Edited version of your written advice

Authorisation Number: 1051444167656

Date of advice: 25 October 2018

Ruling

Subject: Employee share plan

Question 1

Will irretrievable cash contributions made by the Company to the trustee of the Trust (the Trustee) in accordance with the Plan and the Trust Deed to fund the subscription for, or acquisition on-market of, the Company’s Shares be assessable income of the Trust pursuant to sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) or Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will the Trustee make a capital gain when a Participant becomes absolutely entitled to the Shares when allocated, by reason that the Trust is an employee share scheme trust pursuant to Subdivision 130-D of the ITAA 1997?

Answer

No.

Question 3

Will the dividends received and distributed by the Trustee on Shares which have been allocated to a Participant be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936?

Answer

Yes.

Question 4

Will dividends and other income received by the Trustee on Unallocated Shares be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936?

Answer

Yes.

Question 5

Will the net income of the Trust under section 95 of the ITAA 1936 be assessed to the Trustee under section 99A of the ITAA 1936?

Answer

Yes, in respect of the net income of the Trust to which no beneficiary is presently entitled to the income of the trust estate.

Question 6

Will the Trustee be entitled to the benefit of franking credits under Subdivision 207-B of the ITAA 1997, attached to franked distributions on Unallocated Shares?

Answer

Yes, provided the Trustee holds the Unallocated Shares for a continuous period of not less than 45 days during the period beginning the day after the Trustee acquires the Unallocated Shares and ending on the 45th day after the Unallocated Shares become ex-dividend.

This ruling applies for the following period:

XXXX

The scheme commences on:

XXXX

Relevant facts and circumstances

1. The Company is an Australian resident company and is the head company of an income tax consolidated group (the Company TCG).

2. The Company has established an employee share plan (the Plan) as part of its remuneration strategy.

3. Under the Plan and in accordance with the Plan Rules, eligible employees who are invited to participate in the Plan (Participants) may be granted Performance Rights entitling them to acquire fully paid ordinary shares in the Company (Shares) subject to meeting Performance Hurdles, Vesting Conditions and Exercise conditions as defined in the Plan Rules.

4. The Plan operates as follows:

● The Company established a trust (The Trust) and executed the trust deed (Trust Deed) to facilitate the acquisition, holding and allocation of Shares to Participants in accordance with the Trust Deed.

● The Company makes irretrievable cash contributions to the Trustee to enable the Trustee to acquire Shares to satisfy the grants of Performance Rights.

● The Performance Rights are offered by the Company to Participants. When the Performance Hurdles, Vesting and Exercise Conditions are met the Shares are allocated to Participants by the Trustee at which point those shares become known as Allocated Plan Shares in accordance with the Trust Deed.

● Until the Trustee receives a direction from the Company or a Participant to transfer the legal or beneficial title in Allocated Plan Shares to a Participant, the Trustee holds the Allocated Plan Shares on trust for the benefit of Participants from time to time. Participants are absolutely entitled to Allocated Plan Shares and any other benefits attached to those Allocated Plan Shares.

5. The Trust Deed provides:

a. The Trustee must not accept any payment from Participants for the grant, exercise or allocation of Shares.

b. The irretrievable cash contributions are accretions to the corpus of the Trust.

c. Shares which have been acquired by the Trustee for the purpose of granting Performance Rights and not yet allocated to any Participant are known as Unallocated Shares.

d. The Trustee may, in respect of any Unallocated Shares, apply any capital receipts, dividends or other distributions received in respect of those Unallocated Shares to purchase further Shares as trust property.

e. The Company and the Trustee agree that the Trust will be managed and administered in a way that satisfies the requirements of subsection 130-85(4) of the ITAA 1997.

f. The Trustee is not permitted to carry out any activities in its capacity as Trustee which are not matters connected to or for the purposes of the Plan and is not permitted to do anything that may cause the Trust to fail the definition of an ‘Employee Share Trust’.

g. Upon termination of the Trust the balance of the capital or income of the Trust to which no Participant is entitled may be applied in whole or in part to a Participant in the Plan or any charity nominated by the Trustee as the Trustee thinks fit. The Trustee must not pay any balance to a member of the Group or the Company.

6. The Company pays for all the on-going administration costs of the Trust.

7. The Company is not a beneficiary of the Trust and has no legal or beneficial interest in the Shares held by the Trustee.

8. The Participants will return income on their Performance Rights in accordance with Subdivision 83A-C of the ITAA 1997 as the Plan is an employee share scheme to which Subdivision 83A-C applies.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Section 99A

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subdivision 130-D

Income Tax Assessment Act 1997 Subdivision 207-B

Reasons for decision

All legislative references in the Reasons for Decision are to the ITAA 1997 unless otherwise specified.

Question 1

Section 95 of the ITAA 1936 defines net income in relation to a trust as follows:

“net income”, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions…

Subsection 6-5(1) states:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Further, subsection 6-10(1) states:

Your assessable income also includes some amounts that are not ordinary income.

Note: These are included by provisions about assessable income. For a summary list of these, see section 10-5.

None of the provisions listed in section 10-5 are relevant in this situation. Therefore, irretrievable contributions made by the Company to the Trust will not be assessable income under section 6-10. They will only be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6-5.

The income tax legislation does not define income according to ordinary concepts. Chief Justice Jordan in Scott v. Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215; (1935) 52 WN (NSW) 44; (1935) 3 ATD 142 provided a definition of ’income’ for Australian income tax law. In his judgement at SR (NSW) 219 the Chief Justice considered that:

The word ’income’ is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts.

The decision by the US Supreme Court in Eisner, Collector of United States Internal Revenue for 3^rd District of New York v. Macomber 252 US 189 (1919) is generally cited to also illustrate the common law principle of ordinary income (which arises as income from property). Justice Pitney at pages 206-207 explained that:

The fundamental relation of “capital” to “income” has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being “derived” that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal;…that is income derived from property. Nothing else answers the description.

In G.P. International Pipecoaters Proprietary Limited v. The Commissioner of Taxation of the Commonwealth of Australia (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. Brennan, Dawson, Toohey, Gaudron and McHugh JJ stated at CLR 138 that:

To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient’s purpose in engaging in the transaction, venture or business.

Receipts of a capital nature do not constitute income according to ordinary concepts. The Trust Deed provides that all funds received by the Trustee from the Company will constitute accretions to the corpus of the Trust.

In ATO Interpretative Decision ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme (ATO ID 2002/965) the view is expressed that the Trustee of the employee share scheme trust will not be assessed under sections 6-5 or 6-10 on contributions made to it by an employer for the sole purpose of the employer’s employee share scheme. The underlying principle of the decision is that the contributions constitute capital receipts of the Trustee.

Consistent with ATO ID 2002/965, the irretrievable cash contributions made by the Company to the Trustee to fund the acquisition of the Company Shares by the Trust in accordance with the Trust Deed will not be assessable income of the Trust pursuant to sections 6-5 or 6-10.

Under Division 6 of the ITAA 1936, it is generally the beneficiaries of a trust who are presently entitled to a share of the income of the trust who include that share of ‘net income’ of the trust as assessable income. The trustee of a trust is generally taxed on the balance of the ‘net income’ as defined in subsection 95(1) of the ITAA 1936, which is not included in the assessable income of a beneficiary.

Given that the irretrievable cash contributions made by the Company to the Trustee are neither ordinary income nor statutory income, they will not be included in the net income of the Trust and will not be assessed to the Trustee under Division 6 of the ITAA 1936. Accordingly, the Trustee will not be assessed on irretrievable contributions made by the Company under sections 6-5 or 6-10 of the ITAA 1997 or Division 6 of the ITAA 1936.

Question 2

Exception to liability for capital gains from CGT Events E5 and E7

Section 130-90 may operate to disregard a gain or loss under sections 104-75 and 104-85 where specified conditions are satisfied. Relevantly for the Plan, section 130-90 provides:

Shares held to satisfy the future exercise of rights acquired under employee share schemes

130-90(1)

Disregard any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, to the extent that it results from a CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

(b) the CGT event happens in relation to a share; and

(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d) 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.

130-90(2)

Subsection (1A) or (1) does 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

Subsection 130-85(4) provides:

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 conditions in paragraphs 130-85(4)(a) and (b)

The beneficial interest in a Share received by a Participant under the terms of the Trust Deed is an ESS interest (defined in subsection 995-1(1) to have the meaning given by subsection 83A-10(1) in the ITAA 1997). Subsection 995-1(1) defines an ‘employee share scheme’ to have the meaning in subsection 83A-10(2), as being a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) of a company or subsidiaries of a company in relation to the employees’ employment.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) because it is scheme that provides rights (Performance Rights) to acquire beneficial interests in the ordinary shares of the Company to employees of the Company or subsidiaries of the Company in relation to the employee’s employment.

The Company has established the Trust to acquire Shares and to allocate those Shares to Participants in order to satisfy ESS interests (Performance Rights) acquired by those Participants under the Plan. A beneficial interest in a Share is itself provided under an employee share scheme because it is provided under the same scheme under which the Performance Rights are provided to Participants in relation to their employment, being an employee share scheme as defined in subsection 83A-10(2).

Paragraphs 130-85(4)(a) and (b) are therefore satisfied.

The condition in paragraph 130-85(4)(c)

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) will also require that the Trustee undertake incidental activities that are a function of managing the Plan.

In 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 (ATO ID 2010/108) the Commissioner discusses a number of activities which are considered to be within the category of merely incidental for the purposes of paragraph 130-85(4)(c):

● the opening and operation of a bank account to facilitate the receipt and payment of money;

● the receipt of dividends in respect of shares held by the trust on behalf of an employee, and their distribution to the employee;

● the receipt of dividends in respect of unallocated shares and using those dividends to acquire additional shares for the purposes of the employee share scheme;

● dealing with shares forfeited under an employee share scheme including the sale of forfeited shares and using the proceeds of sale for the purposes of the employee share scheme;

● the transfer of shares to employee beneficiaries or the sale of shares on behalf of an employee beneficiary and the transfer to the employee of the net proceeds of the sale of those shares;

● the payment or transfer of trust income and property to the default beneficiary on the winding up of the trust where there are no employee beneficiaries; and

● receiving and immediately distributing shares under a demerger.

However, as indicated in ATO ID 2010/108, activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental. In the present case there is no clause in the Trust Deed to suggest that the Trustee will engage in activities that result in employees being provided with such additional benefits.

In fact, the Trust Deed provides that The Company and the Trustee agree that the Trust will be managed and administered in a way that satisfies the requirements within subsection 130-85(4).

Paragraph 130-85(4)(c) is therefore satisfied as any activities undertaken by the Trustee other than the acquisition of Shares and the allocation of those Shares to the employees in accordance with the Deed and the Plan Rules are merely incidental to operation of the Plan.

Accordingly, the Trust satisfies the definition of an employee share trust in subsection 130-85(4) as:

● the Trust acquires shares in a company (being the Company);

● the Trust ensures that ESS interests (as defined in subsection 83A-10(1), being beneficial interests in the shares of the Company), are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating the Company’s Shares to Participants in accordance with the Deed and Plan Rules; and

● the Trust Deed does not provide for the Trustee to participate in any activities which are not considered to be merely incidental to the function of administering the Trust.

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 (disregarding any legal disability the beneficiary is under).

Subsection 104-75(2) provides that the time of the CGT event is when the beneficiary becomes absolutely entitled to the asset.

In the present case, CGT event E5 will happen under the terms of the Plan upon allocation of the Shares to a Participant as the Participant becomes absolutely entitled to those Shares as against the Trustee as the Trust is not a unit trust or a trust to which Division 128 applies. Therefore, paragraph 130-90(1)(a) will be satisfied.

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. Subsection 104-75(2) provides that the time of the CGT event is when the disposal occurs.

Under section 106-50 from just after the time that a beneficiary (Participant) becomes absolutely entitled to a CGT asset as against the trustee of a trust, the asset is treated as being the beneficiary’s asset (instead of being an asset of the trust) and an act done in relation to the asset by the trustee is treated (for CGT purposes) as if the act had been done by the beneficiary (instead of the trustee.

Under the Plan Participants become absolutely entitled to a specified number of Shares triggering CGT event E5. When the Trustee transfers the legal ownership of the Shares to a Participant following allocation, section 106-50 will deem the Shares to be an asset of the Participant and the transfer of the Shares by the Trustee to have been done by the Participant. Therefore, as an entity cannot transfer an asset it already holds to itself, CGT event E7 will not happen.

Paragraph 130-90(1)(b)

The term ‘a share in a company’ is defined by paragraph 995-1(1)(a) to mean a share in the capital of a company and includes stock. An ordinary share in the Company held by the Trustee and to which a Participant is entitled upon vesting or exercise of a Performance Right is a fully paid ordinary share in the capital of the Company. Accordingly, paragraph 130-90(1)(b) will be satisfied as CGT event E5 will happen in relation to an ordinary share in the Company for the purposes of this paragraph.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in an ordinary share of the Company upon exercising of a Performance Right provided under the Plan.

Paragraph 130-90(1)(d)

Subsection 83A-20(1) of Subdivision 83A-B states:

This Subdivision applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

As explained above, subsection 995-1(1) defines an employee share scheme to have the meaning in subsection 83A-10(2) as being 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 that provides rights (Performance Rights) to acquire beneficial interests in ordinary shares in the Company to employees in relation to the employee’s employment. Each Performance Right is acquired for no cost.

Further, the Participants will return income on their Performance Rights in accordance with Subdivision 83A-C of the ITAA 1997 as the Plan is an employee share scheme to which Subdivision 83A-C applies. In this circumstance paragraph 130-90(1)(d) will be satisfied.

Accordingly, all the conditions in subsection 130-90(1) are satisfied.

Subsection 130-90(2)

Provided a Participant does not acquire the beneficial interest in a Share of the Company for more than its cost base in the hands of the Trustee at the time that CGT event E5 happens, subsection 130-90(2) will not operate to apply to deny the application of section 130-90. In the present case, the Trustee must not accept any payment from Participants for the grant, exercise or allocation of Shares. In these circumstances subsection 130-90(2) will not apply.

Conclusion

Section 130-90 will operate to disregard any capital gain or loss made by the Trustee on any ordinary share of the Company when a Participant becomes absolutely entitled to the share in the Company (CGT event E5).

Question 3

Broadly, net income is defined by section 95 of the ITAA 1936 to mean the total assessable income of the trust estate calculated under the ITAA 1936 as if the trustee were a resident taxpayer in respect of that income and less allowable deductions.

Section 44 of the ITAA 1936 includes in the assessable income of a resident shareholder, dividends that are paid to the shareholder by the company out of profits derived by it from any source.

If dividends and other income are received by the Trustee, those amounts are included in the Trustee’s calculation of its net income for a year of income under section 95 of the ITAA 1936.

For Allocated Plan Shares that the Trustee holds on behalf of a Participant, the Participant is entitled to receive all dividends paid in respect of the Participant’s Shares. Therefore, the dividends received by the Trustee as registered shareholder of the Allocated Plan Shares will be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936.

Question 4

As previously explained the net income of a trust estate is defined by section 95 of the ITAA 1936 to mean the total assessable income of the trust estate calculated under the ITAA 1936 as if the trustee were a resident taxpayer in respect of that income, less all allowable deductions.

Section 44 of the ITAA 1936 includes in the assessable income of a resident shareholder, dividends that are paid to the shareholder by the company out of profits derived by it from any source.

Before the allocation to a Participant of Shares held by the Trustee, the Trustee may, in respect of such Unallocated Shares, apply any capital receipts, dividends or other distributions received in respect of those Unallocated Shares to purchase further Shares as trust property.

If dividends and other income are received by the Trustee, those amounts are included in the Trustee’s calculation of its net income for a year of income under section 95 of the ITAA 1936.

Question 5

Where no beneficiary is presently entitled to the income of a trust estate, the net income of that trust estate will be taxed in the hands of the trustee under either section 99 or 99A of the ITAA 1936. Section 99A will apply unless one of the exclusions from its operation contained in subsection 99A(2) applies. In the present case the exclusion in subsection 99A(2) does not apply to the Trust.

Where there is no part of the net income of a resident trust estate that is included in the assessable income of a beneficiary of the trust estate under section 97 or the trustee is not assessed under section 98 of the ITAA 1936, the trustee shall be assessed and is liable to pay tax on the net income of the trust estate (subsection 99A(4) of the ITAA 1936).

Question 6

Amounts to be included in assessable income

Subsection 207-5(3) provides that if a franked distribution is made to a member that is a trustee of a trust, an amount equal to the franking credit on the distribution is included in the member’s assessable income. However, subsection 207-5(4) provides that a tax offset in relation to that distribution is only available to an entity (who may be a trustee) if the distribution flows indirectly to it and does not flow indirectly through it to another entity. The tax offset is equal to its share of the franking credit on the distribution.

Subdivision 207-B deals with the effect of receiving a franked distribution through certain partnerships and trusts. Section 207-25 provides:

This Subdivision deals with an entity that receives a benefit of a franked distribution where:

(a) the distribution is made to a … trustee of a trust; and

(b) the benefit is received either directly or through other interposed partnerships or trusts.

The distribution is regarded as flowing indirectly to the entity under this Subdivision.

Subsection 207-35(1) provides that if a franked distribution is made in an income year to an entity that is a trustee of a trust and the entity is not a corporate tax entity nor the trustee of a complying superannuation entity, then the assessable income of the trust for that income year includes the amount of the franking credit on the distribution.

Pursuant to subsection 207-50(4), a franked distribution will be taken to flow indirectly to the trustee of a trust relevantly if:

● the distribution is made to the trustee, and

● the trustee is liable to be assessed on all or part of the trust’s net income for that year under section 99A of the ITAA 1936 (subparagraph 207-50(4)(b)(ii)); and

● the trustee’s share of the distribution under section 207-55 is a positive amount, whether or not the trustee actually receives any of that share.

Tax offset

Section 207-45 provides an entity that is the ultimate recipient of a franked distribution to whom a distribution flows indirectly is entitled to a tax offset for that income year equal to its share of franking credit attached to the distribution. The ultimate recipients of a franked distribution are the recipients that can use the tax offset and includes trustees that are liable to be assessed under section 99A of the ITAA 1936.

The Trustee will be liable to be assessed under section 99A of the ITAA 1936 in relation to dividends on Unallocated Shares.

However, where a franked dividend is paid to a person, subsection 207-145(1) denies a gross-up and tax offset where the person is not a qualified person for the purposes of Division 1A of the former Part IIIAA of the ITAA 1936.

Qualified person

Broadly, a person will be taken to be a qualified person in respect of a dividend paid on shares if the shares are held at risk for a period of 45 days and the person or an associate does not make a related payment in respect of the dividend (former section 160APHO of the ITAA 1936).

It is accepted that no related payment will be made by the Trustee. Therefore, the Trustee will be a qualified person if it has held the Unallocated Shares for a continuous period of not less than 45 days during the period beginning the day after the Trustee acquires the Unallocated Shares and ending on the 45th day after the Unallocated Shares become ex-dividend.

Limit of tax offset

Subsection 67-25(1) provides that where a tax offset is available under Division 207, that tax offset is subject to the refundable tax offset rules unless otherwise stated in the section. Subsection 67-25(1B) provides that the tax offset is only subject to the refundable tax offset rules if the trustee entitled to the tax offset is not liable to be assessed under section 98 or 99A of the ITAA 1936.

As franked distributions flow indirectly to the Trustee, the Trustee is entitled to a franking tax offset under section 207-45. However, the Trustee is assessed on the distributions under section 99A of the ITAA 1936. Therefore, the tax offsets available to the Trustee are limited to the amount of tax payable and any excess franking tax offset is not refundable.