Edited version of private advice

Authorisation Number: 1051601165241

Date of advice: 30 October 2019

Ruling

Subject: Employee Share Scheme

Question 1

Will Company P obtain an income tax deduction, pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the irretrievable payments made by Company P or any subsidiary member of its consolidated group to the Trustee to fund the subscription for, or acquisition on-market of, ordinary shares in Company P by the Trust?

Answer

Yes.

Question 2

Will Company P obtain an income tax deduction, pursuant to section 8-1 of the ITAA 1997, in respect of costs incurred by Company P or any subsidiary member of its consolidated group in relation to the on-going administration of the Plans and the Trust?

Answer

Yes.

Question 3

Will irretrievable payments made by Company P or any subsidiary member of its consolidated group to the Trustee, to fund the subscription for, or acquisition on-market, Company P shares by the Trust, be deductible to Company P at a time determined by section 83A-210 of the ITAA 1997?

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 Company P in respect of the irretrievable cash contributions made by Company P or any subsidiary member of its consolidated group to the Trustee to fund the subscription for, or acquisition on-market, of Company P's shares by the employee share trust (EST) and costs incurred by Company P in relation to the on-going administration of the Plans and the Trust?

Answer

No.

Question 5

Will the consideration received by the Company P, as a result of participants exercising their options granted under the Plan to acquire shares in the Company P, be included in the Company P's assessable income under section 6-5 of the ITAA 1997?

Answer

Yes

Question 6

Will the provision of shares to employees of Company P or any subsidiary of Company P under the Plans constitute a 'fringe benefit' within the meaning of the term in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No.

Question 7

Will the irretrievable payments made by Company P or by any subsidiary of Company P to the Trustee, to subscribe for, or acquire on-market, Company P shares and/or fund the ongoing administration of the Trust, be treated as a 'fringe benefit' within the meaning of the term in subsection 136(1) of the FBTAA?

Answer

No.

Relevant facts and circumstances

Background

Company P is an Australian listed company which undertakes its primary business activities through a number of wholly owned subsidiaries. Company P and its wholly owned subsidiaries are members of Company P's income tax consolidated group.

Company P introduced long and short term incentive plans (together referred to as the Plans) to reward executives of Company P and of subsidiaries.

Employees who are eligible to participate in the Plans (participants) will be granted with options and/or rights to acquire shares in Company P.

Company P established an employee share trust (EST/Trust) to facilitate the provision of shares in Company P to participating employees under each of the Plans. The EST is an independent third party.

The Plans operate as follows:

·                 Rights entitle the participant to acquire a share for nil consideration at the end of the performance period.

·                 On granting options an exercise price is paid to be allocated a share.

·                 Upon satisfactory completion of the vesting conditions, Participants are eligible to exercise their vested options/rights to be issued with shares in Company P

·                 Company P or the subsidiaries will make irretrievable cash contributions to the Trust to enable the Trustee to acquire shares in Company P, to satisfy the exercise of options/rights by participants

·                 Company P shares are allocated by the Trust to participants, and

·                 Participants are entitled to hold or dispose of their shares in accordance with the Plan rules.

The rights are subject to performance hurdles and will be provided at a discount and the granting of options are subject to the requirement to remain employed with Company P and will only vest once the required period of employment has elapsed.

All dealings between the participants, Company P, its subsidiaries and the Trustee which are conducted in accordance with the rules set out in the Plan and Deed are at arms-length.

Company P and its subsidiaries are not beneficiaries of the Trust and have no interest in the shares held by the Trustee.

The Trust will operate as follows:

·                 The Trust will be managed and administered so that it satisfies the sole activities test for the purposes of subsection 130-85(4) of the ITAA 1997).

·                 The funds contributed will be used by the Trustee to acquire Company P shares either on-market, off-market or via a subscription for new shares in Company P, based on written instructions from Company P. Any off-market transaction will occur at market value

·                 When the Trustee allocates shares to a participants' share account, the shares are held as allocated shares. At this point, the participant becomes a beneficial owner of the shares and is entitled to receive cash dividends in respect of the shares held by the Trustee on behalf of the participant.

·                 Any dividend income received by the Trustee on unallocated shares will be treated as assessable income and taxed in the hands of the Trustee.

·                 The Trustee may use the after tax proceeds from dividends received on unallocated shares to purchase additional shares.

·                 A dividend on unallocated Shares cannot be paid to Company P.

·                 The Trustee cannot pay dividends on unallocated shares to participants on the basis there is no present entitlement.

Company P (or any subsidiary of Company P) will not make an upfront contribution that is intended to provide for the Trust's operations for several years in the future.

Company P will make irretrievable cash contributions to the Trust as and when required.

Contributions will be made after the relevant rights or options are granted. These contributions may occur before or after vesting.

The amount of each cash contribution made by Company P to the Trust is equal to the market value of shares to be acquired by the Trust.

The Trustee of the Trust holds all Company P shares pursuant to the Plans on capital account.

The Trust will only be used to provide shares to participants in satisfaction of awards granted under the Plans. The Trust will not provide awards in cash or in an alternative.

Company P incurs or will incur various costs in relation to the on-going administration of the Trust.

Any ESS granted pursuant to waived or reduced conditions, including due to special circumstances, will nevertheless satisfy the 'genuine restrictions on immediate disposal requirement'.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A

Income Tax Assessment Act 1936 subsection 177C

Income Tax Assessment Act 1936 paragraph 177D(2)

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1997 section 6-5

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 subsection 8-1(2)(a)

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 subsection 83A-10

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

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

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 section 83A-210

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

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

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

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

Reasons for decision

Question 1

Summary

Company P is entitled to income tax deductions pursuant to section 8-1 in respect of the irretrievable payments that it or any subsidiary makes to the Trustee to fund the subscription for, or acquisition on-market of, ordinary shares in Company P by the Trust.

Detailed reasoning

In accordance with the Plan rules and Trust Deed, Company P or any subsidiary will make payments to the Trustee to enable the Trust to purchase shares in Company P to benefit employees. Shares will be acquired either on-market or via a new subscription of shares.

The Trust Deed states that contributions made by Company P or any subsidiary to the Trustee will constitute accretions to the capital of the Trust and will be irretrievable to Company P and the subsidiaries, and non-refundable by the Trustee. As the funds are not repayable by the Trustee, the contributions will represent a permanent loss or outgoing incurred by Company P.

Company P will generally incur the contributions at the time these are made to the Trust in accordance with the Plan rules and the Trust Deed. (See further the Detailed reasoning for Question 3 below as to the timing of deductions for the contributions).

The Commissioner accepts that the contributions made by Company P or any subsidiary to the Trust are or will be incurred in gaining or producing the assessable income of Company P for the purposes of section 8-1.

Company P's payments will generally be deductible when made (subject to the timing rule in section 83A-210, as they will enable Company P to meet its obligations arising from the grant of options, rights or shares under the Plan rules.

Relevantly, the ATO-view set out in ATO Interpretative Decision ATO ID 2010/103 states:

The provision of money to the trustee of an employee share trust by the employer for the purpose of remunerating its employees under an employee share scheme is an outgoing in carrying on the employer's business and is deductible under section 8-1 of the ITAA 1997.

It is not necessary to consider the 'necessarily incurred' part of this limb.

Further, the contributions made by Company P or any subsidiary are not of, nor will be of a private or domestic nature (paragraph 8-1(2)(b)).

However, paragraph 8-1(2)(a) provides that a loss or outgoing is not deductible under section 8-1 to the extent that it is a loss or outgoing of capital, or of a capital nature.

The Commissioner accepts that the contributions to the Trust to fund the acquisition of shares are on revenue account and are not capital or capital in nature (Spotlight Stores Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 745 and Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 58 ATR 210). Therefore, the contributions will be deductible to Company P pursuant to section 8-1 on the basis that the contributions are regular and recurrent employment expenses.

The Commissioner accepts that the contributions made by Company P or any subsidiary to the Trust will be deductible irrespective of whether the Trust acquires shares on-market or via a new subscription of shares.

Paragraph 1.72 of the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 which introducedDivision 83A recognises that a general deduction may be available to companies that provide securities under an employee share scheme and states:

The employee share trust may acquire the securities by buying them on the market or by participating in a share issue by the employer.

Apportionment

The combined operation of subsections 8-1(1) and 8-1(2) may require apportionment of a loss or outgoing into deductible and non-deductible components, where a single loss or outgoing is incurred for more than one purpose or on items of a differing nature.

Where a contribution is made for the purpose of securing for the employer advantages of both a revenue and capital nature, but the advantages of a capital nature are only expected to be very small or trifling by comparison, apportionment may not be required. Advantages of a capital nature will be considered small or trifling if the capital advantage obtained is permanently diminished within a relatively short period of time.

The outgoings incurred by Company P by way of contributions to the Trust in order to carry on its business are either not capital in nature or any capital component is sufficiently small or trifling such that the Commissioner will not seek to apportion the deduction.

Question 2

Summary

Company P is entitled to an income tax deduction pursuant to section 8-1 in respect of costs it or a subsidiary incurs in relation to the on-going administration of the Plans and the Trust.

Detailed reasoning

The Commissioner accepts that the on-going costs incurred by Company P or any subsidiary towards the on-going administration of the Plans and the Trust are deductible to Company P under section 8-1. The on-going costs are considered to be regular and recurring expenses in connection with employees. The Commissioner also accepts these costs are deductible in accordance with the ATO-view set out in ATO Interpretative Decision ATO ID 2014/42.

Question 3

Summary

Irretrievable cash contributions made by Company P or any subsidiary to fund the subscription for or an acquisition on-market of Company P shares by the Trust are deductible to Company P at the time determined by section 83A-210.

Detailed reasoning

Section 83A-210 states that if:

(a) at a particular time, you provide another entity with money or other property:

(i) under an *arrangement; and

(ii) for the purposes of enabling an individual (the ultimate beneficiary ) to acquire, directly or indirectly, an *ESS interest under an *employee share scheme in relation to the ultimate beneficiary's employment (including past or prospective employment); and

(b) that particular time occurs before the time (the acquisition time ) the ultimate beneficiary acquires the *ESS interest;

then, for the purposes of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time.

As discussed in the Detailed reasoning for Question 1 above, a deduction is generally available to Company P pursuant to section 8-1 in the income year in which it or a subsidiary incurs the relevant outgoing.

Where Company P makes irretrievable payments to the Trustee which are not in excess of the amount required, the Commissioner accepts that Company P will be entitled to the deduction pursuant to section 8-1 in the year of income the irretrievable payments are made. Section 83A-210 will not operate to defer the timing of the deduction in this instance

Therefore, a deduction will be available to Company P once the contributions are made to the Trust, even if the relevant shares have not been acquired and allocated (i.e. exercise on vesting), provided the contributions are not in excess of the amount required, or do not purchase shares in excess of the number required, to meet the exercise of options, rights or shares that have been acquired by employees (before or during the year of income) under the Plans

The Commissioner confirms that where contributions are made by Company P to the Trust:

·                 In the same income year or a later income year to that in which the options, rights or shares are acquired by (i.e. granted to) the employee under the Plans, then as long as the contributions do not exceed a sufficient amount to acquire the requisite number of ESS interests, the deduction under section 8-1 will be available in the income year in which the contribution is made.

Question 4

Summary

The Commissioner will not seek to make a determination that Part IVA applies to deny, in part or full, any deduction claimed by Company P in respect of the irretrievable cash contributions made by Company P or a subsidiary to the Trustee to fund the subscription for, or acquisition on-market of, shares by the Trustee, and costs incurred by Company P in relation to the on-going administration of the Plans and the Trust.

Detailed reasoning

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

The following requirements must all be present before the Commissioner can make a determination under subsection 177F(1):

·                  a 'tax benefit', as defined in section 177C has been obtained or would (but for subsection 177F(1)) be obtained

·                  the tax benefit was, or would have been, obtained in connection with a 'scheme' as defined in section 177A, and

·                  having regard to the matters in subsection 177D(2), the person or persons who entered into or carried out any part of the scheme did so for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme.

In the present case, the Plans and the Trust Deed constitute a 'scheme' for the purposes of section 177A. The deduction which Company P is entitled to is a tax benefit under paragraph 177C(1)(b).

In considering the Relevant facts and circumstances and taking into account the commercial rationale for using a trust for the remuneration program, the Commissioner accepts that it cannot be objectively concluded that the person or persons who entered into or carried out any part of the scheme did so for the dominant purpose of enabling Company P to obtain a tax benefit in connection with the scheme.

Therefore, as one of the requirements is not present, the Commissioner will not seek to make a determination under subsection 177F(1).

Question 5

Summary

The consideration received by the Company P, as a result of participants exercising their options granted under the Plan to acquire shares in the Company, will be included in the Company P's assessable income under section 6-5.

Detailed reasoning

Ordinary income

Subsection 6-5(1) states:

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

...

The expression 'income according to ordinary concepts' is not defined in Australian income tax legislation, however the courts have considered a number of factors which indicate whether a receipt has the character of income according to ordinary concepts.

Whether a particular receipt has the character of income or capital depends upon its quality in the hands of the recipient: Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 14 ATD 286; (1966) 10 AITR 367, GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; (1990) 21 ATR 1; 90 ATC 4413 and ATO Interpretive Decision ATO ID 2010/155.

Where an employee share trust subscribes for shares in the company, ATO ID 2010/155 states that:

In accordance with the ESS, the trustee either acquires the shares on market or it subscribes for the issue of shares using the funds provided by the employer. If the trustee subscribes for the issue of shares, it pays the full subscription price for the shares and the company receives a contribution of share capital from the trustee. The subscription price received by the company from the trustee is a capital receipt of the company.

Accordingly, any consideration (i.e. exercise price) received by the Company, as a result of participants exercising their options granted under the Plan to acquire shares in the Company P will form part of the assessable income of Company P as ordinary income under section 6-5.

Question 6

Summary

The provision of shares employees of Company P or of any subsidiary under the Plans will not be a 'fringe benefit' within the meaning of the term in subsection 136(1).

Detailed reasoning

The term 'fringe benefit' is defined in subsection 136(1). A fringe benefit will only arise under this section where 'benefits' are provided by 'employers' to 'employees' or 'associates of employees'.

However, paragraph (h) of the definition of 'fringe benefit' relevantly states that a fringe benefit does not include:

... 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; ...

Paragraph (h) uses the term 'ESS interest' and specifically excludes such an interest from the definition of a fringe benefit where it is acquired under an employee share scheme at a discount.

As the options, rights or shares are subject to performance and/or employment hurdles, the Commissioner accepts that Subdivision 83A-C applies to the Rights.

Should Subdivision 83A-C not apply, the Commissioner accepts that Subdivision 83A-B would apply to the options, rights or shares as these will be provided at a discount.

Therefore, the provision of options, rights or shares to employees under the Plans will not constitute the provision of a 'fringe benefit' in accordance with paragraph (h) of the term in subsection 136(1).

Question 7

Summary

The irretrievable payments made by Company P or any subsidiary to the Trustee, to fund the subscription for or acquisition on-market of Company P shares and/or fund the ongoing administration of the Trust will not be treated as a fringe benefit within the meaning of the term in subsection 136(1).

Detailed reasoning

Paragraph (ha) of the definition of 'fringe benefit' in subsection 136(1) states that a fringe benefit does not include:

... 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); ...

The term 'employee share trust' is defined in subsection 130-85(4) as follows:

... for an employee share scheme, 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 Commissioner accepts that paragraphs 130-85(4)(a) and (b) will be satisfied as

·                 the trust will acquire shares in Company P, and

·                 the trust will ensure that 'ESS interests' as defined in subsection 83A-10(1), being the beneficial interests in those shares, will be provided under an ESS, as defined in subsection 83A-10(2), by allocating those shares to the employees in accordance with the governing documents of the scheme.

For paragraph 130-85(4)(c),Draft Taxation Determination TD 2019/D8 lists a number of activities which are merely incidental.

Provided the Trustee administers the Trust according to the terms of the Trust Deed, the Commissioner accepts that the activities of the Trustee will satisfy the 'sole activities test'. The Trust will therefore constitute an 'employee share trust', as defined in subsection 130-85(4).

Accordingly, the contributions to the Trustee will not be a fringe benefit in accordance with paragraph (ha) of the definition of 'fringe benefit' in subsection 136(1).