Edited version of private advice

Authorisation Number: 1051498680564

Date of advice: 1 May 2019

Ruling

Subject: Employee Share Schemes Start-up concession

Question 1

Do the ESS interests acquired by employee X satisfy the Employee Share Scheme start up concession eligibility tests under section 83A-33 and section 83A-45 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Will Method 1 of the Income Tax Assessment Act 1997 (Methods for Valuing Unlisted Shares) Approval 2015 be applicable in working out the value of the ordinary shares of A Pty Ltd for the purposes of subsection 83A-33(5) of the Income Tax Assessment Act 1997 as at the time when the relevant Employee Share Scheme interests are acquired (the valuation time)?

Answer

Yes

Question 3

Do the ESS interests acquired by employee X satisfy the eligibility test to be subject to the special timing rules under subsection 115-30(1) Item 9A of the Income Tax Assessment Act 1997 for the shares acquired as a result of exercising those options?

Answer

Yes

This ruling applies for the following periods:

Year of income ended 30 June 201C

Year of income ended 30 June 201D

The scheme commences on:

1 July 201B

Relevant facts and circumstances

Employee X is an employee of A Pty Ltd.

A Pty Ltd

·        Is an Australian incorporated private company;

·        Was incorporated in State A on a specific date in 201B;

·        Currently have two subsidiaries, Y Pty Ltd which is the licence holder and Z Pty Ltd which is the distributor. The subsidiaries were incorporated in State A in late 201A and early 201B respectively;

·        Operates a business in Australia.

A Pty Ltd intends to implement an Employee Share Scheme, where it will grant options to acquire ordinary shares in A Pty Ltd for its employees by 30 June 201D. Employee X is one of these employees.

Associates of these employees are not eligible to be granted options to acquire shares in A Pty Ltd.

The valuation date is prior to 30 June 201D, when the options will be granted.

A Pty Ltd had an aggregated turnover of $0 in the 201C year of income.

A Pty Ltd intends to adopt Method 1 of the Income Tax Assessment Act 1997 (Methods for Valuing Unlisted Shares) Approval 2015 to determine the market value of the ESS interests it will provide.

Under Method 1, the market value per share in the company at the valuation date of the options is calculated at $0.13.

The exercise (strike) price for the option will be in excess of the market value per share in the company.

The ESS interests issued under the plan are rights.

All employees who will be granted ESS interests will be employed by A Pty Ltd at the valuation date.

A Pty Ltd will only issue ordinary shares under the employee share scheme.

The employees acquiring the ESS interests will hold their interests for a period of at least 3 years.

Immediately after acquiring the ESS interests, employee X does not hold a beneficial interest in more than 10% of the shares in the company and is not in a position to cast or control the casting of more than 10% of the maximum number of votes that may be cast at a general meeting of the company.

A Pty Ltd anticipates that there will not be a change of control of the company occurring within the period ending 6 months after the valuation time.

A Pty Ltd raised capital of $X on a specific date in late 201C.

A Pty Ltd will prepare a financial report in accordance with accounting standards under the Corporations Act 2001 for the year in which the valuation time occurs.

A Pty Ltd has X ordinary shares on issue.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 83A-25

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 section 83A-45

Income Tax Assessment Act 1997 subsection 115-30(1) item 9A

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Question 1

Summary

The ESS interests acquired by employee X satisfy the Employee Share Scheme start up concession eligibility tests under section 83A-33 and section 83A-45.

Detailed reasoning

Under subsection 83A-25(1) the assessable income of the acquirer of an Employee Share Scheme (ESS) interest includes the discount given in relation to the interest in the income year in which the ESS interest is acquired.

The ESS start up concession operates to reduce the total amount included in the assessable income of the acquirer of an ESS interest under subsection 83A-25(1) by the total of the amounts included in their assessable income under that subsection.

To qualify for the start-up concession, a taxpayer's Employee Share Scheme (ESS) interests must meet the primary conditions under section 83A-33 and the further conditions under section 83A-45. As the ESS interests here are options and not beneficial interests in shares, subsection 83A-105(2) (about broad availability of schemes) does not apply.

Under the primary conditions in section 83A-33:

·        The company that grants the ESS interest (and its corporate group) must not have any interests listed on an approved stock exchange in the income year prior to the ESS interest being offered. (section 83A-33(2))

·        The company (and its connected entities) must have been incorporated for less than 10 years (section 83A-33(3)).

·        The company that grants the ESS interests must have had an aggregated turnover of less than $50 million in the income year prior to the year the interests are granted. The turnover test includes connected entities (section 83A-33(4)).

·        In the case of an ESS for options, the exercise price must not be less than the market value of shares in the company at the date of grant of the options (section 83A-33(5)).

·        In the case of an ESS that is a share plan, the shares must not be offered for more than a 15% discount on the market value of the shares at the date of grant (section 83A-33(5)).

·        The employing company (which can be a subsidiary of the company granting the ESS interests) must be an Australian resident taxpayer (section 83A-33(6)).

In this instance:

·        A Pty Ltd is a privately held company; therefore it is not listed on any stock exchange.

·        A Pty Ltd was incorporated on a specific date in 201B and its subsidiary members (Y Pty Ltd and Z Pty Ltd) were incorporated on a specific date in late 201A and early 201B respectively. The company and its connected entities have therefore been incorporated for less than 10 years.

·        A Pty Ltd had an aggregated turnover of $0 in the 201C income year.

·        As illustrated in the use of Method 1 of valuing unlisted shares in question 2, the market value per share in the company at the valuation date of the options is $0.13. The strike price of the option will be in excess of the market value per share in the company.

·        The ESS interests issued under the plan are rights.

·        A Pty Ltd has been an Australian resident from its incorporation date.

All the primary conditions under section 83A-33 are therefore satisfied in this instance for employee X.

In addition, there are further eligibility criteria set out under section 83A-45 that are required to be met for a taxpayer's ESS interests to be eligible for the start-up tax concessions, which are:

·        The taxpayer must be employed by the company that issued the ESS interest, or a subsidiary of that company, when their ESS interest was acquired. (subsection 83A-45(1))

·        The ESS must only relate to the issue of "ordinary" shares (subsection 83A-45(2)).

·        The taxpayer must satisfy an integrity rule that is designed to prevent contrived schemes which provide employees with shares in unrelated companies. Such schemes involve creating a company within the group that principally engages in trading or investing in the unrelated shares. The created company also employees the taxpayer under the scheme (subsection 83A-45(3)).

·        The taxpayer must satisfy the minimum holding period of three years, subject to some exceptions. This requires the taxpayer-employee to hold their ESS interest for this period, but it also requires the scheme to provide the same minimum holding period for all other acquirers during the taxpayer's three-year period (subsection 83A-45(4)) and subsection 83A-45(5)).

·        There is a 10% limit on the shareholding and voting power that the taxpayer employee/associate can have under the ESS (subsection 83A-45(6)).

In this instance:

·        Employee X and all other employees who will be granted ESS interests will be employed by A Pty Ltd when their ESS interests are acquired.

·        A Pty Ltd will only issue ordinary shares under the ESS. The only ESS interests that will be acquired by employees under the plan are right to acquire ordinary shares in A Pty Ltd.

·        The company does not engage in the trading or investing of unrelated shares.

·        The employees acquiring the ESS interests (including employee X) will hold their interests for a period of at least 3 years.

·        The employees who are granted ESS interests in A Pty Ltd (including employee X) have ownership rights in the company of X%, Y%, Y% and Z% each immediately after they have acquired the interest. None of them have more than 10% ownership in the company.

All the further conditions under section 83A-45 are therefore satisfied in this instance for the ESS interests issued to employee X.

Therefore those ESS interests issued to Employee X satisfy the ESS start-up concession eligibility tests under section 83A-33 and section 83A-45.

Question 2

Summary

Method 1 of the Income Tax Assessment Act 1997 (Methods for Valuing Unlisted Shares) Approval 2015 is applicable in working out the value of the ordinary shares of A Pty Ltd for the purposes of subsection 83A-33(5) as at the time when the relevant ESS interests are acquired (the valuation time).

Detailed Reasoning

The Income Tax Assessment Act 1997 (Methods for Valuing Unlisted Shares) Approval provides approved valuation methods for companies making an offer of ESS interests to eligible persons under an ESS which would otherwise qualify for the ESS start-up concession under sections 83A-33 and 83A-45.

The methods set out in clause 5 of the Approval may be used only in working out the value of unlisted ordinary shares for the purposes of subsection 83A-33(5) as at the time when the relevant ESS interests are acquired (the valuation time).

The Approval applies to a company that:

·        Issues ESS interests that are eligible for the ESS start-up concession; and

·        Reasonably anticipates that there will not be a change of control of the company occurring within the period ending six months after the valuation time (the time of issue of the ESS interest).

In this instance:

·        A Pty Ltd issues ESS interests that are eligible for the ESS start-up concession (having satisfied sections 83A-33 and 83A-45).

·        A Pty Ltd anticipates that there will not be a change of control of the company occurring within the relevant period.

The Approval therefore applies to A Pty Ltd.

Under sub-clause 1 of Method 1 for valuing unlisted ordinary shares:

For a company that:

a)     Has not raised capital of more than $10 million during the period of 12 months immediately before the valuation time; and

b)     At the valuation time, either:

                                     i.          Has been incorporated for not more than 7 years; or

                                    ii.          Is a small business entity within the meaning of section 328-110; and

c)     Prepares, or will prepare, a financial report (within the meaning of the Corporations Act 2001), for the year in which the valuation time occurs, that complies with the accounting standards under the Corporations Act 2001;

the method set out in sub-clause (2) is an approved valuation method.

In this instance:

A Pty Ltd raised capital of $X on a specific date in late 201C; and

At the valuation time:

·        A Pty Ltd was incorporated on a specific date in 201B, which is less than 7 years at valuation time;

·        Alternatively, the aggregated turnover of A Pty Ltd for the purposes of the small business entity test is nil and therefore less than $10 million, making it a small business entity; and

·        A Pty Ltd will prepare a financial report in accordance with accounting standards for the year in which the valuation time occurs.

The method set out in sub-clause (2) below is then an approved valuation method for A Pty Ltd.

Step 1: Work out the amount of the net tangible assets of the company (disregarding any preference shares on issue) at that time;

The Net Tangible Assets of A Pty Ltd is set out below:
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Step 2: Work out the amount of the return that would be required to be provided under the terms of any preference shares on issue at the valuation time if those shares were to be redeemed, cancelled, bought back or otherwise satisfied at that time (disregarding any contingencies as to the provision of that return and any return that would not rank before ordinary shareholders upon a winding up);

A Pty Ltd has only ordinary shares on issue; therefore step 2 is not applicable.

Step 3: Reduce the Step 1 amount by the Step 2 amount;

Given there is no reduction to be applied as a result of Step 2 above, the amount resulting from Step 3 is $Z.

Step 4: Divide the Step 3 amount by the total number of:

·        Ordinary shares; and

·        Any preference shares that may participate together with any ordinary shares in the residual assets of the company upon a winding up;

on issue in the company at that time.

A Pty Ltd has X ordinary shares on issue. A Pty Ltd only issues ordinary shares; therefore there are no preference shares applicable.

Dividing Step 3 by the total amount of ordinary shares held, results in an amount of $0.13 per share.

Valuation under this method provides a market value of $0.13 per share. This meets the ATO standard of valuing unlisted shares and satisfies subsection 83A-33 (5) of the ITAA97.

Question 3

Summary

The ESS interests issued to employee X satisfy the eligibility test to be subject to the special timing rules under subsection 115-30(1) Item 9A when employee X acquires shares in A Pty Ltd as a result of exercising his options.

Detailed reasoning

Item 9A of subsection 115-30(1) states that a share the acquirer acquires by exercising an ESS interest if:

a)     section 83A-33 (about start-ups) reduces the amount to be included in the acquirer's assessable income in relation to the ESS interest; and

b)     exercising the ESS interest causes Subdivision 130-B or Division 134 to apply

is acquired when the acquirer acquires the ESS interest.

The basic structure of Division 83A is that shares and rights (ESS interests) provided to employees and at a discount are included in the employee's assessable income.

Section 83A-33 is a start-up concession which applies to rights such that if they meet the conditions the amount of the discount is excluded from the assessable income of the employee under Division 83A.

Normally where an asset which is an option (right) is exercised the share is taken for CGT purposes to have been acquired on the date of exercise of the option and the normal CGT provisions would apply from that date (including the operation of the 12 month CGT discount).

Item 9A of subsection 115-30(1) effectively backdates the acquisition date of the share to the date that the ESS interest (the right or option) was acquired. But Item 9A only applies where the acquirer of the ESS interest has had their assessable income reduced by section 83A-33 and where exercising the ESS interest causes Subdivision 130-B or Division 134 to apply.

When employee X acquires his ESS interests, then he will have his assessable income reduced under section 83A-33. Exercising the ESS interest should also cause Subdivision 130-B (rights) or Division 134 (options) to apply to employee X.

In that case, both eligibility tests to be subject to the special timing rules under subsection 115-30(1) Item 9A will be satisfied for the ESS interests issued to employee X when he acquires shares in A Pty Ltd as a result of exercising the options.