Edited version of private advice

Authorisation Number: 1051589146786

Date of advice: 8 October 2019

Ruling

Subject: Acquisition and exercise of options under a scheme

Question 1

Are the returns of corpus from the Trust Fund (the Fund) to you, which are applied to:

·        purchase the Options, and

·        exercise the Options

assessable as ordinary or statutory income under sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the issuing of the Options to you assessable as ordinary or statutory income under sections 6-5 and 6-10 of the ITAA 1997?

Answer

No.

Question 3

Will the first element of your CGT cost base and reduced cost base of each Option acquired be equal to the Subscription Price for the Options in accordance with sections 110-25 and 110-55 of the ITAA 1997 respectively?

Answer

Yes.

Question 4

Will any capital gain or capital loss made by you from exercising the Options be disregarded in accordance with subsection 134-1(4) of the ITAA 1997?

Answer

Yes.

Question 5

To the extent that the Options expire before they are exercised, will you make a capital loss equal to the Subscription Price upon expiry of the Options in accordance with subsection 104-25(3) of the ITAA 1997?

Answer

Yes.

Question 6

If the resolution to vary the Fund's Trust Deed is approved, will the implementation of the fee variations by the Fund give rise to a capital gain or loss for you under section 104-155 of the ITAA 1997?

Answer

No.

Question 7

If the Options are exercised, will the first element of your cost base and reduced cost base of each Security acquired be equal to the total of the Subscription Price and the Exercise Price for the Options in accordance with Item 1 of subsection 134-1(1) of the ITAA 1997?

Answer

Yes.

Question 8

If the Options are exercised, will you be taken to have acquired your Securities at the time the Options are exercised in accordance with section 109-10 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 2019 to 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

Background

1.     You are an Australian proprietary limited company and an Australian resident for tax purposes.

2.     You own units in the Fund.

3.     You hold your units in the Fund on capital account and do not hold them as an item of trading stock in accordance with Division 70 of the ITAA 1997.

4.     You are not subject to the Taxation of Financial Arrangements (TOFA) rules in Division 230 of the ITAA 1997 in relation to financial arrangements under the scheme.

5.     Your cost base for your units in the Fund is greater than the total of the Subscription Price and Exercise Price.

6.     The Fund is a managed investment trust.

7.     The Fund is a unit trust and its operation is governed by the Trust Deed.

8.     The Fund is managed by the Manager.

9.     As part of a scheme you are entitled to participate in the Offer.

The Offer

10.  Under the Offer, you will be entitled to purchase Options. The number of Options that you are entitled to purchase is calculated by reference to the value of your investment in the Fund.

11.  You will receive an Option Application and Investor Details Form which you are required to sign and return in order to receive the Options.

12.  In order to fund the purchase of the Options, the Fund will make a return of corpus to you equal to the Subscription Price of the Options. In addition, on receiving notice that the exercise conditions for the Options have been satisfied, the Fund will make a further return of corpus to you equal to the Exercise Price of the Options.

13.  If you accept the Offer, by signing the Option Application and Investor Details Form, the return of corpus will be automatically applied by the Fund to acquire the Options.

14.  If you do not accept the Offer, the return of corpus will be paid to you as a cash distribution.

15.  The Options will be issued pursuant to the Option Agreement, which has the following terms:

(i)          Each Option will be issued at the Subscription Price.

(ii)         Each Option will have an Exercise Price.

(iii)        Each Option entitles the holder to subscribe for one Security.

(iv)       The Options are not able to be sold, assigned, transferred or otherwise disposed of. Furthermore, the holders cannot enter into any other option over the Options or create a security or other interest or right over the Options.

(v)         The Options will expire at the Expiry Time.

(vi)       The Options will automatically exercise on satisfaction of specified conditions prior to the Expiry Time.

(vii)      On receiving notice that the specified conditions have been satisfied, the Exercise Price must be paid, unless you have authorised the Manager to withhold the Exercise Price from a further return of corpus in respect of your interest in the Fund.

(viii)     You will be issued with Securities.

The variation of the Fund's Trust Deed

16.  As part of this scheme, you will also be invited to vote on a resolution to vary the Trust Deed of the Fund.

17.  The variation will involve increasing the fees payable by the Fund to the Manager and extending the term of the Fund.

18.  You are not entitled to receive any money or other consideration and you will not incur any incidental expenses in relation to the variation of the Trust Deed of the Fund.

Assumptions

1.       You will sign and return the Option Application and Investor Details Form in order to receive the Options.

2.       You will authorise the Manager to withhold the Exercise Price from a return of corpus in respect of your interest in the Fund and provide it to satisfy the payment requirements upon exercise of the Options.

3.       You will hold your Securities on capital account and will not hold them as an item of trading stock in accordance with Division 70 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 104-155

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 section 109-10

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-55

Income Tax Assessment Act 1997 subsection 134-1(1)

Income Tax Assessment Act 1997 subsection 134-1(4)

Reasons for decision

All legislative references are to the ITAA 1997 unless specified otherwise.

Question 1

Are the returns of corpus from the Trust Fund (the Fund) to you, which are applied to:

·        purchase the Options, and

·        exercise the Options

assessable as ordinary or statutory income under sections 6-5 and 6-10?

Detailed reasoning

Amounts from a trust not included in assessable income

Subsection 6-5(1) provides that your assessable income includes income according to ordinary concepts, which is called ordinary income. In working out whether you have derived an amount of ordinary income, subsection 6-5(4) provides that you are taken to have received the amount as soon as it is applied or dealt with on your behalf or as you direct.

In Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 10 AITR 367; (1966) 14 ATD 286, Windeyer J stated at CRR 526, AITR 375; ATD 293 that:

Whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1, the High Court unanimously stated that the following factors were important in determining the nature of a receipt:

To determine whether a receipt is of an income or 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.

Consideration

The Fund's distributions of trust capital were distributions of trust capital for the year ended 30 June 2020 (being a payment of corpus) which were applied or dealt with on your behalf or as you directed. They do not, however, have the quality of income in your hands. Therefore, they are not ordinary income under subsection 6-5(1).

Statutory income - trust distribution

Division 6 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) provides the primary scheme for including distributions from trusts in the assessable income of beneficiaries. Subsection 99B(1) of the ITAA 1936 provides that an amount, being property of a trust estate, paid to, or applied for the benefit of, a beneficiary of the trust estate who was a resident at any time during the year of income, is the assessable income of the beneficiary, subject to the exceptions in subsection 99B(2) of the ITAA 1936.

The exception in paragraph 99B(2)(a) of the ITAA 1936 reduces the amount that would otherwise be included in assessable income by the amount that represents corpus of the trust estate and is not attributable to amounts derived by the trust estate that, if they had been derived directly by a taxpayer being a resident, would have been included in the assessable income of that taxpayer:

99B(2) [Amounts not included in assessable income]

The amount that, but for this subsection, would be included in the assessable income of a beneficiary of a trust estate under subsection (1) by reason that an amount, being property of the trust estate, was paid to, or applied for the benefit of, the beneficiary shall be reduced by so much (if any) of the amount, as represents:

(a)   corpus of the trust estate (except to the extent to which it is attributable to amounts derived by the trust estate that, if they had been derived by a taxpayer being a resident, would have been included in the assessable income of that taxpayer of a year of income);

...

Consideration

On the basis that the Fund has resolved that the distributions were distributions of trust capital for the year ending 30 June 2020, the receipt of the distributions did not result in you being presently entitled to a share of the income of the Fund and no amount will be included in your assessable income pursuant to Division 6 of Part III of the ITAA 1936.

Statutory income - CGT event E4

Subsection 6-10(1) includes amounts that are not ordinary income as your assessable income where those amounts are included by statutory provisions about assessable income. Subsection 102-5(1) includes net capital gains made under Chapter 3 in your assessable income.

Relevantly, under subsection 104-70(1), GCT event E4 happens if the trustee of a trust makes a payment to a beneficiary in respect of a unit or interest in the trust that the beneficiary holds and some or all of the payment is not included in the beneficiary's assessable income, referred to as the 'non-assessable part'.

Under subsection 104-70(4), the beneficiary will make a capital gain to the extent that the non-assessable part of the payment to the beneficiary exceeds their cost base in the unit or interest in the trust.

To the extent that the amount of the non-assessable part is less than the cost base in the unit or interest in the trust, pursuant to subsection 104-70(5), the cost base or reduced cost base will be reduced by that amount.

Consideration

The distributions by the Fund will be payments to you in respect of a unit that you hold and all of the payments are not included in your assessable income. As such, CGT event E4 will happen in relation to the distributions and, to the extent that the amount of the distributions is less than your cost base in the unit, you are required to reduce your cost base by that amount.

If the cost base of the units you hold in the Fund was less than the total of the two distributions, the distributions will result in a capital gain under CGT event E4 in accordance with subsection 104-70(4).

Conclusion

The returns of corpus from the Fund, which are applied on your behalf to acquire and exercise the Options, are not assessable as ordinary income. They are, however, subject to CGT event E4 and to the extent that the amount of the distributions are less than your cost base in the units in the Fund, it will not give rise to a capital gain, but will reduce the cost base and reduced cost base of the units.

Question 2

Is the issuing of the Options to you assessable as ordinary or statutory income under sections 6-5 and 6-10?

Detailed reasoning

Ordinary income

Subsection 6-5(1) provides that a taxpayer's assessable income includes income according to ordinary concepts (ordinary income) as set out above.

Consideration

Whilst you receive something of value (the Options) their acquisition will not be ordinary income for you as you will have paid to receive the Options (funded by the return of corpus).

Statutory income

Subsection 6-10(1) includes amounts that are not ordinary income as your assessable income where those amounts are included by statutory provisions about assessable income. Subsection 102-5(1) includes net capital gains made under Parts 3-1 and 3-3 in your assessable income.

Relevantly, there are a number of CGT events that could apply when you receive the Options.

CGT event C3

Subsection 104-30(1) states that CGT event C3 occurs if an option a company or a trustee of a trust granted to an entity to acquire shares in the company, units in the trust or debentures in the company or trust ends.

CGT event D1

Subsection 104-35(1) states that CGT event D1 occurs if you create a contractual right or other legal or equitable right in another entity. CGT event D1 will be excluded from happening in certain circumstances as outlined relevantly in paragraphs 104-35(5)(e) and 104-35(5)(f) which state:

CGT event D1 does not happen if:

...

(e) a company grants an option to acquire equity interests, non-equity shares or *debentures in the company; or

(f) the trustee of a unit trust grants an option to acquire units or debentures in the trust; or

...

CGT event D2

Subsection 104-40(1) states that CGT event D2 occurs if you grant an option to an entity, or renew or extend an option you had already granted. CGT event D2 is specifically excluded from occurring by subsection 104-40(6), which states:

This section does not apply to an option granted, renewed or extended by a company or the trustee of a unit trust to acquire a CGT asset that is:

(a) shares in the company or units in the unit trust; or

(b) debentures of the company or unit trust.

CGT event H2

Subsection 104-155(1) states that CGT event H2 happens if:

(a)   an act, transaction or event occurs in relation to a CGT asset that you own; and

(b)   the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base.

You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred that relate to the event. You make a capital loss if those capital proceeds are less (subsection 104-155(3)).

According to subsection 104-155(5), CGT event H2 will not happen if:

(e) a company grants an option to acquire equity interests, non-equity shares or debentures in the company; or

...

(f) the trustee of a unit trust grants an option to acquire units or debentures in the trust; ...

Consideration

The issuing of the Options will not result in assessable statutory income under the CGT provisions to you as, relevantly:

·        CGT event C3 will not happen at the time that the Options are issued, but rather at the time when they expire (being the Expiry time) according to subsection 104-30(2).

·        CGT event D1 will not happen due to the exclusions in paragraphs 104-35(5)(e) and 104-35(5)(f).

·        CGT event D2 is specifically excluded from occurring by subsection 104-40(6).

·        CGT event H2 will not happen due to the similar exclusions in paragraphs 104-155(5)(e) and 104-155(5)(f).

Conclusion

The issuing of the Options, which occurs when the return of corpus is applied on your behalf, does not give rise to an amount of ordinary or statutory income.

Question 3

Will the first element of your CGT cost base and reduced cost base of each Option acquired be equal to the Subscription Price for the Options in accordance with sections 110-25 and 110-55 respectively?

Detailed reasoning

Subsection 110-25(2) states that the first element of the cost base of a CGT asset is the total of:

(a)   the money you paid, or are required to pay, in respect of acquiring it, and

(b)   the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out at the time of the acquisition).

Subsection 110-55(2) states that all of the elements (except the third one) of the reduced cost base of a CGT asset are the same as those for the cost base. As such, the first element of the cost base and reduced cost base of a CGT asset will be the same.

In relation to the Options you acquired you paid the Subscription Price. This payment was met by the return of corpus from the Fund, which would have otherwise been paid to you in cash, had you not accepted the Offer.

As such, the first element of your CGT cost base and reduced cost base for each Option you acquired is the Subscription Price.

Question 4

Will any capital gain or capital loss made by you from exercising the Options be disregarded in accordance with subsection 134-1(4)?

Detailed reasoning

At the time you exercise the Options, CGT event C2 (about a CGT asset ending) happens in relation to the Options (section 104-40).

However, subsection 134-1(4) states:

A capital gain or capital loss the grantee makes from exercising the option is disregarded. However, this rule does not apply if the grantee acquired the option under a trust restructure (see Subdivision 124-N) and, on exercising the option, held the resulting asset as an item of trading stock.

As you did not acquire the Options under a trust restructure any capital gain or capital loss you make from exercising the Options is disregarded.

Question 5

To the extent that the Options expire before they are exercised, will you make a capital loss equal to the Subscription Price upon expiry of the Options in accordance with subsection 104-25(3)?

Detailed reasoning

CGT event C2 occurs for you under paragraph 104-25(1)(c) at the time that the Options expire.

According to subsection 104-25(2), the time of the event will be when the Options end, which is at the Expiry Time.

Subsection 104-25(3) details whether you make a capital gain or capital loss upon the event:

You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

You will not receive any capital proceeds upon the Options expiring.

The first element of your CGT cost base and reduced cost base for each Option you acquired is the Subscription Price, as established above.

As such, based upon the assumption that none of the other cost base elements will be applicable to you, upon expiry of the Options you will make a capital loss equal to the Subscription Price.

Question 6

If the resolution to vary the Fund's Trust Deed is approved, will the implementation of the fee variations by the Fund give rise to a capital gain or loss for you under section 104-155?

Detailed reasoning

Subsection 104-155(1) states that CGT event H2 happens if:

(a)   an act, transaction or event occurs in relation to a CGT asset that you own; and

(b)   the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base.

When the fee variations are implemented by amending the Trust Deed of the Fund an act, transaction or event occurs in relation to the units in the Fund, which are CGT assets that you own.

When the fee variations are implemented by amending the Trust Deed of the Fund, the cost base or reduced cost base of the units in the Fund is not adjusted.

As the requirements in subsection 104-155(1) are satisfied, CGT event H2 happens.

You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred that relate to the event. You make a capital loss if those capital proceeds are less (subsection 104-155(2)).

The table in subsection 116-20(2) states that the capital proceeds for CGT event H2 are:

The money, or other consideration you received, or are entitled to receive, because of the act, transaction or event.

You are not entitled to receive any money or other consideration and you will not incur any incidental expenses in relation to the variation of the Trust Deed of the Fund. You will, therefore, not receive any capital proceeds because of CGT event H2 and will not have any incidental costs.

As such, you will not make a capital gain or capital loss upon the implementation of the fee variations by the Fund.

Question 7

If the Options are exercised, will the first element of your cost base and reduced cost base of each Security acquired be equal to the total of the Subscription Price and the Exercise Price for the Options in accordance with Item 1 of subsection 134-1(1)?

Detailed reasoning

Item 1 in the table in subsection 134-1(1) sets out the effects of the exercise of an option on the first element of the cost base and reduced cost base of the asset acquired for the grantee of the option.

It provides that where a grantor creates (including grants or issues) a CGT asset the first element of the cost base and reduced cost base for the CGT asset for the grantee will be what the grantee paid for the option (or to renew or extend it) plus any amount the grantee paid to exercise it.

Upon exercise of the option you will receive Securities.

The cost base and reduced cost base of the Securities will, therefore be the total of what you paid for the option (being the Subscription Price which was funded via the first return of corpus from the Fund) plus any amount you paid to exercise the option (being the Exercise Price which was funded by the second return of corpus from the Fund).

Question 8

If the Options are exercised, will you be taken to have acquired your Securities at the time the Options are exercised in accordance with section 109-10?

Detailed reasoning

You acquired your Securities at the Issue Date, when the Manager procured the company to issue you with shares and the responsible entity of the trust to issue you with units.

The table in section 109-10 sets out specific rules when a CGT asset is acquired otherwise than as a result of a CGT event happening. In particular, Items 2 and 3 in the table state:

Based upon the above table, you will, therefore, be taken to have acquired the Securities at the time when the contract was entered into to bring about the relevant acquisitions. In accordance with the decision in Van v FC of T [2002] AATA 1313, (2002) 51 ATR 1153, 2002 ATC 2325, the date you will be taken to have acquired the Securities is the date that the Options are exercised.