Edited version of private advice

Authorisation Number: 1051599957064

Date of advice: 29 October 2019

Ruling

Subject: Employee share schemes

Question

Did the employee share scheme (ESS) deferred taxing point for the ESS interests occur on their respective vesting dates?

Answer

No.

This ruling applies for the following periods:

20XX-XX income year

20XX-XX income year

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Taxpayer is an Australian resident employee of an Australian subsidiary a foreign listed company.

The Taxpayer has participated in the company's ESS and received ESS interests (being Restricted Stock Units and Stock Options) under deferral schemes. The Taxpayer has received ESS statements indicating that the deferred taxing point has happened during the 20XX-XX and 20XX-XX income year for some for certain of these ESS interests.

The details on the ESS statements for the 20XX-XX and 20XX-XX income year show the ESS discounts being assessable as at the respective vesting dates.

The company has a comprehensive Insider Trading Compliance Policy that applies to all employees and to their family members.

The Taxpayer, as an executive, was a member of the Restricted Group of senior officials that were subject to the following additional restrictions in relation to dealings in company shares:

·         The Restricted Group may not enter into or conduct any transaction involving the Company's securities during the period that begins on the eighth business day of the last month of the fiscal quarter and ends 24 hours after earnings have been released (the Blackout Period).

·         No trading is permitted in puts, calls, exchange or otherwise traded options or similar securities.

·         All transactions in company securities (including those by certain family members and others specified under Section II) are subject to pre-clearance from the Company's General Counsel and Chief Financial Officer. A request for pre-clearance should be submitted to the General Counsel and Chief Financial Officer at least one business day in advance of the proposed transaction. The General Counsel and Chief Financial Officer are under no obligation to approve a transaction submitted for pre-clearance, and may require additional information or time to evaluate the proposed transaction.

·         Generally, pre-cleared transactions must be completed within two trading days of receipt of the pre-clearance with respect to market purchases and sales, and as otherwise specified for all other pre-cleared transactions.

·         Receipt of pre-clearance for any transaction does not constitute confirmation from the company that the recipient does not possess material non-public information. Receipt of pre-clearance will not relieve the recipient of his or her legal and compliance obligations under this policy and federal securities laws.

Blackout Periods commenced a matter of days after each vesting date (and while the Taxpayer held vested ESS interests or shares acquired by exercising them).

As at each vesting date identified above, the Taxpayer held inside information and continued to hold inside information until it was determined by the various departments that the Taxpayer no longer had inside information and was then granted permission to sell the company shares. The Taxpayer then promptly sold these shares.

The ESS interests that vested during the 20XX-XX income year (or the resulting shares) were sold by the Taxpayer during the trading window immediately after the second Blackout Period after the vesting dates.

The ESS interests that vested during the 20XX-20XX income year (or the resulting shares) were sold by the Taxpayer during the trading window immediately after the first Blackout Period after the vesting dates.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Section 83A-120

Reasons for decision

Summary

The ESS deferred taxing points for the ESS interests did not occur on their respective vesting dates.

Detailed reasoning

The ESS provisions are contained in Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997).

In summary, the ESS provisions recognise the dual nature of grants of shares or rights to acquire shares (collectively ESS interests) as both a component of an employee's remuneration package and also as an ongoing investment. To this end, the ESS provisions provide a mechanism for recognising an appropriate value for remuneration purposes and an adjustment to the purchase price for investment purposes to reflect the amount treated as remuneration.

The ESS provisions achieve this outcome by determining:

·         When a taxpayer needs to include any discount received in relation to ESS interests in their assessable income, and

·         The amount of the discount.

For the ESS interests that are the subject of this private ruling, the amount of the discount is worked out and is assessable at the deferred taxing point.

The deferred taxing point for ESS interests that are rights to acquire shares is determined in accordance with section 83A-120 of the ITAA 1997 (as applicable to ESS interests granted between 1 July 2009 and 30 June 2015) as the earliest of the following:

·         The earliest time that there are no selling restrictions on the rights

·         Cessation of the Taxpayer's employment

·         Seven years from the grant date, or

·         The earliest date that all of the following conditions are met:

-        The forfeiture conditions on the rights end

-        Any exercise restrictions end (if there were some when they were granted)

-        Any forfeiture conditions on the shares acquired by exercising the rights end, and

-        Any selling restrictions on the shares acquired by exercising the rights end.

At present, the first three possible deferred taxing points have not occurred. The Taxpayer is a continuing employee of an Australian subsidiary of the foreign listed company, the ESS interests cannot be sold and they were granted less than seven years ago.

Therefore this private ruling will be considering the fourth possible deferred taxing point.

Subsection 83A-120(7) of the ITAA 1997 (as applicable to ESS interests granted between 1 July 2009 and 30 June 2015) states:

The 4th possible taxing point is the earliest time when:

(a) there is no real risk that, under the conditions of the scheme, you will forfeit or lose the ESS interest (other than by disposing of it, exercising the right or letting the right lapse); and

(b) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately exercising the right - the scheme no longer so restricts you; and

(c) there is no real risk that, under the conditions of the scheme, if you exercise the right, you will forfeit or lose the beneficial interest in the share (other than by disposing of it); and

(d) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately disposing of the beneficial interest in the share if you exercised the right - the scheme no longer so restricts you.

The first three conditions within the fourth possible deferred taxing point were met as from the respective vesting dates. The forfeiture conditions on the ESS interests as rights have ended, they have been or can be exercised and there are no forfeiture conditions on the resulting shares.

Was the Taxpayer genuinely restricted from selling the shares?

The real question relates to the fourth condition in the fourth possible deferred taxing point. Restating this provision it would read:

What is the earliest time when the scheme no longer genuinely restricts the Taxpayer from immediately disposing of his beneficial interest in the share (after the vesting date)?

The explanatory memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 states the following in relation to genuine selling restrictions for shares and rights to acquire shares:

1.192 Genuine restrictions preventing disposal could include a condition of the scheme that contractually prevents disposal of shares. If disposing of an ESS interest would be a criminal offence, for example under a law regulating insider trading, then the employee would also be considered genuinely restricted from disposing of the share.

1.193 A company's internal share trading policy is only considered to be a restriction preventing disposal for the purposes of deferring the taxing point if the penalty for breaking the policy constitutes an effective sanction. This means that if there is no legal prohibition on the disposal of the ESS interest, there must be serious and enforced consequences for breaching the policy.

1.194 A restriction that otherwise meets the conditions for a genuine restriction, but is able to be lifted in cases of severe financial hardship, is nonetheless considered to be a genuine restriction.

1.195 Restrictions preventing disposal are considered to be lifted once an opportunity arises in which a taxpayer can realise the share.

1.196 In the case of a trading window, or restrictions that may lift and then re-engage, if the employee does not avail themself of the opportunity to dispose of the share and the window subsequently closes, there is no further delay in the taxing point. The taxing point would still be at the commencement of the first trading window.

1.197 The restriction and conditions covered by the deferred taxing points are only those that existed when the employee acquired the ESS interest. Conditions and restrictions that have been added subsequent to acquisition are ignored for the purposes for determining the deferred taxing point.

...

1.200 The taxing point is the point at which the taxpayer can take some action to realise the benefit. It does not matter whether or not they chose to do so.

The Taxpayer's situation

The company has reported that the deferred taxing point has happened on the respective vesting dates in accordance with Example 12 on the web page titled 'ESS - Genuine disposal restrictions and deferred taxing points (which can be accessed using quick code QC 27241 in the Search bar in the ATO web site).

The Taxpayer is a member of the Restricted Group and subject to strict limitations on the Taxpayer's ability to deal in the company's shares. Therefore, the Taxpayer is potentially entitled to the consequences outlined in Examples 8 and 11 of the same web page which result in the deferred taxing point being later than the vesting date.

The Taxpayer must seek and obtain permission to trade before conducting any dealings in the company's shares.

The 'genuine selling restriction' test could be re-stated in the Taxpayer's case as:

What is the earliest time (after the vesting date) that the Taxpayer could have received permission to trade in the company's shares?

For the purpose of this ruling, it is not required to determine when this 'earliest time' occurred; merely whether it occurred at the respective vesting dates.

The ESS interests that vested during the 20XX-XX income year

As a member of the Restricted Group, the Taxpayer is strictly prohibited from dealing in the company's shares during the black-out periods and during periods that inside information is held.

The Taxpayer held inside information from before the first vesting date until after the next Blackout Period began a matter of days later. This Blackout Period ran for some eight weeks.

Consequently, the Taxpayer could not seek and obtain permission to trade the company's shares until at least eight weeks after the respective vesting dates.

Therefore, the Taxpayer was subject to genuine selling restrictions as at the respective vesting dates meaning that the deferred taxing point did not occur at those times.

Instead, the deferred taxing point occurred later - either during next the trading window (if there was a time within this period that the Taxpayer did not hold inside information, or on the respective sale dates (as the Taxpayer has received permission to sell and the sales have occurred within 30 days of the opening of the following trading window).

The ESS interests that vested during the 20XX-XX income year

As a member of the Restricted Group, the Taxpayer is strictly prohibited from dealing in the company's shares during the black-out periods and during periods that inside information is held.

The Taxpayer held inside information from before the first vesting date until after the next Blackout Period began a matter of days later. This Blackout Period ran for some eight weeks.

Consequently, the Taxpayer could not seek and obtain permission to trade the company's shares until at least eight weeks after the respective vesting dates.

Therefore, the Taxpayer was subject to genuine selling restrictions as at the respective vesting dates meaning that the deferred taxing point did not occur at those times.

Instead, the deferred taxing point occurred later on the sale date (as the Taxpayer has received permission to sell and the sale has occurred within 30 days of the opening of the next trading window).