Edited version of private advice

Authorisation Number: 1051786612636

Date of advice: 3 December 2020

Ruling

Subject: Employee share schemes

Question 1

Will Company X (as head entity of Company X income tax consolidated group) be entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of irretrievable contributions made by Company X (or a subsidiary member of Company X's income tax consolidated group) to the trustee (Trustee) of the employee share trust (the Trust) to acquire Company X's shares (Shares) to fund the subscription for, or acquisition on-market and / or off-market of the Shares?

Answer

Yes

Question 2(a)

Will the irretrievable cash contributions made by Company X (or a subsidiary member of Company X income tax consolidated group) to the Trustee of the Trust, to fund the subscription for, or acquisition on-market and / or off-market of, Shares by the Trustee to satisfy ESS interests issued pursuant to the Plan, be deductible to Company X under section 8-1 of the ITAA 1997 at the time determined by section 83A-210 of the ITAA 1997, if the contributions are made before the acquisition of the relevant ESS interests by the ultimate beneficiaries?

Answer

Yes

Question 2(b)

Will the irretrievable contributions made by Company X (or a subsidiary member of Company X income tax consolidated group) to the Trustee of the Trust, to fund the subscription for, or acquisition on-market and / or off-market of, Shares by the Trustee to satisfy ESS interests issued pursuant to the Plan, be deductible to Company X under section 8-1 of the ITAA 1997 in the income year when the contributions are made, if the contributions are made after the acquisition of the relevant ESS interests by the ultimate beneficiaries?

Answer

Yes

Question 3

Will the Commissioner seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Company X for the irretrievable cash contribution made to the Trust to fund the subscription for, or acquisition on-market and / or off-market of Shares by the Trustee, pursuant to the Plan?

Answer

No

Question 4

Will the provision of ESS interests to employees of Company X (or its subsidiaries) under the Plan constitute a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefit Tax Assessment Act 1986 (Cth) (FBTAA)?

Answer

No

Question 5

Will the irretrievable cash contributions made by Company X (or a subsidiary member of Company X income tax consolidated group) to the Trustee of the Trust, to fund the subscription for or acquisition on-market and / or off-market of, Shares pursuant to the Plan, constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No

Relevant facts and circumstances

Company X (Company) is a publicly listed company on the Australian Securities Exchange and the head entity of an income tax consolidated group (the Group).

Company X has subsidiaries registered in foreign jurisdictions.

The Company established a Plan as the long-term incentive component of eligible employees' remuneration. The Plan allows for grant of performance rights (Rights) to allow eligible employees to acquire Shares in the Company for nil consideration and the Rights are subject to the satisfaction of certain vesting conditions (Conditions).

Employee Share Plan

The Plan is operated by the Company in accordance with Subdivision 83A-C of the ITAA 1997. Under the Plan, each Right will constitute a right to acquire a fully paid Share by its holder (Participant) subject to the Plan Rules and the terms of each particular offer.

Rights will only vest once the board of the Company determines any relevant Conditions have been satisfied. On the exercise of vested Rights, the board must procure the allocation of one Share to the Participant for each Right that is exercised in accordance the Plan Rules, or make a cash equivalent amount.

Rights may not be transferred by a Participant unless the prior consent of the Board is obtained and the Shares may be subject to trading restrictions after being allocated.

Employee Share Trust

Company X established an employee share trust under the terms of the employee share plan trust deed (Trust Deed), with an independent third party as the Trustee.

The Trust was used as a vehicle to acquire, hold, allocate and dispose of Shares for the purposes of the Plan.

The Trustee would acquire, deliver and allocate Shares to Participants in accordance with the instructions received from the board and pursuant to the Trust Deed, provided that the Trustee receives sufficient payment from the Company or has sufficient unallocated Shares available in the Trust.

The Trustee declares to hold the Trust property on behalf of eligible Participants under the Trust Deed. The Deed also limits the Trustee's power in relation to unallocated Shares and the Trustee can only apply capital proceeds and dividends to purchase further Shares or to meet relevant costs of the Trust.

Any forfeited Shares would be returned to the Trustee and held on an unallocated basis as general trust property.

Neither the Company nor any subsidiaries of the Group has any charge, lien or any other proprietary right or interest in the Shares held on Trust by the Trustee. The Trust Deed further provides that no amount of income or capital of the Trust can be applied under the Trust Deed for the benefit of the Company or any subsidiary of the Group.

The Contributions made by Company X were only in respect of the Rights granted to Australian employees that are employed by the Company for the purposes of producing assessable income in Australia.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 130-85

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 section 995-1

Fringe Benefits Tax Assessment Act 1986 section 136

Reasons for decision

Questions 1 to 3 - application of the single entity rule in section 701-1

The consolidation provisions of the ITAA 1997 allow certain groups of entities to be treated as a single entity for income tax purposes. Under the single entity rule (SER) in section 701-1 the subsidiary members of an income tax consolidated group are taken to be parts of the head company. As a consequence the subsidiary members cease to be recognised as separate entities during the period that they are members of the income tax consolidated group with the head company of the group being the only entity recognised for income tax purposes.

The meaning and application of the SER is explained in Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997.

As a consequence of the SER, the actions and transactions of the subsidiary members of the Company's income tax consolidated group (TCG) are treated, for income tax purposes, as having been undertaken by Company X as the head company of the tax consolidated group.

Questions 4 and 5

The SER in section 701-1 has no application to the FBTAA 1986. The Commissioner has therefore provided a ruling to Company X and relevant subsidiary member of the tax consolidated group in relation to questions 4 and 5.

Question 1

Subsection 8-1(1) will allow you to deduct from your assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, pursuant to subsection 8-1(2), you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of capital, or of a capital nature.

The Company carries on a business which produces assessable income in Australia and it operates an employee share scheme (ESS) as part of its remuneration strategy.

Under the Plan, Company X grants Rights to employees and makes irretrievable contributions to the Trust (in accordance with the Rules and the Deed) which the Trustee will use to acquire Shares (either on-market or by subscription) for allocation to Participants to satisfy their Rights.

Incurred in carrying on a business

Company X (or a subsidiary member of the Group) must provide the Trustee with all the funds required to enable the Trustee to subscribe for, or acquire the Shares.

The contributions made by Company X are irretrievable and non-refundable to Company X in accordance with the Deed as:

-   Neither the Company (or any other member of the Group) has any entitlement to any part of the Trust fund

-   The Trustee's power in relation to unallocated Shares is limited to only applying capital proceeds and dividends to purchase further Shares or to meet relevant costs

-   Any forfeited Shares will not be returned back to the Company but become part of the general trust property held by the Trustee.

The contribution made by the Company to the Trust was in essence an expense related to remunerating and rewarding the employees, and as such it is incurred in the process of carrying on a business for gaining or producing assessable income by Company X.

Not capital or of a capital nature

The contributions by Company X to the Trustee of the Trust are for the purpose of acquiring Shares to meet Company X's commitments arising under the Plan Rules and the Rights. The advantage sought by the contributions is to effectively substitute ongoing expenditure (e.g. cash salary and bonus payments) with ESS interests so as to obtain the trust and confidence of Company X's employees.

The contributions do not form a permanent nucleus of the Trust, but rather will be permanently dissipated in remunerating the employees through provision of ownership in the Shares.

While the contributions may secure an enduring or lasting benefit for the employer that is independent of the year to year benefits that the employer derives from a loyal and contented workforce, that enduring benefit is considered to be sufficiently small. Therefore, the payments are not capital, or of a capital nature.

For completeness, the longer a contribution is intended to be retained in the Trust, the harder it may become for the taxpayer to establish the revenue nature of that amount.[1]

Question 2(a)

An amount is normally deductible under section 8-1 to a taxpayer in the income year it is incurred. However, section 83A-210 of the ITAA 1997 modifies this rule in certain circumstances in respect of contributions provided by an employer to a trust to purchase shares under an ESS.

Section 83A-210 specifically provides that:

If:

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

                             i.                under an arrangement; and

                            ii.                for the purpose 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 purpose 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.

The effect of section 83A-210 is to deem the timing an employer incurred the outgoing to be the time when the ESS interest is acquired by a beneficiary, rather than the time when the employer makes the contribution to the trust, if the contribution was made before the shares are acquired.

Company X's ESS Plan is an employee share scheme for the purposes of subsection 83A-10(2) as it is a scheme under which ESS interests are provided to employees (i.e., Participants) in relation to their employment with the Company.

An ESS interest is defined in subsection 83A-10(1) as a beneficial interest in a share or a beneficial interest in a right to acquire a beneficial interest in a share in the company. The Rights that are granted pursuant to the offer are ESS interests within the definition of subsection 83A-10(1).

If Company X Limited provides irretrievable contributions to the Trustee before the time the employees acquire the ESS interests, then section 83A-210 will apply. As a consequence, Company X can only deduct the amount of contribution in the income year the ESS interests are granted to the relevant Participants.

Question 2(b)

Consistent with the analysis in Question 2a (above), where the contribution is made after the acquisition of the relevant ESS interests, irretrievable contributions made by Company X to the Trustee of the Trust to fund the subscription for or acquisition of Shares by the Trust to satisfy the ESS interests granted to Participants will be deductible in the income year in which the contribution is made by Company X pursuant to section 8-1.

Question 3

Part IVA of the ITAA 1936 is a general anti-avoidance provision which gives the Commissioner the power 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 Commissioner generally accepts that a general deduction may be available where an employer provides money or other property to an employee share trust where the conditions of Division 83A of the ITAA 1997 are met.

In this case, the scheme does not contain the elements of artificiality or unnecessary complexity and the commercial drivers sufficiently explain the entry into the use of the employee share trust arrangement.

Therefore, having regard to the eight factors set out in subsection 177D(2) of the ITAA 1936, the Commissioner has concluded that the scheme is not being entered into or carried out for the dominant purpose of enabling Company X (or a subsidiary member of the Group) to obtain a tax benefit.

Question 4

The term 'fringe benefit' is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee in respect of the employment of the employee, but does not include 'a benefit constituted by the acquisition of an ESS interest under an employee share scheme' within the meaning of the ITAA 1997 to which Subdivision 83A-B or 83A-C of the Act applies (paragraph 136(1)(h) of the FBTAA).

An ESS interest means a beneficial interest in a share or in a right to acquire a beneficial interest in a share of a company (section 83A-10 of the ITAA 1997).

The Commissioner accepts that the Plan is an employee share scheme, the Rights provided to the Participants pursuant to the Invitation Letter are ESS interests and that Subdivision 83A-B or 83A-C applies to those ESS interests.

Accordingly, the provision of Rights under the Plan will not be excluded from fringe benefits tax under the FBTAA.

For completeness, the Shares received by the Participants upon the exercise of Rights granted under the employee share scheme will not give rise to a fringe benefit, as the Shares will be provided to the Participant in respect of the exercise of the Right and not in respect of his or her employment (refer to ATO Interpretative Decision ATO ID 2010/219 Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme).

Question 5

Similar to paragraph 136(1)(h) mentioned above, another benefit excluded from being a 'fringe benefit', pursuant to paragraph (ha) of subsection 136(1) of the FBTAA, is a benefit constituted by the acquisition of money or property by an employee share trust within the meaning of the ITAA 1997.

The 'employee share trust' is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by subsection 130-85(4) of the ITAA 1997.

Subsection 130-85(4) provides that 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).

Paragraphs 130-85(4)(a) and (b) are satisfied because:

a)    The Trust acquires Shares in Company X;

b)    The ESS interests are provided to the Participants in relation to their employment with Company X under the employee share scheme in accordance with the Plan Rules.

Therefore, whether the Trust is an employee share trust will depend on the scope of the activities undertaken by the Trustee pursuant to the Trust Deed.

The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13: Income tax: what is an 'employee share trust'? It also provides a list of examples for the activities that are considered to be 'merely incidental' (paragraph 12) and not 'merely incidental' (paragraph 13) for the purpose of the provision.

Consistent with the examples listed in TD 2019/13, the types of activities that the Trustee may engage in pursuant to the Trust Deed are considered to be natural incidents or consequences of the Trust obtaining, holding and providing Shares or Rights under an ESS.

Therefore, the Trust is an employee share trust as the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and (b), and its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c) of the ITAA 1997.

Consequently, the provision of contributions by Company X to the Trustee of the Trust to acquire Shares pursuant to the Trust Deed is not a fringe benefit within the meaning of that term in subsection 136(1) of the FBTAA as it is excluded by virtue of paragraph 136(1)(ha) of the FBTAA.

[1] Taxation Ruling TR 2018/7: Income tax: employee remuneration trusts, paragraph 89.