Edited version of private advice

Authorisation Number: 1051502631828

Date of advice: 10 April 2020

Ruling

Subject: Employee share scheme

Question 1

Will the Company obtain a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for irretrievable cash contributions made (which includes contributions made by subsidiary members of the Group) to the Trustee of the employee share trust (EST) to fund the subscription for, or acquisition on-market of the Company's shares?

Answer

Yes.

Question 2

Are irretrievable cash contributions made by the Company (including contributions made by subsidiary members of the Group) to the Trustee of the EST, to fund the subscription for or acquisition on-market of the Company's shares by the EST to satisfy employee share scheme (ESS) interests, deductible to the Company at a time determined by section 83A-210 of the ITAA 1997, in respect of those ESS interests which are subject to Division 83A of the ITAA 1997, where the irretrievable contributions are made before the acquisition of the relevant ESS interests?

Answer

Yes

Question 3

Are irretrievable cash contributions made by the Company (including contributions made by subsidiary members of the Group) to the Trustee of the EST, to fund the subscription for or acquisition on-market of the Company's shares by the EST to satisfy ESS interests, deductible to the Company under section 8-1 of the ITAA 1997 in the income year when the irretrievable cash contributions are made, where the irretrievable cash contribution is made after the acquisition of the relevant ESS interests?

Answer

Yes.

Question 4

Will the Commissioner seek to make a determination that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to deny, in part or full, any deduction claimed by the Company in respect of the irretrievable cash contributions made (including irretrievable cash contributions made by subsidiary members of the Group) to the Trustee of the EST to fund the subscription for or acquisition on-market of the Company's shares by the EST?

Answer

No.

Question 5

Is the provision of rights, options or shares in the Company under the Company's Plan by the Company to its employees and the employees of any subsidiary member of the Group a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

Question 6

Will the irretrievable contributions made by the Company (including contributions made by any subsidiary member of the Group) to the Trustee of the EST, to fund the subscription for or acquisition on-market of the Company's shares, be treated as a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

Question 7

Will the Company obtain a deduction under section 8-1 of the ITAA 1997, in respect of costs incurred in relation to the on-going administration of the EST?

Answer

Yes.

Relevant facts and circumstances

The Company is the head company of an income tax consolidated group (the Group) comprised of itself and other wholly owned Australian resident subsidiaries.

The Company has one class of share on issue, which are ordinary shares listed on the Australian Securities Exchange.

The Company's employee share plan (the Plan) is a component of the Group's compensation and benefits arrangements.

The Plan allows the Company to grant Options and Rights (collectively referred to as Awards) over fully paid ordinary shares in the Company (Shares), to employees.

The object of the Plan is to assist the Company in rewarding and retaining talent, and to align performance with shareholders' interests.

The Plan was approved by Shareholders at an Annual General Meeting.

The Company will grant the following types of Awards to employees under the Plan:

·         Options - a right to be issued a Company Share upon payment of the Exercise Price and satisfaction of specified Vesting Conditions (as defined in the LTIP and relevant Offer documentation), the term of the Options is ten years from the date of Grant. Options that are not exercised within this timeframe automatically lapse, and

·         Rights - a right to be issued a Share for nil Exercise Price upon satisfaction of specified Vesting Conditions.

The Company has applied the following Vesting Conditions to Awards granted under the Plan. The Vesting Conditions must be satisfied in order for the Awards to vest/be exercised:

·         Retention: the Participant must remain employed with the Group until the vesting date. This continued employment vesting condition applies to all Awards, and

·         Earnings per share (EPS): Awards vest only if the Taxpayer's annual compound EPS growth equals or exceeds a pre-determined EPS target for the relevant performance period.

The Company established the EST to assist with its capital management for the Plan and to facilitate the acquisition of newly issued or market purchased Shares to satisfy Awards under the Plan. The Trust Deed allows the Trustee to acquire, hold and allocate Shares to Participants.

The EST is an independent legal entity and is not part of the tax consolidated group.

The Company will provide irretrievable cash contributions to the EST, for the Trustee to acquire Shares (either through subscription for newly issued shares or an on-market purchase) to satisfy Awards made by the Company to the Group's employees, in accordance with the Plan and the terms of the EST.

Timing of contributions will be as follows:

·         where Shares are to be acquired on-market, contributions may be made to the Trust at any time to satisfy existing or future grants, and

·         where Shares are to be newly issued, contributions will typically be made around the time Rights vest, or are expected to vest, and are exercised.

Reasons for decision

Legislative references in this Ruling are to provisions of the ITAA 1936, or to provisions of the ITAA 1997, unless otherwise indicated.

Questions 1 to 4 and 7 - application of the single entity rule in section 701-1

The consolidation provisions of the Income Tax Assessment Act 1997 allow certain groups of entities to be treated as a single entity for income tax purposes. Under the single entity rule (SER) in section 701-1 the subsidiary members of an income tax consolidated group are taken to be parts of the head company. As a consequence, the subsidiary members cease to be recognised as separate entities during the period they are members of the consolidated group with the head company of the group being the only entity recognised for income tax purposes.

The meaning and application of the SER is explained in the Taxation Ruling 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997.

As a consequence of the SER, the actions and transactions of the subsidiary members of the Company's income tax consolidated group (TCG) are treated, for income tax purposes, as having been undertaken by the Company, as the head company of the TCG.

Questions 5 and 6

The SER in section 701-1 has no application to the Fringe Benefits Tax Assessment Act 1986. The Commissioner has therefore provided a ruling to the Company and each company which is a subsidiary member of the Group in relation to questions 5 and 6.

Question 1

Detailed reasoning

Subsection 8-1(1) allows you to deduct from your assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, pursuant to subsection 8-1(2), you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of capital, or of a capital nature.

The Company carries on a business which produces assessable income and it operates an employee share scheme (ESS) as part of its remuneration strategy.

Under the Plan, the Company grants Options and Rights to employees (Participants) and makes irretrievable cash contributions to the employee share trust (EST) (in accordance with the Plan and the Trust Deed) which the Trustee will use to acquire Shares (either on-market or by subscription), for allocation to Participants.

Incurred in carrying on a business

The Company or a subsidiary member of the Group must provide the Trustee with all the funds required to enable the Trustee to subscribe for, or acquire, the Company shares.

The contributions made by the Company are irretrievable and non-refundable, in accordance with the Trust Deed, as follows:

·      Neither the Company, nor any other member of the Group has any entitlement to any part of the Trust Fund, including any shares that form part of the Trust Fund, at any time

·      The Trustee must not repay to the Company or any Group company any amount received as funds for the purchase of Shares, and

·      On termination of the Trust, the Company or any other member of the Group do not have any entitlement to any part of the Trust Assets.

The Company has granted (and will in the future grant) Options and Rights to Shares (Awards) under the Plan and will continue to do so as part of its remuneration and rewards program. The costs incurred by the Company for the acquisition of shares to satisfy Options and Rights arise as part of these remuneration arrangements, and contributions to the EST are part of an on-going series of payments in the nature of remuneration of its employees.

Not capital or of a capital nature

The costs will be an outgoing incurred for periodic funding of an ESS for employees of the Company and the Group. Costs incurred are likely to be in relation to more than one grant of Awards (rather than being one-off), and the Company intends to continue satisfying outstanding Awards using shares acquired by the EST. This indicates that the irretrievable cash contributions to the EST are ongoing in nature and are part of the broader remuneration expenditure of the Company.

While the irretrievable cash contributions may secure an enduring or lasting benefit for the employer that is independent of the year to year benefits that the employer derives from a loyal and contented workforce, that enduring benefit is considered to be comparatively small. Therefore, the payments are not capital, or of a capital nature. Therefore, paragraph 8-1(2)(a) is not satisfied.

Accordingly, the Company will be entitled to deduct an amount under section 8-1 for its irretrievable cash contributions to the Trustee of the EST to acquire shares in the Company to satisfy ESS interests issued pursuant to the Plan.

Question 2

Detailed reasoning

Section 83A-210 applies to determine the timing of the deduction, but only in respect of the contribution provided to a trust to purchase shares in excess of the number required in a year of income, under an employee share scheme. Further information is available in ATO Interpretative Decision ATO ID 2010/103 Income Tax- Employee share scheme: timing of deduction for money provided to the trustee of an employee share trust.

The Plan is an ESS for the purposes of subsection 83A-10(2) as it is a scheme under which ESS interests (i.e. a beneficial interest in a share or a beneficial interest in a right to acquire a beneficial interest in a share) are provided to employees (i.e., Participants) in relation to their employment with the Company.

The Company's ESS contains a number of interrelated components which include the provision of irretrievable cash contributions by the Company to the Trustee of the EST. These irretrievable cash contributions enable the Trustee to acquire shares in the Company for allocation to Participants, who have a beneficial interest in a share or a beneficial interest in a right to acquire a beneficial interest in a share.

The provision of irretrievable cash contributions by the Company to the Trustee of the EST is for the purpose of enabling the Participants (each an 'ultimate beneficiary', as defined in paragraph 83A-210(a)), to acquire, directly or indirectly, an ESS interest under an employee share scheme in relation to the ultimate beneficiaries' employment.

The deduction for the irretrievable cash contribution can only be deducted from the assessable income of the Company in the income year when the relevant beneficial interest in a share in the Company, or beneficial interest in a Right to a beneficial interest in a share in the Company, is acquired by a Participant under the Plan.

Indeterminate rights under the Equity Incentive Plan

Rights and Options provided under the Plan are indeterminate rights for the purposes of section 83A-340. That is because, on exercise, the Board has the discretion to make cash payment instead of allocating the Company Shares. In this regard, such Rights and Options are not rights to acquire a beneficial interest in a Share unless and until the Board determines the Rights and Options that will be satisfied by the provision of the Company Shares.

Once this is determined, section 83A-340 operates to treat such a Right or Option as though it had always been a right to acquire a beneficial interest in the Share.

If an irretrievable contribution is provided to the Trustee before such Rights or Options are acquired (and the Rights or Options subsequently do become ESS interests), section 83A-340 operates to deem the Rights or Options to always have been ESS interests. Where this occurs, section 83A-210 will apply to modify the timing of the deduction claimed under section 8-1. In such a case, a deduction for the contribution will only be available to the Company in the income year in which the relevant Participant acquires the Right or Option.

Where an indeterminate right does not become an ESS interest because it is ultimately satisfied in cash, the outgoing should not flow through the EST. This is because the EST would not satisfy the sole activities test for the purposes of subsection 130-85(4).

Question 3

Detailed reasoning

Consistent with the analysis in question 2 (above), where the irretrievable cash contribution is made after the acquisition of the relevant ESS interests, irretrievable cash contributions made by the Company to the Trustee of the EST, to fund the subscription for or acquisition on-market of Shares by the EST, to satisfy the ESS interests granted to Participants, will be deductible in the income year in which the irretrievable cash contribution is made by the Company.

Question 4

Detailed reasoning

Part IVA is a general anti-avoidance provision which gives the Commissioner the power to cancel a 'tax benefit' that has been obtained (or would be obtained, but for section 177F) by a taxpayer in connection with a scheme to which Part IVA applies.

The Commissioner generally accepts that a general deduction may be available where an employer provides money or other property to an employee share trust where the conditions of Division 83A are met.

In this case, the scheme does not contain the elements of artificiality or unnecessary complexity: the commercial drivers sufficiently explain the entry into the use of the EST arrangement.

Therefore, having regard to the eight factors set out in subsection 177D(2), the Commissioner has concluded that the scheme is not being entered into or carried out for the dominant purpose of enabling the Company to obtain a tax benefit.

Question 5

Detailed reasoning

An employer's liability to fringe benefits tax (FBT) arises under section 66 of the Frings Benefits Tax Assessment Act 1986 (FBTAA), which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer for the relevant year of tax.

In general terms, a 'fringe benefit' is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee 'in respect of' the employment of the employee. However, certain benefits are excluded from being a 'fringe benefit' by virtue of paragraphs (f) to (s) of the 'fringe benefit' definition.

In particular, paragraph (h) of subsection 136(1) of the FBTAA excludes the following from being a 'fringe benefit':

(h) a benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83A-B or 83A-C of that Act applies;

The Commissioner accepts that the Plan is an employee share scheme, the Rights and Options and Company shares provided under the Plan are ESS interests and that Subdivision 83A-B or 83A-C applies to those ESS interests.

Accordingly, the provision of Rights and Options for the Company shares under the Plan will not be subject to FBT on the basis that they are acquired by Participants under an employee share scheme (to which Subdivision 83A-B or 83A-C will apply) and are thereby excluded from being a fringe benefit by virtue of paragraph (h) of the definition of fringe benefit in subsection 136(1) of the FBTAA.

In addition, when an option is later exercised, it will not give rise to a fringe benefit as any benefit received would be in respect of the exercise of the option and not in respect of employment (refer ATO Interpretative Decision ATO ID 2010/219 Fringe Benefits Tax Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme).

Question 6

Detailed reasoning

One benefit excluded from being a 'fringe benefit', pursuant to paragraph (ha) of subsection 136(1) of the FBTAA, is 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.

In examining whether the requirements of subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that is relevant. To qualify as an employee share trust, a trustee's activities must be limited to those described in paragraphs 130-85(4)(a), (b) and (c).

Paragraph 130-85(4)(a) and (b) are satisfied because:

·         The EST acquires Shares in a company, and

·         The EST ensures that ESS interests as defined in subsection 83A-10(1) (being Options or Rights in the Plan) are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating those Shares to the employees in accordance with the Trust Deed and the Plan.

Paragraph 130-85(4)(c) provides that a trustee can engage in activities that are merely incidental to those described in paragraphs 130-85(4)(a) and (b). The phrase 'merely incidental' takes its ordinary meaning, with further guidance drawn from the context and purpose of the legislation in which it appears. 'Merely incidental' is not defined in the legislation and has not been judicially considered in the context of subsection 130-85(4). The Macquarie Dictionary defines 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'.

The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13: Income tax: what is an 'employee share 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 to be merely incidental.

In the present case, the objects of the EST are for the sole purpose of undertaking activities that are in line with the definition of an employee share trust under subsection 130-85(4) including paragraph 130-85(4)(c) as the other activities undertaken by the Trustee are merely incidental to managing the EST.

Therefore, the cash contribution made by the Company to fund the subscription for or acquisition on-market of the Company Shares by the EST will not be a fringe benefit.

Question 7

Detailed reasoning

Section 8-1 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are a capital, private or domestic nature, incurred in producing exempt or non-assessable non-exempt income or where a provision of the tax law prevents the deduction.

The Company carries on a business which produces assessable income and operates an ESS as part of its remuneration strategy.

The Company incurs on-going administration costs in operating the ESS such as:

·         professional fees (but not for the establishment of the EST), and

·         accounting advice and assistance in the operation of the EST.

These costs are regular and recurrent employment expenses which are deductible under section 8-1 as they are costs necessarily incurred in running the ESS while carrying on its business for the purpose of gaining or producing its assessable income.