Edited version of your written advice

Authorisation Number: 1051500064385

Date of advice: 01 April 2019

Ruling

Subject: Employee share schemes

Question 1

Will the irretrievable cash contributions to the Trustee of the employee share trust (EST), be assessable income of the EST, pursuant to either sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will a capital gain or capital loss that arises for the Trustee for the Company A EST at the time when either CGT Event E5 or E7 happens in relation to Company A shares be disregarded under section 130-90 of the ITAA 1997, if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee?

Answer

Yes

Relevant facts and circumstances

Company A submitted an application for a private binding ruling on aspects of its employee equity plans (the Plans).

The application for a private binding ruling (the Application) stated that:

● Company A has two equity based compensation plans which are currently in use.

● Company A established an employee share trust (the EST) to facilitate the provision of shares in Company A for Australian employees and executives.

A summary of each of the Plans is as follows:

General Plan (GP)

GP allows all employees to share in Company A’s financial success by enabling them to invest in it on attractive terms. It provides all employees with the opportunity to subscribe for shares at a discount to the applicable market price, as follows:

● Employees receive dividend distributions and capital returns and are able to vote at Company A’s general meetings.

● If an employee’s employment is terminated, the employee will automatically be withdrawn from the GP. The entire balance of the employee’s contribution account at the time will be refunded at this time.

● The Board may apply a Holding Lock to some or all Shares acquired by an employee under the GP for the duration of the relevant Holding Lock Period.

● The GP uses the EST as outlined below for contributions by employees to acquire Shares.

Performance Plan (PR)

The PR has been established to provide Company A with a mechanism to attract key prospective employees, to retain them and to strengthen the link between employee performance and increases in shareholder value.

The PR broadly operates as follows:

● The Board may issue an invitation to eligible employees to acquire “Performance Rights” and “Performance Options” (together “Options”) with the absolute discretion to develop and amend any policies in relation to these Options.

● Performance Rights and Performance Options are collectively defined as ‘Options’.

● The invitation will specify various aspects of the Options such as performance hurdles and period, test dates, expiry date, exercise price, etc.

● Performance Rights granted by Company A under the Plan will be granted for no consideration payable by employees, unless otherwise determined by the Board. Performance Options will be granted with an exercise price based on market value of a Share at the time of the original invitation.

● Employees must achieve a minimum “good” rating under Company A’s performance appraisal system for each year from the grant date to the test date.

● Each Option can be converted into one ordinary Share in Company A on satisfaction of the vesting period and the performance hurdles.

● An Option does not confer on an employee the right to participate in new issues of Shares by Company A, including by way of bonus issue, rights issue or otherwise.

● Shares issued as a consequence of the exercise of Options will, from the date of allotment, rank equally with all other issued Shares, and will be entitled in full to those dividends which have a record date for determining entitlements after the date of issue.

● The PR uses the EST as outlined below (refer “Operation of the EST” section below).

● Employees are absolutely entitled to the shares as against the Trustee of the EST from when the Shares are allocated to them.

● Performance Rights may be settled in cash where Board has made a determination in relation to good leaver provisions or in cases of early testing on change of control events.

Operation of the EST

The EST broadly operates as follows:

● it was established as a sole purpose trust to acquire shares for Australian employees of Company A.

● it is funded by contributions from Company A and where applicable from employees.

● such funds will be used by the Trustee of the EST to acquire the shares in Company A either on-market or via a subscription for new shares.

● such Shares acquired by the Trustee will be immediately allocated to the relevant employees who will become absolutely entitled to those Shares at that point in time.

● the Trustee will be permitted to sell shares on behalf of an employee where directed by Company A or the employee to do so.

● The Trust Deed specifies that the Trust will be administered so that it satisfies the sole activities test for the purposes of subsection 130-85(4) of the ITAA 1997 and be an “employee share trust” as defined in sub-section 995-1(1) of the ITAA 1997.

● The EST will not provide loans to employees of Company A.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 6-10(1)

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Section 83A-10(1)

Income Tax Assessment Act 1997 Section 83A-10(2)

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Section 83A-20

Income Tax Assessment Act 1997 Subsection 83A-20(1)

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 Section 104-75

Income Tax Assessment Act 1997 Subsection 104-75(1)

Income Tax Assessment Act 1997 Subsection 104-75(2)

Income Tax Assessment Act 1997 Section 104-85

Income Tax Assessment Act 1997 Section 130-85

Income Tax Assessment Act 1997 Subsection 130-85(1)

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

Income Tax Assessment Act 1997 Paragraph 130-85(4)(a)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(b)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(c)

Income Tax Assessment Act 1997 Section 130-90

Income Tax Assessment Act 1997 Section 130-90(1)

Income Tax Assessment Act 1997 Section 130-90(2)

Income Tax Assessment Act 1997 Section 130-90

Income Tax Assessment Act 1997 Section 130-90(d)

Income Tax Assessment Act 1997 Subsection 130-90(1)

Income Tax Assessment Act 1997 Paragraph 130-90(1)(a)

Income Tax Assessment Act 1997 Paragraph 130-90(1)(b)

Income Tax Assessment Act 1997 Paragraph 130-90(1)(c)

Income Tax Assessment Act 1997 Paragraph 130-90(1)(d)

Income Tax Assessment Act 1997 Subsection 130-90(2)

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Issue 1

Question 1

Section 95 of the ITAA 1936 defines net income in relation to a trust as follows, insofar as it is relevant:

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) of the ITAA 1997 states:

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

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 of these provisions, see section 10-5.

None of the provisions listed in section 10-5 of the ITAA 1997 is relevant to the facts and circumstances of this ruling and therefore irretrievable contributions made by the Company to the EST will not be assessable income under section 6-10 of the ITAA 1997. 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 of the ITAA 1997, which is considered in the following section of the reasons for decision.

Pursuant to the Trust Deed, all contributions by the Company to the EST for the purpose of acquiring the Company’s Shares constitute accretions to the corpus of the EST. Furthermore, pursuant to clauses of the Trust Deed the Trustee must, when directed by the Company, acquire Shares on behalf of participating employees and use the contributions made by the Company and the employees to do so.

The general powers granted to the Trustee pursuant to the Trust Deed must be exercised only for the purposes of the EST and only to give effect to the plans which the EST supports. To this end, the contributions received from the Company and participating employees must, therefore, only be used to acquire Shares in accordance with the terms of the Trust Deed and the Plans.

Accordingly, the irretrievable contributions made by the Company to the Trustee to acquire Shares will not be assessable income under section 6-5 of the ITAA 1997, but will constitute capital receipts of the Trustee. Therefore, the irretrievable cash contributions made by the Company to the Trustee of the EST to fund the acquisition of Shares by the EST in accordance with the Trust Deed will not be assessable income of the EST pursuant to sections 6-5 or 6-10 of the ITAA 1997. This accords with the view expressed in ATO ID 2002/965.

The Trust Deed provides that whilst the Trustee is not entitled to receive any fees, commissions or remuneration in respect of the performance of its obligations, the Company may pay to the Trustee from its own resources any fees, commission or remuneration as the Company and the Trustee may agree, from time to time. Such receipts will be assessable income of the Trustee in contrast to the irretrievable contributions made to facilitate the acquisition of the Company’s Shares.

Question 2

Where a Participant becomes absolutely entitled to the shares as against the Trustee, CGT event E5 will occur and therefore under section 104-75 of the ITAA 1997, the Trustee will make a capital gain or loss. CGT Event E7 will happen at the time the Trustee disposes of Shares according to the Trust Deed and in satisfaction of a beneficiary’s interest. However, section 130-90 of the ITAA 1997 operates to disregard that gain or loss where the specified conditions are satisfied.

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 (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.

EST

The term ‘employee share trust’ referred to in subsection 130-90(1) of the ITAA 1997 is defined in section 995-1 of the ITAA 997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

Subsection 130-85(4) of the ITAA 1997 provides that an EST for an employee share scheme (having the meaning given by subsection 83A-10(2) of the ITAA 1997) 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 right to acquire a share and the beneficial interest in the share that is acquired pursuant to the exercise of the right are both ESS interests within the meaning of subsection 83A-10(1) of the ITAA 1997.

An ESS 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 Plans comprise an ESS within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which Options to acquire Shares are provided to employees in relation to the employee’s employment (see further discussion of term ‘employee share scheme’ under the heading ‘Paragraph 130-90(1)(d) of the ITAA 1997’ below).

Under the Plans the Company has established the EST to acquire Shares in the company and to allocate those shares to employees to satisfy the Options acquired under the scheme. The beneficial interest in the Share is itself enabled under an ESS because it is provided under the same scheme as the Options to acquire the Shares are provided to the employee in relation to the employee’s employment, being an ESS as defined in subsection 83A-10(2) of the ITAA 1997.

Therefore, paragraph 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

● the EST acquires shares in the company,

● the EST ensures that ESS interests as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in those shares, are provided under an ESS, as defined in subsection 83A-10(2) of the ITAA 1997, by allocating those shares to the employees in accordance with the governing documents of the scheme.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will require a trustee to undertake incidental activities that are a function of managing the ESS and administering the trust. 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 merely incidental.

For the purposes of the EST the general powers of the Trustee are set out in the Trust Deed. Other clauses effectively read down the general powers given to the Trustee so as to ensure that the general powers are exercised for the purposes of the Plans, thereby making it clear that the Trustee can only use the contributions received exclusively for the acquisition of shares for eligible employees in accordance with the Plans. To this end, all other duties and general powers listed in the Trust Deed are considered to be merely incidental to the functions of the Trustee in relation to its dealing with the shares to be acquired for eligible employees for the purposes of the Plans.

Therefore, the EST is an employee share trust, as defined in subsection 995-1(1) of the ITAA 1997, as the activities of the EST 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 (general powers) are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997.

Paragraph 130-90(1)(a) of the ITAA 1997

CGT event E5 happens where a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee, the trustee will make a capital gain or capital loss under subsection 104-75(3) of the ITAA 1997.

CGT event E7 happens where the trustee of the trust disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary’s interest in the trust capital, the trustee will make a capital gain or capital loss under subsection 104-85(3) of the ITAA 1997.

Accordingly, CGT event E5 is the CGT event that will apply under the terms of the Plans at the time the Participant becomes absolutely entitled to the Shares in the Company as against the Trustee. Therefore paragraph 130-90(1)(a) will be satisfied.

Paragraph 130-90(1)(b) of the ITAA 1997

Section 995-1 of the ITAA 1997 defines a share to mean a share in the capital of a company. An ordinary Share in the Company held by the Trustee and to which a participant is entitled upon exercise of an Option is a share in the capital of a company i.e. the Company.

Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c) of the ITAA 1997

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a share (in the Company) by exercising an Option granted under the Plans.

Paragraph 130-90(1)(d) of the ITAA 1997

Subsection 83A-20(1) of Subdivision 83A-B of the ITAA 1997 states:

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

The term ‘employee share scheme’ is defined in subsection 83A-10(2) of the ITAA 1997, as follows:

An employee share scheme is a *scheme under which *ESS interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:

(a) the company;….

in relation to the employees' employment.

For the purposes of subsection 83A-10(2) of the ITAA 1997, section 995 of the ITAA 1997 defines the term 'scheme' as follows:

scheme means:

(a) any ^*arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The Plans are an employee share scheme for the purposes of Division 83A of the ITAA 1997 as they are an arrangement (scheme) under which an ESS interest i.e. a beneficial interest in an option to acquire a beneficial interest in a share of the Company, is provided to eligible employees in relation to their employment by the Company.

Accordingly, prima facie, Subdivision 83A-B of the ITAA 1997 - Immediate inclusion of discount in assessable income, will apply to Options acquired under the Plans as pursuant to subsection 83A-20(1) of the ITAA 1997 the ESS interest (i.e. Options issued under the Plans) will be acquired under an employee scheme at a discount. It should be noted however that whether a Participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B of the ITAA 1997) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C of the ITAA 1997 - Deferred inclusion of gain in assessable income), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. Under either circumstance paragraph 130-90(1)(d) of the ITAA 1997 will be satisfied. Accordingly, all the conditions in subsection 130-90(1) of the ITAA 1997 have been satisfied.

Provided that the beneficiary does not acquire the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time that CGT event E5 happens, subsection 130-90(2) of the ITAA 1997 will also have been satisfied.

Under these circumstances, section 130-90 of the ITAA 1997 operates to disregard any capital gain or loss made by the Trustee on any share when a Participant becomes absolutely entitled to that share.