Edited version of private advice

Authorisation Number: 1051580524795

Date of advice: 13 September 2019

Ruling

Subject: Employee remuneration trust arrangement

Issue 1

Employer contributions to an employee remuneration trust

Question 1

Are the irretrievable contribution(s) that the Company makes to the Trustee of the employee remuneration trust (the ERT) deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Issue 2

Employer obligations - fringe benefits tax

Question 1

Are contribution(s) made by the Company to the Trustee of the ERT, a fringe benefit within the meaning of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No

Question 2

Does the provision of a loan by the trustee of the ERT to a particular person, for the purpose of that person uses those funds to acquire units in the ERT, give rise to a loan fringe benefit for the relevant employing entity?

Answer

Yes

Question 3

If the provision of the loan by the trustee of the ERT to a person does give rise to a loan fringe benefit for the relevant employing entity, does the otherwise deductible rule apply to reduce the taxable value of that loan to nil?

Answer

Yes

Question 4

Does a debt waiver fringe benefit arise when the person discharges the loan to the Trustee of the ERT on the Crystallisation Date for a lesser value than the outstanding loan balance?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

The scheme commences on:

1 July 2018

Relevant facts and circumstances

The Company established an ERT for the purpose to retain and attract newly appointed employees to the Company's senior management.

The terms and conditions of the newly appointed employees including their entitlement to participate in the ERT is set out in their employment contract, which provides terms and conditions, including restrictions in relation to the shares allocated under the ERT.

The Company will make irretrievable contributions to fund the ERT. The Trustee will use the money to make loans to a specified person in order for the person to fund the acquisition of units in the ERT. The loan made to the person to acquire units will be non-recourse except to the market value of the units (as on the Crystallisation Date) and will be interest free.

The Trustee will then use those funds (representing the amount paid by the person for the units) to acquire Shares in the Company.

Each Share acquired by the Trustee will be allocated to a unit, and the relevant unit will be allocated to the person. The person will be entitled to certain rights and benefits under the terms of the Trust Deed including all distributions referrable to their unitholding and a payment of a Redemption Amount. The Company has continuously paid out dividends in respect of their shares and it can be reasonable expected that the units will produce assessable income.

At the Crystallisation Date the person is required to repay the loan and the Trustee must pay the Redemption Amount to the person in accordance with the loan terms and conditions which will affect a set off. Where the market value of the person's units is less than the initial loan amount, the Trustee will accept this value and the person will be taken to have repaid the Loan Facility in full and is discharged from any further liability or obligation in respect of the Loan Facility.

The Trustee, as per the obligations of the Trust Deed, will then pay the Redemption Amount (less the required withholding amount) to the person from proceeds from the sale of Shares allocated to the units or may provide the shares (if the person elects to have the shares and pays an amount equal to the estimated to the withholding 1 week prior to the Crystallisation Date). The Trustee will as soon as practicable cancel or redeem the units.

The Crystallisation Date will not exceed 5 years from the date the contribution is made from the Company to the Trustee.

Relevant legislative provisions

Income Tax Assessment Act 1936

Income Tax Assessment Act 1997

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-2

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 8-1(1)

Income Tax Assessment Act 1997 subsection 8-1(2)

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Fringe Benefits Tax Assessment Act 1986

Fringe Benefits Tax Assessment Act 1986 section 14

Fringe Benefits Tax Assessment Act 1986 subsection 16(1)

Fringe Benefits Tax Assessment Act 1986 section 19

Fringe Benefits Tax Assessment Act 1986 subsection 19(1)

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Reasons for decision

Issue 1

Question 1

Summary

The irretrievable contributions that the Company makes to the Trustee of the ERT will be deductible under section 8-1.

Detailed reasoning

An employer is entitled to a deduction under section 8-1 for a contribution paid to the trustee of a Trust to the extent 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, a deduction is not allowed under subsection 8-1(2) to the extent that the loss or outgoing 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 Income Tax Assessment Act 1936 (ITAA 1936) ('negative limbs').

Taxation Ruling TR 2018/7 Income tax: employee remuneration trusts (TR 2018/7) sets out the Commissioner's views on how the taxation laws apply to an employee remuneration trust (ERT) arrangement that operations outside the employee share scheme rules in Subdivision 83A-B or Subdivision 83A-C.

Paragraph 9 of TR 2018/7 provides that a contribution is deductible to the employer under section 8-1 where all the following applies:

·        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

·        it is made because the employer reasonably expects their business to benefit from their contribution via an improvement in employee performance, morale, efficiency or loyalty, and

·        it is intended to be permanently and entirely dissipated in remunerating employees of that business within a relatively short period of the contribution being made (other than employees who are wholly engaged in affairs of capital of the business).

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, 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) provide guidance.

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.

The Company has established the ERT for the purpose of making loans to Participants to fund the acquisition of units in the Trust, by making irretrievable contributions to the ERT. The Trustee must apply the money contributed by the Company to advance a Loan Amount to a person for the sole purpose of funding the acquisition of the units by the person.

The contributions made by the Company are considered irrevocable and irretrievable to the Company. Therefore, it is concluded that the Company will incur an outgoing for the purposes of subsection 8-1(1) at the time it makes irretrievable contributions to the Trustee of the ERT.

Second positive limb - incurred in gaining or producing assessable income or necessarily incurred in carrying on a relevant business

Further, 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.

In order to satisfy the second limb of section 8-1, there must be a relevant connection between the outgoing and the business. 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. FC of T (1949) 78 CLR 47; Magna Alloys & Research Pty Ltd v. Federal Commission of Taxation (1980) FCA 150).

Paragraph 10 of TR 2018/7 provides that the following considerations are relevant to establishing a sufficient connection between a contribution and the benefit to the employer's business:

·        the nature and timing of the benefits to be derived by the employer and the employees

·        employee awareness of the scheme, and

·        whether the scheme and the contribution address (or has the capacity to address) the business-related need, function or complaint.

The broad objectives of the Company's ERT arrangement are to:

·        provide an incentive for employees of the Company to remain in their employment in the long term

·        recognise the ongoing ability of newly appointed employee and their expected efforts and contribution in the long term to the performance and success of the Company and its subsidiaries, and

·        facilitate the provision of payments/entitlements to newly appointed employees.

The Company expects that the ERT arrangement will result in an improvement in employee performance, morale, efficiency, retention and loyalty. The scheme is included in the person's employment contract and as such, they are made aware of the operation of the ERT and their potential to benefit from it.

Accordingly, it is considered that the irretrievable contributions made by the Company to the ERT have a sufficient connection with the Company'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 - income 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 suggests 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.

Paragraph 16 of TR 2018/7 provides that a contribution is not deductible under section 8-1 to the extent it secures a capital advantage for the employer, unless that advantage is small or trifling.

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.

When considering the character of expenditure, it is critical to consider the advantage sought by it from a practical and business point of view.

Paragraph 19 or TR 2018/7 provides that where a contribution is made to secure any of the following benefits (without limitation), it is likely to be capital expenditure by the employer:

·        to acquire an asset that is likely to generate an enduring or permanent improvement to employee goodwill

·        to provide loans, on a continuous basis, to employees

·        to 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

·        to 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.

Whilst the Trustee of the ERT uses the contribution to provide loans to Participants for them to acquire units, the contribution which secures this capital advantage is considered to be small or trifling (and therefore disregarded) because it will be permanently and entirely dissipated in remunerating employees and/or divest legal and beneficial ownership of the shares within a relatively short period of the contribution being made (see paragraphs 16 and 87 to 90 of TR 2018/7).

The contribution will be permanently and entirely dissipated within 5 years because the Crystallisation Date will exceed 5 years, and thus the Redemption Amount will be paid prior the fifth anniversary of the contribution being made to the Trustee of the ERT. .

Accordingly, the irretrievable cash contributions made by the Company to the Trustee of the ERT will be an allowable deduction under section 8-1.

Issue 2

Question 1

Summary

The irretrievable cash contributions will not constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

Detailed reasoning

The term 'fringe benefit' is defined in subsection 136(1) of the FBTAA to mean benefits provided by an employer, an associate of the employer or under an arrangement with the employer, to employees, in respect of the employment of the employee.

Under paragraph (f) of that definition, a 'fringe benefit' does not include a payment of 'salary or wages'.

Paragraphs 26 and 27 of TR 2018/7 provide that:

A contribution is a fringe benefit where the trustee is an associate of an employee and the contribution is a benefit provided in respect of the employment of a particular employee, or two or more employees, 'provided the identity of each of the employees who will take a share of the benefit is known with sufficient particularity'. This requires both the employee, and the share of the benefit the employee will take, to be known at the time of the contribution.

A contribution is not a fringe benefit if it is a payment of salary or wages, or to the extent to which it is to be applied by the trustee to make payments of salary or wages, to employees on behalf of the employer within a relatively short period of the contribution being made. A step in a series of steps having the effect of delivering a payment of salary or wages to an employee does not in itself constitute a separate benefit provided to the employee with separate taxation consequences.

Paragraph 59 of TR 2018/7 outlines factors which evidence that benefits provided by a trustee are remuneration or remuneration in nature, which includes:

·        it is agreed between the parties that the benefit is consideration for services rendered by the employee and is a payment of salary, wage or bonus

·        the benefit arises from a contract, arrangement or plan established by the employer for employees, to enable or facilitate the delivery of remuneration to employees

·        the benefits provided by the trustee can also be provided by the employer, in lieu

·        the benefits are conditional on meeting individual or specific performance targets

·        the benefits depend upon continued employment with the employer and are forfeited when employment ends, or

·        the benefits are provided at the discretion of either the employer or the trustee who takes direction or recommendations from the employer.

Under the terms of the Trust Deed the Trustee has an obligation to make a payment of a Redemption Amount on the Crystallisation Date. As the contribution will be dissipated within 5 years in making a payment of the Redemption Amount by the Trustee which the parties agree will be a payment of salary or wages, then the contribution is not a fringe benefit as outlined in paragraphs 26, 27 and 59 of TR 2018/7.

Question 2

Summary

The provision of a loan by the Trustee of the ERT to a person, for the purpose that the person uses those funds to acquire units in the employee share trust, gives rise to a loan fringe benefit for the relevant employing entity.

Detailed reasoning

A loan fringe benefit is defined in subsection 136(1) of the FBTAA as 'a fringe benefit that is a loan benefit.' Subsection 136(1) states that a 'loan benefit means a benefit referred to in subsection 16(1)', which provides:

Where a person (in this subsection referred to as the provider) makes a loan to another person (in this subsection referred to as the recipient), the making of the loan shall be taken to constitute a benefit provided by the provider to the recipient and that benefit shall be taken to be provided in respect of each year of tax during the whole or a part of which the recipient is under an obligation to repay the whole or any part of the loan.

Under the arrangement between the Company and the Trustee of the ERT, the Trustee applies the contribution to provide loans to Participants, in accordance with their employment agreement. Under the Loan Terms, the person is under an obligation to repay the lesser the market value of the units and the Loan Amount. Therefore the Company (or the relevant employer) is taken to have provided a loan fringe benefit.

Question 3

Summary

The taxable value of the loan fringe benefit, which arises from the provision of a loan by the trustee of the ERT to the person, would be reduced to nil.

Detailed reasoning

The taxable value of a loan fringe benefit may be reduced by the 'otherwise deductible rule' in section 19 of the FBTAA of the where had the employee incurred interest, it would have been deductible. This requires the loan to be used for a purpose attended with a reasonable expectation of sufficient income.

In this case, the Loan Amount was used by the person to acquire units, which are referable to the relevant Allocated Shares. As per the Trust Deed, the person is entitled to receive the distributions paid in respect of their Allocated Shares.

As the Company has continuously paid dividends, the units can be reasonably expected to produce assessable income by way of dividends while the person holds the units.

As such, subsection 19(1) of the FBTAA will apply to reduce the taxable value of the loan fringe benefit to nil.

Question 4

Summary

A debt waiver fringe benefit will not arise when a the person discharges the loan to the trustee of the employee share trust on the Crystallisation Date for a lesser value than the outstanding loan balance, because the value of the units have a lesser value than the outstanding loan balance.

Detailed reasoning

Debt Waiver

A 'debt waiver benefit' is defined in subsection 136(1) of the FBTAA to mean a benefit referred to in section 14 of that Act.

Section 14 of the FBTAA states that:

Where, at a particular time, a person (in this section referred to as the "provider" ) waives the obligation of another person (in this section referred to as the "recipient") to pay or repay to the provider an amount, the waiver shall be taken to constitute a benefit provided at that time by the provider to the recipient.

The word 'waive' is defined in the FBTAA at subsection 136(1) as 'includes release'.

The word 'waive' has also been considered by the courts. In Banning v Wright (1972) 2 All ER 987 it was held to mean the giving up or abandoning of some right.

Under the Loan Terms, at the time of the Crystallisation Date:

·        the person is required to repay the Loan Facility and the Trustee must pay the Redemption Amount to the person in accordance with the Loan Terms, as such, effecting a set off between the two amounts, and

·        where the market value of the person's units is less than the initial loan amount, the Trustee will accept this value and the person will be taken to have repaid the Loan Facility in full and is discharged from any further liability or obligation in respect of the Loan Facility.

In these circumstances it is considered that the person has satisfied the obligation to repay the loan that arises under the Loan Terms, rather Trustee releasing or waiving the person's obligation.

This view is also supported by the decision in Case W2 (1989) ATC at 124:

'The circumstances that a lender may not make, or be entitled to make, any claim upon a borrower... but who will rely upon security only is not to be aptly described as a person who has released or abandoned his claim to be repaid the monies lent'

Thus it is considered that the discharge of the loan via the transfer of shares to the lender does not constitute the waiving of a debt, that is, no debt waiver fringe benefit arises at this time.

Note: If the loan agreement under the scheme had not provided for the loan to be satisfied by the transfer of shares, and the lender had subsequently accepted the transfer of shares in satisfaction of the debt, then a debt waiver benefit may arise.

Further Taxation Determination TD 2008/11 Fringe benefits tax: where an employer mistakenly pays to their employee an amount that the employee is not legally entitled to, but is obliged to repay, does the employer's subsequent waiver of that obligation constitute a 'debt waiver benefit' under section 14 of the Fringe Benefits Tax Assessment Act 1986? provides at paragraph 15:

Where the employer gives the employee a bonus equal to the amount of the debt outstanding and agrees to set-off this bonus against that debt these actions will not be a debt waiver. The principles in Re Harmony and Montague Tin and Copper Mining Company (Spargo's Case ) (1873) 8 Ch. App. 407 establish that a payment can occur by way of set-off. As a bonus is a payment to which Division 12 of Schedule 1 to the Taxation Administration Act 1953 (TAA) applies, the exclusion in paragraph (f) in the definition of 'fringe benefit' in subsection 136(1) of the FBTAA is satisfied. Either section 6-5 or subsection 15-2(1) of the Income Tax Assessment Act 1997 (ITAA 1997) will apply to include the amount of the bonus in the assessable income of the employee.

As the Redemption Amount will be assessable to the person under section 6-5 or section 15-2, the setting off the Loan Amount against the Redemption Amount is considered a payment and the debt will not be a debt waiver.