Edited version of private advice

Authorisation Number: 1051877933635

Date of advice: 29 July 2021

Ruling

Subject: Employee share schemes - will the Commissioner exercise the power in paragraph 83A-45(5)(a) to allow the minimum holding period in subsection 83A-45(4) to be reduced?

All legislative references are to the Income Tax Assessment Act 1997.

Question

Will the Commissioner allow the minimum holding period, for the specified employees under the company's Employee Option Plan, to end at an earlier time under paragraph 83A-45(5)(a), namely, when all of the company's shares are disposed of to the purchaser under a share sale agreement?

Answer

Yes

This ruling applies for the following period:

1 July 2021 to 30 June 2022

The scheme commences on:

1 July 2021

Relevant facts and circumstances

1. The applicant ('the Company') is an Australian proprietary limited company.
2. The Company adopted an Employee Option Plan ('EOP'), managed by the Company's board. The Board had the discretion to select participants and determine the terms and conditions of offers made to participants under the EOP.
3. The EOP states that:

•                 an Offer may specify any vesting conditions, or other vesting events which must be satisfied before an Option vests

•                 the Board may, in its absolute discretion (and amongst other things), notify an optionholder of the number of Options that will vest as a result of the Exit Event occurring

•                 interests in options may not be disposed of until after 180 days following a listing, or the occurrence of an exit event

•                 interests in options or option shares may not be disposed until the earlier of three years after the issue, or some earlier time as the Commissioner allows under subsection 83A-45(5), or where the option holder becomes a leaver.

4. The applicant submits that the primary objective of the EOP was to act as a tool to retain staff, and it always operated on the basis that Options would be held by employees for a minimum of three years.
5. The Company, and all of its shareholders and optionholders, entered a share sale and purchase agreement ('Share Sale and Purchase Agreement') with a third party ('the purchaser') in mid-2021. Under the Share Sale and Purchase Agreement, all the Company's shares were sold to the purchaser ('the Transaction'). Completion of the Transaction took place later in the same month in mid-2021. The sale includes all Option Shares issued by the Company to the Optionholders immediately before completion of the Transaction, and pursuant to the exercise of their vested options.
6. The Transaction is an Exit Event for the purposes of the EOP. The Company's board:

•                 notified optionholders of the number of unvested options that vested as a result of the transaction

•                 made appropriate arrangements to ensure that such options and all other outstanding options were able to be exercised (on or prior to the exit date) to shares ('Option Shares')

•                 used reasonable endeavours to ensure that the Option Shares issued at or about the same time of an Exit Event were accorded the same rights and receive the same benefits in relation to the Exit Event as pre-existing Ordinary Shares.

7. The optionholders sold their Option Shares to the purchaser on completion of the transaction, simultaneously with the sale of all other the Company Shares by the Company's shareholders, pursuant to the Share Sale and Purchase Agreement.
8. The purchaser and the Company shareholders are not related entities. The Transaction and the Share Sale and Purchase Agreement are on arms' length terms.
9. Options held by the Company's employees under the EOP ('optionholdings') were granted on certain dates in early 20XX, mid 20XX, mid 20XX, and early 20XX. Collectively, we describe the individuals who held those options as 'the optionholders'.
10. The board was aware of the interest from the purchaser as a 'serious investor' in early 20XX, but after the last options mentioned in paragraph 9 were granted. The formal negotiation process started in the following month. The final letter of intent from the purchaser was issued in mid 20XX, and the major terms of the sale were fundamentally agreed to later in the same month. The formal legal documents were finalised a couple of months later, still in mid 20XX.
11. As a start-up entity, the Company has received frequent informal expressions of interest for various investment offers. The board was made aware of a credible offer for purchase in early 20XX, later in the same month after the last options were granted under the EOP. The board resolved to solicit and consider any offer in the following month. The Company submits that the consideration of any offer to sell needed to be overwhelmingly in favour of the shareholders, ie, it was not a foregone conclusion that a sale would take place. The company has never actively sought out a buyer or majority shareholder.
12. The applicant submits that:

•                 the Company and the EOP are compliant with the conditions for the start-up concession under section 83A-33

•                 a number of optionholders ('the relevant optionholders') who exercised their vested Options before completion of the Transaction, and who sold their Option Shares to the purchaser as part of the Transaction, have held a scheme interest, or a beneficial interest in a share acquired as a result of a scheme interest, for less than the three year minimum holding period required by subsection 83A-45(5)

•                 the Company intended for the prohibition on disposal of Options and Option Shares under the EOP to continue for three years after granting the Options; the EOP prohibited the disposal of an option or an option share issued as a result of an option being exercised within three years after the grant of the option, or a shorter period as allowed by the Commissioner

•                 the Company always operated the EOP in accordance with its rules, and continued to enforce those rules until completion of the Transaction

•                 on completion of the Transaction, the unvested optionholdings were allowed to vest, and were then converted into common stock in the Company

•                 the proposal to enable optionholders to exercise their Options and sell their Option Shares to the purchaser has been prompted only by the proposed sale of 100% of the Company's Shares to the purchaser.

Relevant legislative provisions

Section 83A-10 of the Income Tax Assessment Act 1997

Section 83A-25 of the Income Tax Assessment Act 1997

Section 83A-33 of the Income Tax Assessment Act 1997

Section 83A-35 of the Income Tax Assessment Act 1997

Section 83A-45 of the Income Tax Assessment Act 1997

Reasons for decision

Question

Will the Commissioner allow the minimum holding period, for the specified employees under the company's Employee Option Plan, to end at an earlier time under paragraph 83A-45(5)(a), namely, when all of the company's shares are disposed of to the purchaser under a share sale agreement?

Summary

13. Yes. The Commissioner will allow the minimum holding period for the Company's EOP to end when all of the Company's shares were disposed of under the Share Sale Agreement to the purchaser.
14. The EOP prohibited optionholders disposing of those interests before the minimum holding period has expired. At the time all the Company's optionholdings were acquired by the optionholders under the EOP, the Company had not started negotiations with the purchaser or sought out a potential purchaser. Therefore, the Commissioner is satisfied that at the relevant times, the Company intended optionholders would not be permitted to dispose of their options.

Detailed reasoning

15. Division 83A contains rules for determining the tax treatment of interests granted under employee share schemes.
16. An ESS interest means a beneficial interest in:

•                 a share in the company, or

•                 a right to acquire a beneficial interest in a share in the company: subsection 83A-10(1).

17. An employee share scheme ('ESS') means a scheme under which ESS interests in a company are provided to employees in relation to their employment: subsection 83A-10(2).
18. The general rule under section 83A-25 is that when you acquire ESS interests at a discount under an employee share scheme, you include the amount of the discount in your assessable income: subsection 83A-25(1). However, different treatment applies in some circumstances, some of which we list below.

•                 The amount which would be otherwise included in assessable income under subsection 83A-25(1) can be reduced (potentially to nil) if requirements set by section 83A-33 are met, which, very broadly, apply to 'start-up' companies ('the start-up concession').

•                 The amount included in assessable income under subsection 83A-25(1) can be reduced by up to $1,000 if conditions in section 83A-35 are met.

•                 The taxing point may be deferred under subdivision 83A-C, if conditions in section 83A-105 are met. Very broadly, one of the requirements in section 83A-105 is that there is a real risk of forfeiting or losing the ESS interests under the ESS conditions.

19. Section 83A-33 allows for the total amount included in assessable income under subsection 83A-25(1) to be reduced by the total of the amounts included for ESS interests to which all of several specified provisions apply. To broadly summarise these conditions:

•                 the company's equity interests[1] must not be listed on a stock exchange at the end of the company's most recent income year before you acquired the ESS interest: subsection 83A-33(2)

•                 the company must have been incorporated less than 10 years[2] before the end of the income year before you acquired the ESS interest: subsection 83A-33(3)

•                 the company's aggregated turnover must not exceed $50 million in the company's most recent income year before you acquired the ESS interest: subsection 83A-33(4)

•                 under market value rules in subsection 83A-33(5): For beneficial interests in

o   shares, the discount on the ESS interest must be no more than 15% of its market value when you acquired it

o   rights, the amount that must be paid to exercise the right must be greater than or equal to the market value of an ordinary share in the company when you acquire the ESS interest

•                 your employer must be an Australian resident when you acquire your ESS interest: subsection 83A-33(6)

•                 you are employed by the company, or one of its subsidiaries: subsection83A-45(1)

•                 all the ESS interests available for acquisition under the employee share scheme relate to ordinary shares: subsection 83A-45(2)

•                 the company's predominant business[3] is not the acquisition, sale or holding of shares, securities, or other investments: subsection 83A-45(3)

•                 at all times during the interest's minimum holding period, the scheme is operated so that every acquirer of an ESS interest (referred to as the 'scheme interest') under the scheme is not permitted to dispose of either:

o   the scheme interest, or

o   a beneficial interest in a share acquired as a result of the scheme interest: subsection 83A-45(4)

•                 immediately after you acquire the interest, you do not hold a beneficial interest in more than 10% of the shares, or control more than 10% of the votes, in the company: subsection 83A-45(6)

•                 for ESS interests that are beneficial interests in shares, broadly, at least 75% of the permanent employees who have completed at least three years of service, must have been entitled to participate under the ESS: paragraph 83A-33(1)(c), read with subsection 83A-105(2).

20. Oneof the relevant conditions ('the minimum holding period') is set by subsection 83A-45(4), which says:

This subsection applies to an *ESS interest you acquire under an *employee share scheme if, at all times during the interest ' s *minimum holding period, the scheme is operated so that every acquirer of an ESS interest (the scheme interest ) under the scheme is not permitted to dispose of:

(a) the scheme interest; or

(b) a beneficial interest in a *share acquired as a result of the scheme interest;

during the scheme interest ' s minimum holding period.

21. The term 'minimum holding period' is explained in subsection 83A-45(5), which says:

An *ESS interest ' s minimum holding period is the period starting when the interest is acquired under the *employee share scheme and ending at the earlier of:

(a) 3 years later, or such earlier time as the Commissioner allows if the Commissioner is satisfied that:

(i) the operators of the scheme intended for subsection (4) to apply to the interest during the 3 years after that acquisition of the interest; and

(ii) at the earlier time that the Commissioner allows, all *membership interests in the relevant company were disposed of under a particular *scheme; and

(b) when the acquirer of the interest ceases being employed by the relevant employer.

22. The Company has self-assessed that the relevant employees meet all of the relevant conditions for the start-up concession in section 83A-33, other than the minimum holding period rule in subsection 83A-45(4). This ruling does not address whether the other conditions are met.
23. The relevant optionholders acquired their options under the EOP on several dates during a period starting in early 20XX and ending early 20XX. For at least some of those options,[4] the period starting when the interest was acquired, and ending three years later, may not have elapsed when the optionholders disposed of their scheme interests under the Transaction. Therefore, if the relevant optionholders are still the Company employees, the minimum holding period requirement in subsection 83A-45(4) will only be met if the Commissioner allows the minimum holding period to end at an earlier time under paragraph 83A-45(5)(a).
24. The Explanatory Memorandum to the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015, which introduced the Commissioner's power to allow the minimum holding period to end at an earlier time, explained the relevant amendment at paragraph 1.82.

1.82 This Bill makes slight improvements to the existing minimum holding period condition by allowing the Commissioner to reduce the minimum holding period in situations in which all employees are effectively required to exercise and/or dispose of their ESS interests. For example, where there is an initial public offering of the company, or the company is subject to a full trade sale and employees have agreed to a 'tag along' clause in relation to holding of minority interests. The Commissioner in applying the discretion will need to have regard to whether, when employees acquired their interest, there was a genuine intention for the interests to be held for the minimum holding period. [Schedule 1, items 11 and 41, subsections 83A-45(5) and 995-1(1)]

25. To summarise, the Commissioner's power is only available where:

•                 all membership interests in the relevant company were disposed of under a scheme, such as a takeover, initial public offering ('IPO'), or full trade sale, and

•                 the Commissioner is satisfied that the operators of the scheme, at the time the relevant interests were acquired, genuinely intended for the participants to be prohibited from disposing of those interests for three years.

26. Here, all the Company's shares were disposed of to the purchaser under the Transaction, which is a takeover or trade sale. Therefore, the Commissioner's power will be available if the Commissioner is satisfied that the operators genuinely intended the minimum holding period would apply when the relevant options were acquired.
27. The Commissioner's power to allow a shorter holding period has been applied in several class rulings. We summarise some relevant class rulings in the Table.

Table: summary of relevant class rulings

28.  Broadly, the class rulings described in the Table suggest that for a company which enforced an ESS which prohibits disposal within three years, but where relevant interests will be disposed of earlier under a takeover or 100% share sale, the Commissioner:

•                 is likely to allow a shorter minimum holding period for scheme interests issued to employees before the acquirer offered to acquire all its shares under a takeover or trade sale, and before the company had begun negotiations with a potential purchaser to achieve a similar end

•                 is unlikely to allow a shorter minimum holding period for scheme interests issued after the company had agreed to essential terms and was highly likely to sell 100% of its shares to a potential purchaser

•                 mayallow a shorter minimum holding period where, when the scheme interests were issued, negotiations or preparations for a potential sale had started, but there was substantial uncertainty about whether it would take place, and/or whether the eventual sale would require existing holders to dispose of their interests before the three year minimum holding period had expired.

29. Here, the EOP rules prohibited disposal in the three years following the time when the relevant options were acquired, and the operators have administered, and will continue to administer, the scheme in accordance with those rules until the Transaction takes place. The last relevant optionholdings under the EOP were issued in early 20XX. The Company, as the EOP operator, did not become aware of the purchaser's interest in a takeover until later in the same month. Formal negotiations didn't start until the following month, and the letter of intent wasn't submitted until mid 20XX. The Company's board didn't actively seek an acquisition by the purchaser.
30. The Company was not even in negotiations over a shares sale at the times all relevant optionholdings were issued under the EOP. Therefore, the Commissioner is satisfied that the operators intended that participants under the EOP would be prohibited from disposing of their scheme interests when the relevant optionholdings were issued.
31. It follows that the Commissioner will exercise the power in paragraph 83A-45(5)(a) to allow the minimum holding period in subsection 83A-45(4) to end at an earlier time, for the relevant optionholdings. That time will be the date that the purchaser acquired all of the Company's shares under the Transaction.
32. Please note that this ruling only addresses the relevant minimum holding period which will apply to the relevant optionholdings. It does not address whether the relevant optionholders meet any of the other requirements specified in subsection 83A-33(1). It is possible that some or all of the relevant optionholders may not be eligible for the start-up concession if they do not meet one or more of those other requirements.
33. Also note that this ruling does not address the capital gains tax consequences for the optionholders when they dispose of their interests under the EOP.

[1] Subsection 83A-33(2) also extends to any of the company's subsidiaries, its holding company, or any other subsidiaries of the company's holding company.

[2] Subsection 83A-33(3) also extends to any of the company's subsidiaries, its holding company, or any other subsidiaries of the company's holding company.

[3] Subsection 83A-45(3) also extends to any of the company's subsidiaries, its holding company, or any other subsidiaries of the company's holding company.

[4] For the options acquired in early 2017, the three year holding period would have elapsed in early 2020. The three year holding period for all other options, namely those issued mid 2019, mid 2020, and early 2021, did not elapse by completion of the Transaction in mid 2021.