Edited version of private advice

Authorisation Number: 1051632307442

Date of advice: 14 February 2020

Ruling

Subject: Employee share trust

Question 1

Will irretrievable cash contributions made by Company A to the Trustee of the Trust to fund the subscription for, or acquisition on-market of Shares in Company A by the Trustee in accordance with the Deed be assessable income of the Trustee under sections 6-5 or 6-10 of the ITAA 1997?

Answer

No.

Question 2

Will a capital gain or capital loss made by the Trustee as a result of either CGT event E5 (in section 104-75 of the ITAA 1997) or CGT event E7 (in section 104-75 of the ITAA 1997) happening in respect of Shares allocated to a Participant pursuant to the Plan and the Trust Deed be disregarded under section 130-90 of the ITAA 97?

Answer

Yes - provided that Participants do not acquire a beneficial interest in the Share for more than its cost base in the hands of the Trustee.

Question 3

Will dividends and other income received by the Trustee in respect of Shares held by the Trustee but not yet allocated to Participants:

(i)               be included in the calculation of the net income of the Trust under section 95 of the ITAA 36; and

(ii)              assessed to the Trustee under section 99A of the ITAA 36?

Answer

Yes.

Question 4

Will the Trustee be entitled to a tax offset for the franking credits attached to the franked dividend on the unallocated Shares under subdivision 207-B of the ITAA 97?

Answer

Yes - provided the Trustee holds the unallocated Shares at risk for a continuous period of not less than 45 days during the period beginning the day after the Trustee acquires the unallocated Shares and ending on the 45^th day after the unallocated Shares become ex-dividend.

This ruling applies for the following period

Year Ending 30 June 2020

Year Ending 30 June 2021

Year Ending 30 June 2022

Year Ending 30 June 2023

Year Ending 30 June 2024

The scheme commences in

Year Ending 30 June 2020.

Relevant facts and circumstances

1.     Company A is a public company, listed on the ASX.

2.     Company A currently has an Employee Share Option Plan (ESOP or the Plan) in place, pursuant to which eligible employees (Participants) are granted Options for no cost to acquire shares in the company, upon satisfaction of certain vesting conditions.

3.     Once Options vest or are exercised, Shares are allocated to Participants. In the event that certain vesting conditions are not satisfied, the Options granted to Participants will lapse.

4.     The ESOP was established to:

(a)   assist in the reward, retention and motivation of employees; and

(b)   align the economic interests of Eligible Participants with those of shareholders of Company A by providing an opportunity for Eligible Participants to be remunerated by reference to the value of Shares in Company A.

5.     Each Option entitles the Participant to acquire one ordinary Share upon vesting or exercise.

6.     Options do not carry voting or dividend rights.

Operation of Trust

7.     The Board has approved the establishment of an employee share plan trust (EST).

8.     The EST was implemented with a view to:

(a) providing Company A with greater flexibility to accommodate the long-term incentive arrangements whilst the business continues to expand in terms of operation and employee numbers in future years;

(b) accommodating capital management flexibility for Company A in that the EST would be able to use contributions from Company A to either acquire shares on-market or subscribe for new shares in Company A; and

(c) facilitating a streamlined approach to the administration of the ESOP.

9.     The Trust deed indicates that Company A wishes to establish the Trust to acquire, hold and transfer ordinary shares in Company A.

10.  Under the Trust Deed, the activities of the Trustee are to acquire and hold Shares for the purpose of providing them to Participants of the Plan on vesting and exercise of Options, and the administration of the Trust

11.  Company A will, from time to time, give written notice to the Trustee of the number of Shares that must be acquired (by purchase or subscription) or allocated to satisfy the obligations of Company A in respect of Options granted to Participants under a Plan

12.  Prior to individual Participants becoming beneficially entitled to Shares, they will be held in an unallocated account.

13.  Company A will be required to make contributions to the EST which are sufficient to:

(a) acquire the shares that the Trustee is directed to acquire;

(b) pay any transfer taxes and brokerage fees in respect of the acquisition or transfer of shares; and

(c) pay all costs associated with the acquisition or delivery of shares to a Participant and administration of the EST generally.

14.  The Trustee may not levy fees or charges for administering the Trust

15.  Company A is to supply all the funding for the Trust

16.  Upon the exercise of options by Participants pursuant to the ESOP, the Trustee of the EST will acquire shares in Company A, either:

(a) on-market;

(b) by subscribing for new shares; or

(c) allocating shares held by the Trustee to the relevant Participant.

17.  Under the terms of the EST:

(a) the acquisition of shares by the Trustee of the Trust would be funded by irretrievable cash contributions made by Company A to the Trustee of the EST in accordance with the ESOP and terms of the EST trust deed;

(b) the Trustee would use the contributions received from Company A to subscribe for shares in Company A directly or purchase them on-market and hold the shares for the benefit of the Participants;

(c) prior to individual Participants becoming beneficially entitled to shares, they will be held by the Trustee of the EST in an unallocated account;

(d) the Trustee will then allocate shares to Participants, pursuant to their entitlement under the ESOP upon exercise of the Participant's options; and

(e) Participants should be absolutely entitled to the shares as against the Trustee when the shares are allocated to them in accordance with the EST trust deed. While such Shares are held on trust, Participants will be absolutely entitled to receive dividends, exercise voting rights, receive any bonus shares and participate in any rights issue in respect of the shares allocated to them.

18.  Company A will not be a beneficiary under the EST trust deed and will have no interest in the shares held by the EST. Any funds contributed to the EST, other than specifically in the form of a loan, will not be refunded, repaid or returned to Company A other than by way of the Trustee paying the issue price when it subscribes for shares in Company A.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 section 66

Fringe Benefits Tax Assessment Act 1986 section 67

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(h)

Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(ha)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 subsection 177F(1)

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 paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 section 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 section 83A-210

Income Tax Assessment Act 1997 paragraph 83A-210(a)(i)

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

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

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

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

Income Tax Assessment Act 1997 section 701-1 and

Income Tax Assessment Act 1997 subsection 995-1(1).

Reasons for decision

Question 1

Section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) defines net income in relation to a trust as follows, insofar as it is relevant:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions

Subsection 6-5(1) of the ITAA 1997 states:

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

The irretrievable cash contributions made by Company A to Trustee will not be included in the assessable income of Trustee under section 6-5 as ordinary income because the contributions are of a capital nature.

Subsection 6-10(1) of the ITAA 1997 states:

Your assessable income also includes some amounts that are not ordinary income.

Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.

None of the provisions listed in section 10-5 of the ITAA 1997 are relevant in the present circumstances. The irretrievable cash contributions made by Company A to Trustee of the EST will therefore not be included in the assessable income of the Trustee under section 6-10 of the ITAA 1997.

This is also supported by the ATO Interpretative Decision ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme (ATO ID 2002/965) which broadly indicates that contributions to the Trustee of a Trust for the sole purpose of providing Shares under an employee share scheme, will constitute capital receipts of the Trustee, and will not be assessable income.

>Question 2

E5

CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 of the ITAA 1997 applies) as against the trustee (disregarding any legal disability the beneficiary is under). The time of CGT event E5 is when the beneficiary becomes absolutely entitled to the asset (subsection 104-75(2) of the ITAA 1997).

In this case, the EST is neither a unit trust nor a trust to which Division 128 of the ITAA 997 applies (as it does not relate to the death of an individual).

If CGT event E5 happens, the trustee of a trust makes a capital gain if the market value of the asset (at the time of the event) is more than its cost base. The trustee of a trust will make a capital loss if the market value of the asset is less its reduced cost base.

On satisfying any Vesting Conditions a Participant will have an unconditional right to a Plan Share. If such a Plan Share is held by the Trustee as the trustee of the EST the Participant will be absolutely entitled to that Plan Share (being a CGT asset of the EST) as against the Trustee and CGT event E5 will happen (Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax assessment Act 1997 (TR 2004/D25)). However, any capital gain or capital loss made by the Trustee from CGT event E5 may be disregarded pursuant to section 130-90 of the ITAA 1997.

To qualify under section 130-90 of the ITAA 1997, there must be an 'employee share trust' and an 'ESS interest'.

The term 'employee share trust' is defined in subsection 130-85(4) of the ITAA 1997:

An employee share trust, 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 terms 'employee share scheme' and 'ESS interest' are defined in section 83A-10 of the ITAA 1997:

(1) An ESS interest, in a company, is a beneficial interest in:

(a) a share in the company; or

(b) a right to acquire a beneficial interest in a share in the company.

(2) An employee share scheme is a scheme under which ESS interests in a re provided to employees, or associates of employees, (including past or prospective employees) of:

(a) the company; or

(b) subsidiaries of the company;

in relation to the employees' employment.

An option issued under the Plan is an ESS interest under paragraph 83A-10(1)(b) of the ITAA 1997. The Plan Rules are an 'employee share scheme' for the purposes of subsection 83A-10(2) of the ITAA 1997 as it is a scheme under which ESS interests in Company A are provided to employees of Company A in relation to their employment with Company A.

The EST satisfies the definition of an 'employee share trust' in subsection 130-85(4) of the ITAA 1997 as:

·        the EST acquires shares in a company (specifically, Company A); and

·        the EST ensures that ESS interests (as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in Company A shares), are provided under an employee share scheme (as defined in subsection 83A-10(2) of the ITAA 1997) by allocating those shares to the employees in accordance with the EST Deed and Plan.

·        the EST Deed provides that the EST must perform its activities and exercise its power at all times such that it must satisfy the definition of a 'employee share trust' for the purposes of subsection 130-85(4) of the ITAA 1997.

CGT event E5 will happen when a Participant under the Plan Rules becomes absolutely entitled as against the Trustee of the EST to a Plan Share held by the EST. However, as the requirements of section 130-90 of the ITAA 1997 are satisfied, any capital gain or capital loss that the Trustee will make from CGT event E5 will be disregarded.

E7

Subsection 104-85(1) of the ITAA 1997 provides that CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 of the ITAA 1997 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital.

However, section 106-50 of the ITAA 1997 provides:

If you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), this Part and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

A Participant becomes absolutely entitled to a Plan Share allocated to them pursuant to the EST Deed when Vesting Conditions (if any) are satisfied (causing CGT event E5 to happen). When the Trustee of the EST transfers the legal ownership of the Plan Share to a Participant following allocation of the Plan Share, section 106-50 of the ITAA 1997 will deem the Plan Share to be an asset of the Participant. This means that there would be no change in the ownership of the Plan Share when the Trustee transfers the Plan Share to the Participant.

CGT event E7 will not happen when the Trustee transfers legal title in a Plan Share to which a Participant is absolutely entitled to that Participant in accordance with the EST Deed (Paragraph 144 of TR 2004/D25). As such, the Trustee will not make a capital gain or loss from CGT event E7. If such a capital gain/loss did occur.

>Question 3

Subsection 95(1) of the ITAA 1936 defines 'net income' as follows:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except...

Under subsection 44(1) of the ITAA 1936, the assessable income of a resident shareholder in a company includes dividends that are paid to the shareholder by the company out of profits derived by it from any source.

The Trust Deed provides that no Participant has legal or beneficial interest in unallocated shares.

The Trustee holds the legal title to, and is the registered shareholder of, Shares which have not been allocated to a Participant.

Therefore, dividends received by the Trustee as the registered shareholder of Shares which have been allocated to a Participant and unallocated Shares, as well as other income received by the Trustee in respect of unallocated Shares, will be included in the calculation of the net income of the Trust under subsection 95(1) of the ITAA 1936.

Under section 99A of the ITAA 1936, the trustee of a trust estate is assessed and liable to pay tax on the part of the net income of the trust estate:

·        that is not included in the assessable income of a beneficiary of the trust estate pursuant to section 97 of the ITAA 1936 (paragraphs 99A(4)(a) and 99A(4A)(a) of the ITAA 1936)

·        in respect of which the trustee is not assessed and is not liable to pay tax pursuant to section 98 of the ITAA 1936 (paragraphs 99A(4)(b) and 99A(4A)(b) of the ITAA 1936); and

·        that does not represent income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident and is also attributable to sources out of Australia (paragraphs 99A(4)(c) and 99A(4A)(c) of the ITAA 1936).

The trustee pays tax under section 99A of the ITAA 1936 at the rate declared by the Parliament (in subsection 12(9) of the Income Tax Rates Act 1986).

The critical requirement for the application of sections 97 and 98 of the ITAA 1936 is that a beneficiary is presently entitled to a share of the income of a trust estate.

The Trustee will be assessed and liable to pay tax under section 99A of the ITAA 1936 on the part of the net income (as defined in subsection 95(1) of the ITAA 1936) of the Trust that does not fall within one of these three enumerated categories. This would include dividends received by the Trustee in respect of unallocated Shares.

r>Question 4

Subsection 207-45 relevantly states:

An entity to whom a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution if it is:

...

(c) the trustee of a trust that is liable to be assessed on a share of, or all of a part of, the trust's net income under section 98, 99 or 99A of the Income Tax Assessment Act 1936 for that income year;

As established in Question 3 above, the Trustee will be liable to be assessed under section 99A of the ITAA 1936 in relation to dividends on unallocated Shares.

However, where a franked distribution is paid to an entity, subsection 207-145(1) denies a gross-up and tax offset where that entity is not a qualified person for the purposes of Division 1A of the former Part IIIAA of the ITAA 1936.

Qualified person

Former section 160APHO of the ITAA 1936 relevantly states:

(1) A taxpayer who has held shares or an interest in shares on which a dividend has been paid is a qualified person in relation to the dividend if:

(a)   where neither the taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the primary qualification period in relation to the dividend; or

(b)   where the taxpayer or an associate of a taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the secondary qualification period in relation to the dividend.

(2) A taxpayer who has held shares or an interest in shares on which a dividend has been paid satisfies this subsection in relation to a qualification period in relation to the shares or interest if, during the period:

(a)   where the taxpayer held the shares - the taxpayer held the shares for a continuous period (not counting the day on which the taxpayer acquired the shares or, if the taxpayer has disposed of the shares, the day on which the disposal occurred) of not less than:

(i)     if the shares are not preference shares - 45 days; or

(ii)    ...

(b)   where the taxpayer held the interest in the shares - the taxpayer held the interest for a continuous period (not counting the day on which the taxpayer acquired the interest or, if the taxpayer has disposed of the interest, the day on which the disposal occurred) of not less than:

(i)     if the shares are not preference shares - 45 days; or

(ii)    ...

Former section 160APHD of the ITAA 1936 relevantly defines:

primary qualification period, in relation to a taxpayer in relation to shares or an interest in shares, means the period beginning on the day after the day on which the taxpayer acquired the shares or interest and ending:

(a)   if the shares are not preference shares - on the 45^th day after the day on which the shares or interest became ex dividend;

secondary qualification period, in relation to a taxpayer in relation to shares or an interest in shares, means:

(a)   if the shares are not preference shares - the period beginning on the 45th day before, and ending on the 45th day after, the day on which the shares or interest became ex dividend;

The term 'related payment' is defined in former section 160APHN to relevantly mean:

(2) The taxpayer or associate is taken, for the purposes of this Division, to have made, to be under an obligation to make, or to be likely to make, a related payment in respect of the dividend or distribution if, under an arrangement, the taxpayer or associate has done, is under an obligation to do, or may reasonably be expected to do, as the case may be, anything having the effect of passing the benefit of the dividend or distribution to one or more other persons.

Consequently, where the Trustee does not make a related payment in respect of the Trust Shares, the Trustee will be a qualified person in respect of the dividend if the Trustee held the Trust Shares at risk for a continuous period of not less than 45 days (excluding day the Trust Shares were acquired and if the Trust Shares have been disposed of, the day the disposal occurred) during the period beginning on the day after the day on which the Trustee acquired the Trust Shares and ending on the 45^th day after the day on which the Trust Shares became ex dividend (primary qualification period).

However, where the Trustee makes a related payment in respect of the Trust Shares, the Trustee will be a qualified person in respect of the dividend if the Trustee held the Trust Shares at risk for a continuous period of not less than 45 days (excluding day the Trust Shares were acquired and if the Trust Shares have been disposed of, the day the disposal occurred) during the period beginning on the 45^th day and ending on the 45^th day after the day on which the Trust Shares become ex dividend (secondary qualification period).

The meaning of 'ex dividend' is defined in former section 160APHE to mean:

(1)   A share in respect of which a dividend is to be paid, or an interest (other than an interest as a beneficiary of a widely held trust) in such a share, becomes ex dividend on the day after the last day on which the acquisition by a person of the share will entitle the person to receive the dividend.

(2)   An interest as a beneficiary of a widely held trust in a share in respect of which a dividend is to be paid becomes ex dividend on the day after the last day on which the acquisition by a person of the interest will entitle the person to receive a distribution from the trust.

Accordingly, provided that the Trustee does not make a related payment in respect of the unallocated Share and held the unallocated Share at risk for a continuous period of not less than 45 days (not counting the day the share was acquired and if disposed of, the day the disposal occurred) during the period beginning on the day after the unallocated Share was acquired and ending on the 45^th day after the day the share became ex dividend, the Trustee will be a qualified person in respect of the distribution and be entitled to the benefit of the franking credits attached to the distribution paid in respect of unallocated Shares to the extent of tax payable.