Edited version of private advice

Authorisation Number: 1051805114751

Date of advice: 1 March 2021

Ruling

Subject: Trustee in employee share scheme

Question 1

Will the irretrievable cash contributions made pursuant to the Company A Executive Incentive Plan (EIP) to Trustee B, as trustee for the Company A Employee Share Trust ('EST'), to fund the subscription for, or acquisition on-market or off-market of, Company A shares by the Trustee in accordance with the Employee Share Trust Deed between Company A and the Trustee (Trust Deed), be assessable income of the EST under sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will a capital gain or capital loss that arises for the Trustee of the EST at the time the Participants become absolutely entitled to Company A shares under the EIP be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Company A shares for the same or less than the cost base of the Company A shares in the hands of the Trustee?

Answer

Yes

This ruling applies for the following periods:

Income Tax Year ended 30 June 20xx

Income Tax Year ended 30 June 20xx

Income Tax Year ended 30 June 20xx

Income Tax Year ended 30 June 20xx

Income Tax Year ended 30 June 20xx

Relevant facts and circumstances

Background

Company A is an Australian business.

Company A is the head company of the Company A income tax consolidated group ('ACG').

Company A has established an employee share plan, the EIP, under which senior executives may be provided with performance rights ('Rights'), with each Right representing a right to acquire a fully paid ordinary share in Company A (a 'Company A Share') in the future, at no cost, subject to vesting conditions. Senior executives were granted Rights under the EIP on an annual basis as part of their remuneration.

The implementation of the EIP form part of Company A's long-term strategy of creating shareholder wealth by:

•         rewarding the hard work of senior executives in Company A in a way that is competitive, market related and cost-effective for the business;

•         motivating and promoting the long-term retention of senior executives in Company A;

•         reflecting the importance of senior executives to the future success of Company A;

•         enabling the executives to benefit in the long-term growth and ownership of Company A by participating in these plans; and

•         attracting new executive talent to achieve Company A's strategy.

The EIP is currently the only incentive plan at the Company and this ruling only applies to the EIP.

EIP Overview

The EIP is governed by the EIP Rules ('Plan Rules').

Grant

The Board of Directors of Company A (Board) may, from time to time, in its absolute discretion, invite Eligible Employees (as defined in the Plan Rules) to participate in a grant of Rights and/or Restricted Shares. An offer to participate in the EIP (Offer) will be made on the terms set out in the Plan Rules and/or on any additional or alternative terms as the Board may determine.

An Eligible Employee to whom Rights have been granted becomes a 'Participant' under the EIP.

There will be no Participants to the EIP other than those that are "employees, associates of employee or other relationships similar to employment as set out in section 83A-325 of the ITAA 1997." The EIP has operated for a number of years and all of the Participants have been employees of Company B, a wholly owned subsidiary of Company A. Company A does not have any non-Australian resident employees.

The Board will, amongst other things, set out in the Offer:

•         the number of Rights being offered, or the method by which the number will be calculated;

•         the amount (if any) that will be payable for the grant of Rights;

•         any vesting conditions or other conditions that apply, including any vesting period;

•         when Rights may vest; and

•         whether the vesting of Rights will be satisfied through an allocation of Company A Shares or by making a cash payment.

Acceptance of an Offer must be made by the Eligible Employee in accordance with the instructions that accompany the Offer, or in any other way the Board determines.

The Board may, at its discretion, refuse to allow the participation of an Eligible Employee where that Eligible Employee ceases to be an Eligible Employee, or ceases to satisfy any other conditions imposed by the Board, before the grant of Rights is made.

Rights

A Right is defined in the Plan Rules as an automatic entitlement to a Company A Share (or, in certain circumstances, to a cash payment in lieu of a Company A Share) once applicable conditions (including any vesting conditions) are satisfied.

Where an Eligible Employee has accepted an Offer to participate in a grant of Rights, the Board will, subject to its discretion, grant Rights to the Eligible Employee.

Unless the Board determines otherwise:

•         no payment is required for the grant of a Right

•         Rights may not be registered in any name other than that of the Eligible Employee

•         The number of Rights granted may not be known when the Offer is made to the Eligible Employee.

Vesting

The following sets out how a Right will vest:

•         subject to any express clause to the contrary, a Right will only vest where each vesting condition, and all other relevant conditions advised to the Participant by the Board have been satisfied

•         the vesting of a Right will be satisfied by Company A allocating Company A Shares to the Participant

•         the Board may determine that the vesting of a Right will be satisfied by Company A making a cash payment in lieu of an allocation of Company A Shares

•         the Board may determine, prior to making a grant of Rights, that the vesting of those Rights will only be satisfied through an allocation of Company A Shares to the Participant, and not by making a cash payment

•         vesting occurs upon notification from Company A to the Participant that Rights have vested

Allocation

As soon as practicable following vesting of a Right, the Board must issue to, procure the transfer to, or procure the setting aside for the Participant of the number of Company A Shares in respect of which Rights have vested. No further action is required on the part of the Participant.

Payment of cash equivalent

Where the Board exercises its discretion to make a cash payment to a Participant in lieu of an allocation of Company A Shares, it will do so on the following terms:

•         Company A must pay to the Participant an amount in Australian dollars (or any other currency determined by the Board in its absolute discretion) equivalent to the value of Rights that have vested

•         the amount of the cash payment will be calculated by multiplying the number of Company A Shares in respect of which Rights have vested by the Current Market Price (as defined in the Plan Rules)

•         where the Board determines that the payment is to be made in a currency other than Australian dollars, unless the Board determines otherwise, the foreign exchange rate applied will be the average closing exchange rate of the relevant currency for the 5 days prior to the date of vesting

•         A Right will lapse upon the earliest to occur of:

•         the Right lapsing in accordance with a provision of the Plan Rules (including in accordance with a term of an Offer);

•         failure to meet a vesting condition or any other condition applicable to the Right within the vesting period; or

•         the receipt by Company A of a notice in writing from a Participant to the effect that the Participant has elected to surrender the Right.

A Participant is free to deal in Company A Shares allocated to them on vesting of their Right.

The EST

Company A has established the Trust B Share Trust (the 'EST') pursuant to the EST Deed (the 'Trust Deed') between Company A and the 'Trustee' for the purpose of obtaining Company A Shares for the benefit of participating senior executives of the EIP. This includes subscribing for Company A Shares at market value by acquiring Company A Shares on-market or by way of off-market transfers, and allocating, holding and delivering shares in Company A pursuant to the Plan Rules of the EIP. All of the Company A Shares acquired by the EST will be ordinary shares in Company A.

Operation of the EST

The Trust Deed sets out the manner in which contributions can be made to the EST and Company A Shares acquired. Pursuant to the Trust Deed, contributions to the EST are made on the following basis:

•         the EST is required to acquire Company A Shares determined appropriate and necessary by Company A;

•         funds must be transferred to the EST by Company A to enable the Trustee to acquire Company A Shares; the Trustee is not obliged to act in accordance with a request or direction by the Board if a Group company or Participant has not provided it with sufficient funds to comply with the request or direction. The funds contributed to the EST may be contributed by Company C, or another associated entity within the ACG.

•         The Trustee is subject at all times to the requirement that the Trustee manage and administer the EST so that the EST satisfies the definition of an 'employee share trust' for the purposes of subsection 130-85(4) ITAA 1997.

The Trustee will set aside and hold parts of the Trust Fund for identified Participants (each a 'Beneficiary') at the request of the Board, consistent with the Plan Rules.

The Trust Deed, among other incidental powers, and for the sole purpose of exercising its powers and discharging its obligations under the Deed and Plan Rules, grants the Trustee the powers to, including:

•         acquire Company A Shares, dispose of Company A Shares or otherwise make investments (including, without limitation, in Company A Shares) for the benefit of the Beneficiaries consistent with the purposes of the EST;

•         sell any rights that accrue to a Company A Share and apply the proceeds of sale in accordance with the Trust Deed and the Relevant Rules;

•         reinvest dividends and participate in Company A Share entitlements. Note that Company A Share entitlements do not include dividend distributions;

•         to raise and borrow money in any manner (including without limitation from the Company) without security over any part of the Trust Fund and to pay any interest on money borrowed;

•         accumulate, or permit the accumulation of, income;

•         accumulate, or permit the accumulation of, any amounts of the Trust Fund to which no Eligible Employee is presently entitled (whether income or capital in nature);

•         transfer all or any part of the Trust Fund to a new or existing trust that exists for the benefit of some or all of the Beneficiaries;

•         exercise the voting rights in respect of Shares held in the Trust Fund in accordance with the Plan Rules and the Trust Deed

The Trustee may apply Company A Shares which form General Trust Property for the benefit of the Beneficiaries as follows: transferring Company A Shares to, conferring legal title of Company A Shares upon, or granting a beneficial interest in Company A Shares to, a Beneficiary, or disposing of Company A Shares and applying the proceeds for the benefit of a Beneficiary presently entitled to the Company A Shares at the direction of the Beneficiary.

At all times, the decision by the Trustee will be made in accordance with the Trust Deed and in fulfilment of the Trustee's fiduciary duty to beneficiaries. Company A is not a beneficiary under the Trust Deed, and any funds, both the initial contributions and any additional contributions required to fund the EST, cannot be refunded, repaid or returned to Company A (other than by way of the Trustee paying the issue price where it subscribes for shares in Company A, or repayment of loans from a Group company). Further, Company A will have no interest in the shares held by the EST.

Nothing in the Trust Deed confers any right to Company A to Allocated or General Trust Property (other than repayment of any outstanding loans from a Group Company) on termination of the EST.

Reasons for decision

Question 1

Detailed reasoning

The total assessable income of a trust estate is calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1) of the Income Tax Assessment Act 1936).

The assessable income of a taxpayer includes income under ordinary concepts (section 6-5) or statutory income (section 6-10).

None of the provisions listed in section 10-5 are relevant in the present circumstances. Therefore, non-refundable contributions made by Company A to the Trustee for the EST will not be assessable income under section 6-10.

The cash contributions made by Company A to the Trustee of the EST are irretrievable and non-refundable to Company A in accordance with the Trust Deed as Company A and members of the ACG are not Beneficiaries and they have no entitlement to any money or Company A Shares forming part of the Trust Fund.

The funds provided to the Trustee are used in accordance with the Trust Deed and the Plan Rules for the sole purpose of and under the employee share scheme (ESS). The contributions constitute capital receipts to the Trustee, and are not assessable under section 6-5 or 6-10 (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), and hence will not be assessed to the Trustee pursuant to section 95 of the ITAA 1936.

Question 2

Detailed reasoning

Pursuant to section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens.

Under subsection 104-75(1), 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 applies) as against the trustee.

The time of the event is when the beneficiary becomes absolutely entitled to the asset according to subsection 104-75(2).

If CGT event E5 happens, the trustee may make a capital gain or capital loss if the market value of the asset, at the time of the event, is more than its cost base or less than the asset's reduced cost base respectively. The trustee makes a capital loss under subsection 104-75(3) if that market value is less than the asset's reduced cost base.

In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies.

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') explains the principles set out in the leading English trust law case of Saunders v. Vautier (1841) 49 ER 282 in relation to 'absolutely entitled' as follows:

... if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway.

A Participant will become absolutely entitled to the Rights in accordance with the Plan Rules, when the Rights have vested and Company A will allot Company A Shares to the Participant. At this point, the Participant will become absolutely entitled to the XXX Shares as against the Trustee, and CGT event E5 happens pursuant to subsection 104-75(1).

However, any capital gain or loss that the Trustee makes from CGT event E5 is disregarded if section 130-90 applies.

Section 130-90 states:

130-90(1A) [...]

130-90(1) Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if:

(a)  the CGT event is CGT event E5 or E7; and

(b)  the CGT event happens in relation to a *share; and

(c)   the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d)  the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

(2)  Subsection (1A) or (1) does not apply if the beneficiary acquired the beneficial interest in the *shares for more than its *cost base in the hands of the *employee share trust at the time the *CGT event happens.

Therefore, to qualify for the exemption in section 130-90, there must be an 'employee share trust' and an 'ESS interest'.

The EST satisfies the definition of 'employee share trust' in subsection 130-85(4) and the granting of Rights to acquire shares in Company A under the Plan to the Participants falls within the definition of an 'ESS interest' in subsection 83A-10(1).

The Rights granted under the EIP are ESS interests to which Subdivision 83A-B or 83A-C applies because the Participants acquire the ESS interests under an employee share scheme for nil consideration, which are at discount.

As such, any capital gain or loss that arises for the Trustee when the Participants become absolutely entitled to Company A shares under the EIP is disregarded by virtue of section 130-90(1).

Note that subsection 130-90(1) does not apply if the Beneficiary acquired the beneficial interest in the Company A Share for more than its cost base in the hands of the EST at the time CGT event E5 happens (subsection 130-90(2)).