Edited version of private advice

Authorisation Number: 1051655359024

Date of advice: 08 April 2020

Ruling

Subject: Employee share schemes

Question

Do the amounts of ESS discounts reported by the taxpayer's employer need to be included in the 20XX Income Tax Return if they relate to service in Country A when the taxpayer was an Australian Non-Resident for tax purposes?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You worked for the same employer in Country A and Country B.

You were in Country A for the period XX/XX/XXXX to XX/XX/XXXX.

You were employed in Australia from XX/XX/XXXX.

You became an Australian resident for tax purposes on XX/XX/XXXX.

You were granted employee share scheme discounted shares (ESS interests) by your employer each year based on your service.

In the XXXX income year prefill report, your employer reported to the ATO "Discount from deferral schemes with a deferred taxing point during the year" gross assessable amount was $X and the vesting date for the ESS interests was XX/XX/XXXX.

The ESS discount amount predominately relates to service undertaken for your employer in Country A when you were an Australian non-resident for tax purposes.

Country A tax was withheld on the Country A service period.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 6,

Income Tax Assessment Act 1997 Division 83A,

Income Tax Assessment Act 1997 Division 770, and

Convention between the Government of Australia and the Government of Country A for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains Article 14.

Reasons for decision

Summary

The taxpayer was an Australian resident for tax purposes at the deferred taxing point identified for this private ruling. Australian residents pay Australian income tax on all discounts received under an employee share scheme (ESS) regardless of whether they are received in relation to employment in or outside Australia. Therefore, the whole of the ESS discounts that relate to the deferred taxing point is to be included in the taxpayer's assessable income under Divisions 6 and 83A of the Income Tax Assessment Act 1997 (ITAA 1997) for the XXXX income year.

Detailed reasoning

Where a taxpayer was a foreign resident when they acquired their ESS interests, consideration needs to be given to the period the taxpayer commenced work in Australia and the date they became an Australian resident for tax purposes to determine if the ESS discount needs to be apportioned. As some ESS interests are taxed at a different time to when the relevant service was performed, the vesting period of the ESS interests is also important to determine if the ESS discount is assessable in Australia.

The actual liability to tax on ESS discounts is determined by Division 83A of the ITAA 1997 in concert with Division 6 of the ITAA 1997.

Both subsections 83A-25(2) and 83A-110(2) of the ITAA 1997 merely define the component of an ESS discount that relates to foreign employment as having a foreign source.

As statutory income, the actual amount to be included in assessable income is determined by either subsection 6-10(4) of the ITAA 1997 for Australian residents and subsection 6-10(5) of the ITAA 1997 for foreign residents.

Paragraphs 1.347 to 1.357 of the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 confirms this intention and states:

1.347 Consistent with the treatment of most other types of income, whether an amount is included in a taxpayer's assessable income under the new employee share scheme rules will depend on the taxpayer's residency status and the source of the income.

1.348 Under the core rules of the Australian income tax system, an Australian resident taxpayer is subject to income tax on their worldwide income. A foreign resident taxpayer is only subject to Australian income tax on their Australian sourced income.

1.349 Under the existing law, this outcome is achieved by excluding discounts from interests acquired under employee share schemes from tax under the employee share scheme tax rules, to the extent that they relate to foreign service of a taxpayer.

1.350 This mechanism operates in a manner inconsistent with core rules. The new rules use the core rules to achieve the desired outcome. The new rules instead include source rules and rely on the core rules to the exclude foreign sourced income of foreign residents from Australian income tax. That is, the employee share scheme rules attribute a source to discounts received on securities acquired under employee share schemes.

1.351 To the extent that a discount on an ESS interest relates to employment outside Australia, the discount is taken to be from a foreign source. In the case of an ESS interest that is subject to a deferred taxing point, it is the amount included in your assessable income that is attributed a source (that is, both the discount and subsequent gains are attributed with a source). The attribution is done in manner consistent with the rule applying to discounts. [Schedule 1, item 1, subsections 83A-25(2) and 83A-110(2)]

1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development and Cooperation (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005.

1.353 Source is attributed to amounts 'included' in assessable income either upfront or under the deferral method at the ESS deferred taxing point. The inclusion in assessable income is merely notional as all amounts included in assessable income must pass through the core rules before being taken into account in the calculation of taxable income. At this time foreign sourced income of foreign residents will be removed from the calculation of taxable income.

1.354 Whether the discount on the ESS interest acquired under an employee share scheme relates to employment in Australia or outside Australia is a question of fact that needs to be determined on a case-by-case basis.

1.355 Australian resident taxpayers are subject to Australian income tax on all discounts they receive under employee share schemes regardless of whether they received it in relation to employment in Australia or outside Australia. However, this may be affected by Australia's double tax treaties and the temporary residents rules.

1.356 Foreign resident taxpayers are only subject to Australian income tax on discounts they receive under employee share schemes to the extent that the discount relates to the employment in Australia. The core rules are contained in sections 6-5 and 6-10 of the ITAA 1997.

1.357 The outcome effectively mirrors the tax treatment of employment income. It has been necessary to modify the treatment of employee share scheme discounts received in respect of employment outside Australia in order to bring the employee share scheme rules into closer alignment with the ordinary treatment of salary and wage income and to prevent taxpayers avoiding the recent changes to section 23AG of the ITAA 1936 (exemption for foreign employment income).

In your case you acquired ESS interests granted under an ESS that was a deferral scheme. A deferral scheme allows an employee to defer paying tax in relation to their ESS interests until the income year in which the deferred taxing point occurs. Your employer has determined that the deferred taxing point (vesting date) occurred in the XXXX income year on XX/XX/XXXX. As you became an Australian resident for tax purposes on XX/XX/XXXX, the taxing point occurred after you became an Australian tax resident.

Australian resident taxpayers are subject to Australian income tax on all discounts they receive under ESS regardless of whether they receive it in relation to employment in Australia or outside Australia. Section 6-10 of the ITAA 1997 includes both the Australian and the foreign source portions of the ESS discount in your assessable income because you were an Australian resident at the deferred taxing point.

Article 14 of the Convention between the Government of Australia and the Government of Country A for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and on Capital Gains allows Australia to tax remuneration (including ESS discounts) as you were an Australian resident at the point in time when they were assessable under Australian tax law.

Division 770 of the ITAA 1997 allows you to claim a foreign income tax offset in relation to foreign income tax paid in respect of foreign source income that is included in your assessable income.

Please refer to the Guide to foreign income tax offset rules 2019 for assistance in calculating the amount of the foreign income tax offset that you can claim.

In practical terms:

·   You declare the whole amount disclosed on the ESS statements at Item 12, Label F "Discount from deferral schemes" of your income tax return.

·   You disclose the proportion of the ESS discount that relates to your UK service at Item 12, Label A "Foreign source discounts" of your income tax return.

·   You claim your foreign income tax offset at Item 20, Label O "Foreign income tax offsets" of your income tax return.