the term ‘incurred’ is not defined in the legislation, reference can be made to Taxation Ruling TR 97/7 Income tax: section 8-1 – meaning of ‘incurred’ – timing of deductions (TR 97/7) and Taxation Ruling TR 94/26 Income tax: subsection 51(1) – meaning of incurred – implications of the High Court decision in Coles Myer Finance (TR 94/26).

Broadly, a taxpayer incurs an outgoing at the time the taxpayer owes a present money debt that they cannot escape. Otherwise a loss or outgoing is incurred when a taxpayer is definitively committed to the loss or outgoing (refer to FC of T v James Flood Pty Ltd (1953) 88 CLR 492).

It is important to establish that the contributions are irretrievable and not refundable, as they will otherwise not be a permanent loss or outgoing incurred.

A contribution made to the trustee of a trust is incurred only when the ownership of that contribution passes from an employer to the Trustee and there is no circumstance in which the employer can retrieve that contribution – Pridecraft Pty Ltd v Federal Commissioner of Taxation [2004] FCAFC 339; Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCAFC 339.

In the present case, the Employer has established the Trust for the purpose of facilitating the acquisition, holding and allocation and delivery of Shares to meet its obligations under the Plan, by making irretrievable and non-refundable contributions to the Trust. The Trustee will then follow instructions or notices from the Employer to acquire and allocate the Shares for the benefit of Participants.

On this basis, it is concluded that the Employer will incur an outgoing for purposes of subsection 8-1(1) at the time it makes irretrievable contributions to the Trust.

Second positive limb – Relevant Nexus

To be deductible under section 8-1, a contribution must have been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

To satisfy the second positive limb of section 8-1, there must be a sufficient nexus between the outgoing (contributions made by the Employer) and the derivation of the Employer’s assessable income – The Herald and Weekly Times Limited v The Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169, Amalgamated Zinc (De Bavay's) Limited v The Federal Commissioner of Taxation (1935) 54 CLR 295;(1935) 3 ATD 288, W. Nevill And Company Limited v The Federal Commissioner of Taxation (1937) 56 CLR 290;4 ATD 187;(1937) 1 AITR 67, Charles Moore & Co (W.A.) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344;(1956) 6 AITR 379; (1956) 11 ATD 147.

To be deductible under section 8-1, a contribution must have been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

To satisfy the second positive limb of section 8-1, there must be a sufficient nexus between the outgoing (contributions made by the Employer) and the derivation of the Employer’s assessable income – The Herald and Weekly Times Limited v The Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169, Amalgamated Zinc (De Bavay's) Limited v The Federal Commissioner of Taxation (1935) 54 CLR 295;(1935) 3 ATD 288, W. Nevill And Company Limited v The Federal Commissioner of Taxation (1937) 56 CLR 290;4 ATD 187;(1937) 1 AITR 67, Charles Moore & Co (W.A.) Pty Ltd v Federal Commissioner of Taxation (1956) 95 CLR 344;(1956) 6 AITR 379; (1956) 11 ATD 147.

An expense will have the relevant connection to the business when it is ‘desirable or appropriate in the pursuit of the business ends of the business – Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 56) and Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 33 ALR 213.

In the context of a payment to an employee share trust the payment will have the relevant connection where it is an irrevocable payment of cash, made at a time when the employer carries on a business for the purpose of gaining or producing assessable income and the employer reasonably expects their business to benefit from the contribution via an improvement in employee performance, morale, efficiency or loyalty.

On the basis of the facts, the Employer will make contributions to the Trustee for the purpose of enabling the Trustee to acquire the Shares which will, in accordance with the Trust Deed, be allocated to and held for the benefit of Participants.

The beneficial interest in the Share that is acquired pursuant to the Trust Deed is an ESS interest within the meaning of subsection 83A-10(1).

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.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) because it is a scheme under which shares in the Employer are provided to employees in relation to the employee's employment.

Notwithstanding the fact that the Plan was developed and provided by a succession planning firm the objective evidence is that the primary purpose of adopting the Plan is to provide incentives to current employees. This is demonstrated by the fact that the Plan is open to the majority of employees with at least three years service and that no Participant may acquire an interest in the Employer exceeding X% of its issued capital.

Under the Plan, the Employer has also established the Trust to acquire shares in the Employer and to allocate those shares to employees

Accordingly, it is considered that the irretrievable contributions made by the Employer to the Trustee will be an employee remuneration cost incurred in carrying on the Employer’s business and will satisfy the nexus of being necessarily incurred in carrying on that business for the purpose of gaining or producing assessable income.

Negative Limb – Revenue vs Capital

Where a contribution satisfies the positive limbs of subsection 8-1(1), it may not be deductible to an employer under subsection 8-1(2) to the extent that such contribution is a loss or outgoing of capital, or of a capital nature, is a loss or outgoing of a private or a domestic nature, is incurred in gaining or producing exempt income or is prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936.

On the facts, nothing has suggested that the contributions are private or domestic in nature, or are related to producing exempt income or non-assessable non-exempt income, or are otherwise prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936.

Whether an outgoing is capital or revenue in nature can generally be determined by reference to the test articulated by Dixon J in the leading case on the capital/revenue distinction, Sun Newspapers Ltd v Federal Commissioner of Taxation (1938) 61 CLR 337. In that case Dixon J stated that:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay…

Taxation Ruling TR 2017/D5 indicates when a contribution made to the trustee of an employee share trust may be of a capital nature. Although TR 2017/D5 specifically excludes its application to employee share schemes to which Division 83A applies, nevertheless similar principles would apply to a Division 83A scheme in determining whether a contribution was capital in nature. Relevantly paragraphs 85 to 90 of TR 2017/D5 state:

85. A contribution is not deductible under section 8-1 of the ITAA 1997 to the extent it secures a capital advantage for the Employer, unless that advantage is small or trifling.

86. The nature of an outgoing as either capital or revenue can generally be determined by examining the character of the advantage sought, the manner in which it is to be used, relied upon or enjoyed and the means adopted to obtain it.

87. When considering the character of expenditure, it is critical to consider the advantage sought by it from a practical and business point of view, not just on the basis of a 'juristic classification of legal rights'. In the context of an ERT arrangement, a contribution will be considered to secure a capital advantage for the Employer where it secures an asset or investment of a permanent nature. For example, the contribution is applied by the trustee to:

● acquire an asset that is likely to generate an enduring or permanent improvement to employee goodwill (for example, an acquisition of a holiday house for use by employees.

● provide loans, on a continuous basis, to employees

● acquire shares and/or equity in the Employer or a holding company of the Employer in circumstances where it is not intended to divest legal and beneficial ownership of these shares to employees within a relatively short period of the contribution being made, or

● acquire arm's length investments where the intention is to derive a return to be paid to employees, whilst keeping the capital of the trust fund intact.

88. In addition, expenditure incurred in relation to salary or wages paid to employees engaged wholly in affairs of capital is also properly characterised as capital in nature. If the contribution goes to remunerating employees who are engaged solely in the construction and upgrade of the employer's depreciating assets, and those assets form part of the taxpayer's profit yielding structure, the contribution will also be of a capital nature.

89. Further, an advantage obtained from a contribution is to be considered in the context of both the manner in which it is to be used, relied upon or enjoyed and the means by which the advantage was obtained. In this context, the Commissioner considers the following factors to be indicators that a contribution is a capital expense:

● it is a lump sum or instalments of a lump sum

● it forms the permanent and enduring nucleus of a fund

● it “secures and retains the services of a contented and efficient staff” over the employer's business life, or it is otherwise intended to endure over an employer's business life (whether or not the contribution is depleted during this time), and

● it is “a final payment to secure future benefits” for employees.

90. There may be other circumstances in which a contribution is not deductible to the employer. Only the two most common scenarios are identified here.

In this case, irretrievable contributions are provided by the Employer, as an employer, to the Trustee. The contributions may ultimately and in substance be applied by the Trustee to subscribe for shares in the Employer. Thus the Employer could be considered as having acquired an asset or advantage of an enduring nature which is capital or of a capital nature, in whole or in part.

Apportionment

In cases where a contribution is made for the purpose of securing advantages for the Employer of both a capital and revenue nature, section 8-1 may require the contribution to be apportioned into deductible and non-deductible components. However, paragraph 16 of TR 2017/D5 provides that apportionment may not be required where capital advantages are only considered to be small or trifling when, within a relatively short period of the contribution (which secures the capital advantage) being made, so much of the trust fund as comprises that contribution is permanently and entirely dissipated in remunerating employees. Contributions made by an employer to an employee share trust to facilitate an employee acquiring shares and/or rights to shares under an employee share scheme to which Subdivision 83A of the ITAA 1997 applies need to be considered within that statutory context.

The Employer will contribute funds to the Trust to enable it to provide benefits to the Participants in form of a beneficial interest in Shares. Such contributions will be made at or about the time that the Shares will be acquired by the Trust either from other shareholders, on-market (should the Employer list on the ASX or another exchange), or via a new issue of shares by the Employer. The Trustee will then allocate those Shares to Units acquired by the Participants. Participants will, from that time, be entitled to receive the income deriving from the Allocated Shares, direct the Trustee on how the voting rights attached to the Allocated Shares should be exercised and become entitled to redeem their interest in the Allocated Shares progressively over ten years provided that they remain employed by the Employer (allowing for employee’s leaving in Special Circumstances). These elements of the Plan are aimed at achieving the purpose of rewarding employees for loyalty and effort in a way that that aligns the interests of employees with the Employer in maximising the performance of the business and under a Plan that fits within the statutory scheme established under Division 83A.

On weighing up the facts, the Commissioner accepts that any advantages of a capital nature that may arise from the irretrievable contributions made by the Employer to the Trustee are expected to be very small or trifling and that apportionment of the deductible amount under section 8-1 is not required.

Conclusion

Irretrievable contributions made by the Employer to the Trustee are deductible under section 8-1. To the extent that any part of the contribution is of capital or of a capital nature, the Commissioner accepts that such amounts will be very small or trifling and that apportionment to account for any capital component of the contribution would not be required.

Question 2

Summary

Contributions paid by the Employer to the Trust pursuant to the Trust Deed will be deductible in the income year in which the Shares acquired from the contribution are allocated to a Participant.

Detailed reasoning

The provision of money to the Trustee of the Trust by the Employer for the purpose of remunerating its employees under the Plan is an outgoing in carrying on the Employer’s business and is deductible under section 8-1 of the ITAA 1997.

The deduction under section 8-1 of the ITAA 1997 would generally be allowable in the income year in which the Employer incurred the outgoing but under certain circumstances, the timing of the deduction is specifically determined under section 83A-210 of the ITAA 1997.

Section 83A-210 of the ITAA 1997 provides that if:

(a) at a particular time, you provide another entity with money or other property:

(i) under an arrangement; and

(ii) for the purpose of enabling an individual (the ultimate beneficiary) to acquire, directly or indirectly, an ESS interest under an employee share scheme in relation to the ultimate beneficiary's employment (including past or prospective employment); and

(b) that particular time occurs before the time (the acquisition time) the ultimate beneficiary acquires the ESS interest;

then, for the purpose of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time.

Section 83A-210 of the ITAA 1997 will only apply if there is a relevant connection between the money provided to the Trustee, and the acquisition of ESS interests (directly or indirectly) by the Employer under the relevant Plan in relation to the employee's employment.

An ESS interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

Under the Plan, the beneficial interest in a Share granted to an employee will be an ESS interest. This ESS interest will also be granted under an employee share scheme in relation to the employee's employment.

Consequently, the provision of money to the Trustee to acquire shares in the Employer is considered to be for the purpose of enabling the participating employees, to acquire the beneficial interest in Shares. If that money is provided before the Shares are allocated to a Participant then section 83A-210 of the ITAA 1997 will apply to deny the deduction until the income year in which the beneficial interest in the Share is allocated to the Participant.

Question 3

Summary

The Trust is an employee share trust, as defined in subsection 995-1(1) of the ITAA 1997, as the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 and its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997.

As such, paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes the contributions to the Trustee of the Trust from being a fringe benefit.

Accordingly, the Employer will not be required to pay fringe benefits tax in respect of the irretrievable cash contributions it makes to the Trustee of the Trust to fund the acquisition of shares.

Detailed reasoning

Subsection 136(1) of the FBTAA defines a 'fringe benefit', in relation to an employee, as a benefit provided in respect of the employment of the employee, and paragraph (ha) of that definition excludes:

a benefit constituted by the acquisition of money or property by an employee share trust (within the meaning of the Income Tax Assessment Act 1997);

An 'employee share trust' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

Subsection 130-85(4) of the ITAA 1997 provides:

Meaning of employee share trust

130-85(4) 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).

The beneficial interest in the Share is an ESS interest within the meaning of subsection 83A-10(1) of the ITAA 1997.

An employee share scheme is defined in subsection 83A-10(2) of the ITAA 1997 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.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which beneficial interests in Shares are provided to employees of the Employer in relation to the employee's employment.

The Employer has also established the Trust to acquire Shares and to allocate those Shares to its employees. Therefore, paragraphs 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

● the Trust acquires shares in the Employer; and

● the Trust ensures that the ESS interests, being beneficial interests in those shares, are provided under an employee share scheme, to the employees in accordance with the Trust Deed.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will require that the Trustee undertake incidental activities that are a function of managing the Plan and administering the Trust. The incidental activities are covered by paragraph 130-85(4)(c) of ITAA 1997.

The Trust is an employee share trust, as defined in subsection 995-1(1) of the ITAA 1997, as the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 and its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997. As such, paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes the contributions to the Trustee of the Trust from being a fringe benefit.

Accordingly, the Employer will not be required to pay FBT in respect of the irretrievable cash contributions it makes to the Trustee of the Trust to fund the acquisition of shares in accordance with the Trust Deed.

Question 4

Summary

The Commissioner will not seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by the Employer for contributions to the Trustee to fund the subscription for or acquisition of shares in the Employer by the Trustee.

Detailed reasoning

Law Administration Practice Statement PS LA 2005/24 deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936.

Part IVA gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. This discretion is found in subsection 177F(1) of the ITAA 1936.

Before the Commissioner can exercise his discretion to make a determination in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met. These are:

● there must be a scheme within the meaning of section 177A of the ITAA 1936;

● a tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, and

● having regard to the matters in paragraph 177D(b) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose)

The Scheme

Subsection 177A(1) of the ITAA 1936 (subsection 995-1(1)) provides that ‘scheme’ means:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct;

It is considered that this definition is sufficiently wide to cover the proposed arrangement under the Plan which utilises contributions made by the Employer to the Trustee (in accordance with the Trust deed), to fund the acquisition of Shares on behalf of participating employees by the Trustee.

Tax Benefit

'Tax benefit' is defined in paragraph 177C(1)(b) of the ITAA 1936 as including:

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or…

In order to determine the tax benefit that would be derived by the Employer from this scheme, it is necessary to examine other alternative schemes that the Employer might reasonably have been expected to enter into to achieve its aims in relation to employee remuneration. For example,

● the Employer could remunerate employees by way of increased salary, bonuses or deductible superannuation payments. Under these alternatives, identical or similar level of deductible expenses would arise to that which will arise under the proposed arrangement; or

● the Employer could issue shares directly to employees for no consideration.

Having considered the tax advantages of the above alternative remuneration scheme, it suggests that there is no tax benefit for the first alternative. As payments of the additional cash amounts would be deductible to the Employer, the same or similar deductible expenses would arise, compared to the current Plan.

Although the Employer has no stated intention of acquiring Shares other than by purchase from current shareholders; if the Employer was to issue new shares directly to its employees, it would not be entitled to any deduction for the shares (except the costs incurred when issuing and transferring any shares) unless section 83A-205 was satisfied. This provision requires that:

● the Employer must have provided an ESS interest to an individual under an employee share scheme; and

● the Employer did this as the individual’s employer ; and

● with the exception of paragraph 83A-35(2)(b), section 83A-35 must have applied to reduce the amount included in that individual’s assessable income under subsection 83A-25(1).

If the shares did meet these conditions, the Employer would be entitled to a deduction equal to the amount of the reduction allowable to the individual under section 83A-35 to a total amount of $1,000.

By contrast the use of the current trust arrangement permits the Employer, subject to the requirements of sections 8-1 and 83A-210, to claim a deduction for the full amount of the contributions it makes to the Trust. It is probable that this amount would exceed that which would be allowable under section 83A-205 in the alternative scheme above. Therefore, to the extent of any increased deductions because of the Trust arrangement, the Employer obtains a tax benefit.

While, for the reasons noted above by the applicant, it is unlikely that it would choose any other incentive plan that did not utilise a Trust and give rise to an allowable deduction (and therefore there would not be the necessary tax benefit), the analysis below proceeds on the assumption that the Commissioner would in fact be able to identify a relevant tax benefit.

Section 177D of the ITAA 1936 provides that Part IVA only applies if, after having regard to certain factors specified in subsection 177D(2) of the ITAA 1936, it would be concluded that a person who entered into the scheme did so for the sole or dominant purpose of enabling the tax payer to obtain the tax benefit.

Subsection 177D(2) of the ITAA 1936

Subsection 177D(2) of the ITAA 1936 sets out the following factors that must be considered in deciding whether a scheme was entered into for the purpose of obtaining a tax benefit:

(a) the manner in which the scheme was entered into or carried out;

(b) the form and substance of the scheme;

(c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

(a) The manner of the scheme

In considering whether Part IVA applies, the necessary comparison to be made in relation to the factors listed in paragraph 177D (b) of the ITAA 1936 is between the scheme as proposed and the relevant alternative.

The inclusion of the Trust in the scheme does give rise to a tax benefit, but the employer has provided the following reasons for the operation of the Trust:

1. Allows key shareholders to keep control over company ownership.

2. Registration of shares in Trustee’s name provides control over identity of shareholders, preventing a sale to unrelated persons.

3. If the Employer is sold, it is easier to “mop-up” employee shareholders.

4. Enables the disqualification event and disqualification discount provisions to be enforced in a simple manner through the Trust.

It is accepted that the Trust provides benefits to the operation of the scheme that would not be available if the shares were provided directly by the Employer.

(b) The Form and Substance of the scheme

The substance of the scheme is the provision of remuneration in the form of Shares to employees who participate in the Plan. It takes the form of payments by the Employer to the Trustee which acquires the Shares and transfers them to employees.

While existence of the Trust may confer a tax benefit, it cannot be concluded that it is the only benefit provided, as outlined above. The applicant has argued that the form of the arrangement with the Trust provides the scheme with non-tax benefits and this is accepted.

(c) The timing of the scheme

The irretrievable cash contributions made by the Employer to the Trustee enable the Trustee to acquire shares in the Employer and to use market conditions advantageously to meet potential employee share requirements in advance.

The application of section 83A-210 to cash contributions made before the employee receives the Share, prevents any timing advantage for the deductibility of those contributions.

(d) The result of the scheme

The result of the scheme is to provide the Employer with allowable deductions for the contributions they make to the Trust. However, it is noted that the contributions are irretrievable and reflect a genuine non-capital outgoing on the part of the Employer to achieve a business outcome. It is to be expected that a deduction would normally be allowable in these circumstances.

(e) Any change in the financial position of the employer

As noted above, the Employer makes irretrievable cash contributions to the Trust and those contributions constitute a real expense with the result that the Employer’s financial position is changed to that extent. While it is arguable that the quantum of the deductions is higher with a trust as part of the scheme, in contrast to the Employer providing shares to employees directly, there is nothing artificial, contrived or notional about the Employer’s expenditure.

(f) Any change in the financial position of other entities or persons

The contributions by the Employer to the Trustee will form the corpus of the Trust and must be dealt with by the Trustee in accordance with the terms of the Trust Deed, that is, for the acquisition of Shares to ultimately be provided to Participants in the Plan. The Employer is not a beneficiary of the Trust and its contributions cannot be returned to it in any form. Therefore, the contributions made by the Employer amount to a real change to the financial position of the Trustee.

The financial position of Participants in the scheme will also undergo a real change. This will be the case whether the Shares are acquired through the Trust or provided directly by the Employer. There is nothing artificial, contrived or notional about these changes.

(g) Any other consequence

There are no other consequences for the Employer, its employees and or their associates that would be relevant as evidence of a dominant purpose of obtaining a tax benefit.

(h) The nature of any connection between the Employer and any other persons

The relationship between the Employer and the Participants in the Plan is one of employer/employee. The parties are otherwise unrelated.

The contributions made by the Employer to the Trustee are commensurate with the Employer’s aim of providing the Participants with remuneration in a form that aligns their personal financial rewards with the risks and returns of the Employer’s other shareholders. There is nothing to suggest that the parties to the employee share scheme are not acting at arm's length to one another. Accordingly, there is nothing in relation to this factor to indicate a dominant purpose of obtaining a tax benefit.

Conclusion – the purpose of the scheme

A consideration of all the factors referred to in subsection 177D(2) of the ITAA 1936 leads to the conclusion that the dominant purpose of the scheme is to provide remuneration to the Employer’s employees who participate in the scheme in a form that promotes the Employer’s business objectives, rather than to obtain a tax benefit.

Accordingly, the Commissioner will not make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by the Employer in relation to irretrievable contributions made by the Employer to the Trust to fund the acquisition of Shares in accordance with the scheme as outlined above.