Edited version of private advice

Authorisation Number: 1051984536424

Date of advice: 20 May 2022

Ruling

Subject: ESS - deferred compensation

Question 1

Is the deferred compensation stock you received under the Company's Income Deferral Program, an Employee Share Scheme (ESS) interest as defined by subsection 83A-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 1(a)

If the answer to question 1 is yes, please confirm that all taxing points occurred prior to your arrival to Australia, and you would not be assessable in Australia upon receipt of your stocks as an Australian tax resident.

Answer

Not applicable.

Question 1(b)

If the answer to question 1(a) is yes, please confirm whether you were in receipt of a capital asset upon recommencing residency.

Answer

Not applicable.

Question 2

Is the deferred compensation payment you received under the Company's Income Deferral Program for employment performed overseas assessable as ordinary income under section 6-5 or 15-2 of the ITAA 1997?

Answer

Yes. The amount of deferred compensation payment you received under the Company's Income Deferral Program is assessable income under section 6-5 of the ITAA 1997.

Question 3

If the answer to question 2 is yes, will the resulting investment in the fund be capital proceeds under section 116-20 of the ITAA 1997?

Answer

No. The resulting investment in the fund is assessable as ordinary income under section 6-5 of the ITAA 1997.

Question 4

Will the Stock Options (Rights) that you exercised after your arrival in Australia, be assessable under Division 83A of the ITAA 1997?

Answer

No. The exercise of the Rights would be subject to the capital gains tax (CGT) rules.

Question 4(a)

If the answer to question 4 is yes, please confirm whether you were in receipt of a capital asset upon recommencing residency.

Answer

Upon recommencing Australian tax residency, for CGT purposes you were taken to have acquired the Rights at that time for its market value as first element of the cost base and reduced cost base.

Question 5

Will the lump sum cash payment you received in relation to the Company's Retirement Plan be assessable under section 305-70 of the ITTA1997 as applicable fund earnings?

Answer

Based on the given assumptions, section 305-70 of the ITAA 1997 would apply to superannuation lump sum cash payment you received from the Company's Retirement Plan, where the payment was made more than six months after you became an Australian resident and/or after separation from foreign employment. The portion of the lump sum cash payment treated as the 'applicable fund earnings' to be included as part of your assessable income is worked out under section 305-75 of the ITAA 1997.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.    You are an Australian citizen. You departed from Australia in 20XX and resided overseas since.

2.    You retired as a Key Employee of Company A in late 20XX and ceased employment with the Company in 20XX. You returned to Australia in that same year and have been treated as an Australian tax resident from that time onwards.

3.    Following your separation from Company A, you received Cash Payments and Value of Shares amounts in foreign currency under Company A's Income Deferral Program.

4.    You were awarded Stock Options (Rights) under the Company's Share Power Plan (Share Plan) while being employed by the Company.

5.    The Rights were vested fully to you at the time of your retirement and separation from the Company and before your arrival in Australia.

6.    You exercised the Rights after you recommenced as resident of Australia for taxation purposes.

7.    You also received a lump sum Cash Payment in foreign currency for your benefits under the Company's Retirement Plan.

8.    Due to your Key Employee status when you left Company A, payment of your benefits under the Retirement Plan was delayed for a certain period as per the rules under the Plan.

9.    All duties related to the payments in question have been performed overseas.

10.  You elected your base salary and bonuses in certain years to be deferred until separation from service.

11.  Your tax agent confirmed that to the best of their knowledge, you have not been under any compliance review by the ATO from the time of this ruling application to date.

Distributions under the Income Deferral Program

12.  You received amounts in foreign currency comprising of Cash Payments and Value of Shares in the two income years of 20XX and 20XX.

13.  The Value of Shares represented the actual Company shares you received under the Income Deferral Program and these are referred to as 'Deferred Compensation Stock'. These were payouts of deferral amounts invested in certain Funds being made in the form of Company A Common Stock.

14.  The Cash Payments represented payouts of deferral amounts invested in some other investment opportunities under the Income Deferral Program; and these are referred to as 'Deferred Compensation Payment'.

15.  All your entitlements under the Income Deferral Program were vested fully and the minimum deferral period was satisfied at the time of your retirement and separation from the Company.

16.  Foreign tax has been withheld on payments under the Income Deferral Program as well as on market disposal. Under the Program, if you die prior to payment of your entire account, your designated beneficiaries will receive distribution of your account in a single lump sum following your death.

Stock Options (Rights) under the Share Plan of Company A

17.  The Rights that were exercised by you after your arrival in Australia relate to Rights that were granted to you back in 20XX, 20XX, and 20XX while you were a foreign resident.

18.  When you exercised the Rights, you acquired a certain number of shares in Company A. You sold some of the shares and retained some.

19.  Under the Share Plan rules, when the Right is exercised, the excess of the market price of Company A Common Stock on the date of exercise over the exercise price will be taxable to you as ordinary income.

Payment under the Retirement Plan of Company A

20.  The lump sum Payment you received in foreign currency from the Company's Retirement Plan was included in your tax return overseas and the applicable taxes were paid on the distribution.

Income Deferral Program of Company A

21.  The Income Deferral Program allows you as a Participant, to defer receipt of a portion of your income. It allows for deferral of salary and annual incentives such as bonuses. This reduces your current income taxes and enables you to enjoy tax-deferred investment returns on the amounts you choose to defer.

22.  When Participants elect to defer amounts into the Program, they also make the election of when they ultimately would like to receive the relevant earned distributions. Where a deferral of payment until separation of service is chosen, the payment will commence as of the calendar quarter that follows the six-month anniversary of the Participant's separation from service. The initial deferrals are subject to a minimum threshold deferral.

23.  The election to defer a bonus and the election to defer a portion of the base salary once made is irrevocable, except in the event of certain unforeseeable emergencies.

24.  Certain taxes on amounts that are deferred must be paid at the time of deferral unless the deferral is made through certain Funds in which the applicable taxes are deferred until the deferral is no longer subject to a risk of forfeiture.

25.  However, beginning with the 20XX bonus deferral elections made into a certain Fund where the Participant is retirement eligible at the time of deferral, the applicable taxes on the bonus amount deferred must be paid at the time of deferral.

26.  When the deferred income is paid out, amounts invested in certain Funds will be paid out in Company A Common Stock.

27.  The applicable taxes are withheld at the time of the deferral payment for chosen investments in certain Funds.

Company A Matching Stock Fund

28.  Participants of the Income Deferral Program are eligible to defer all or a portion of their eligible incentive bonus into the Company A Matching Stock Fund. Deferrals into this Fund are invested in unit equivalents to shares of Company A Common Stock (phantom shares) and participants also receive additional phantom shares equal to a certain percentage of the phantom shares received resulting from the deferral (matching contribution). The total returns can include any regular phantom appreciation and dividends on Company A Common Stock, plus the value of this matching contribution and the additional phantom appreciation and dividends.

29.  Dividends related to the Company A Matching Stock Fund will be credited at the same rate as Company A Common Stock. When Company A pays a dividend on its common stock, it will accrue to a dividend subaccount an amount equal to the dividend per share times the number of phantom shares in the account of the Participant at that time. That dividend subaccount will accrue interest daily. All distributions from the dividend subaccount will be distributed in cash.

30.  The number of initial phantom shares credited into Participant's account under the Company A Matching Stock Fund is calculated using the closing price of Company A Common Stock on the date of the deferral. The closing price is based on the closing sale price for Company A Common Stock as reported for the date on the composite tape for securities listed on the relevant Stock Exchange rounded to 2 decimal places.

Investment opportunities under the Income Deferral Program

31.  Except for the portion of a Participant's eligible bonus that is deferred under the Company A Matching Stock fund, there are certain four basic deferral investment opportunities available for amounts deferred under the Program as per the Program Prospectus.

32.  Each investment account is a phantom investment opportunity. By 'phantom', the amount that is deferred is not actually placed in the investment options. But rather, the Program credits the Participant's deferral account with the return that is experienced by the investment option chosen.

33.  However, as mentioned earlier payouts of amounts invested in certain Funds will be made in the form of Company A Common Stock.

Non-Transferability

34.  No investment transfers are permitted with respect to amounts deferred under certain Funds. No investment transfers are permitted with respect to the Company A Matching dividend subaccount until after the minimum deferral period has ended.

35.  The deferral account cannot be transferred during the Participant's lifetime or assigned by the Participant in any manner, other than by Will or the laws of descent and distribution.

Restrictions on Issuance and Resale

36.  No share of Company A shall be issued or transferred under the Income Deferral Program until all applicable legal requirements have been complied with to the satisfaction of the Administrator. Participants of the Program will not acquire any of the rights of an owner of Company A Common Stock, unless and until certificates for shares of the Stock are issued to the Participant.

Company A Share Plan

37.  Under the Share Plan, Participants can receive a regular Stock Option (Right), where the grant is stated in terms of the amount of the award (grant amount). The Right is granted with an exercise price equal to the Closing Price of a share of Company A on the date of grant; and can be exercised once they are vested.

38.  Participants would not be deemed to have received any income upon the grant of the Stock Option (Right). When the Right is exercised, the excess of the market price of Company A Common Stock on the date of exercise over the exercise price will be taxable to the participant as ordinary income under the Share Plan rules.

Company A Retirement Plan

39.  The Retirement Plan was established to benefit employees who are ineligible to participate in a retirement plan sponsored by the Company. The Plan Administrator will credit the Participant's Retirement Plan account with Employer Credit, the Earnings Credit, and the Optional Supplemental Credit.

40.  Upon separation from service, a participant shall be entitled to a distribution provided that their Retirement Plan account has become vested and non-forfeitable either upon attaining the minimum service period; or the earliest of the Participant's retirement, death, becoming Disabled, or the occurrence of a Change in Control in the Company.

41.  The distribution of benefits under the Retirement Plan depends on certain factors such as whether the Participant is retirement eligible and a Key Employee.

42.  For each Plan Year in which a Participant is required to pay taxes on any portion of the Retirement Plan account, the Company shall calculate the applicable taxes that are due and shall pay the taxes to the applicable tax authorities. The Company shall withhold such taxes from the Participant's account and reduce the account balance accordingly.

Relevant legislative provisions

Income Tax Assessment Act 1997

section 6-5

Division 83A

subsection 83A-10(1)

subsection 83A-10(2)

section 83A-125

section 83A-340

section 104-25

section 108-5

section 109-60

section 112-97

section 118-20

Subdivision 130-D

section 134

section 305-70

section 305-75

section 855-15

section 855-45

subsection 995-1(1)

Reasons for decision

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

Questions 1 and 1(a) and 1(b)

Summary

There is no indeterminate right to acquire a share in Company A for the purposes of section 83A-340 under the Income Deferral Program. Therefore, the deferred compensation stock received under the Program is not an ESS interest under subsection 83A-10(1).

Given the answer to Question 1 is no, Questions 1(a) and 1(b) are no longer relevant.

Detailed reasoning

ESS is short for employee share scheme. Subsection 995-1(1) provides that an ESS interest in a company has the meaning given by subsection 83A-10(1).

Subsection 83A-10(1) defines 'ESS interest' in a company as a beneficial interest in:

•         A share in the company, or

•         A right to acquire a beneficial interest in a share in a company.

An employee share scheme is a scheme under which ESS interests in a company are provided to employees, or associates of employees, (including past or prospective employees) of the company; or subsidiaries of the company; in relation to the employees' employment - subsection 83A-10(2).

It may seem easy to conclude that an ESS interest has been granted if the grant is specifically a share or a right to acquire a share. However, the tax law needs to be applied to employment agreements which may allow more novel forms of payment or for the form of payment to be determined after the employment agreement has commenced.

For example, an employee may become eligible to receive a bonus, but the employer may reserve the right to pay the bonus in cash, property, or shares. We would describe such an employee as having an indeterminate right.

The indeterminate right would only become a right to acquire a share once the employer committed to providing the bonus as a share or as a right to acquire a share.

Section 83A-340 provides for the consequences for an indeterminate right that later becomes a right to acquire a beneficial interest in a share. In short, it is treated as if the right has always been a right to acquire a beneficial interest in the share as explained in Taxation Determination TD 2016/17.

The Explanatory Memorandum (EM) to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 which introduced the provision makes the following statements about indeterminate rights:

Employment benefits that later become ESS interests

1.367 At the time of acquisition it may be unclear whether a right to an employment benefit will result in the receipt of an ESS interest, or it may be unascertainable how many ESS interests will be received. In such circumstances, that right will be considered to have been an ESS interest from the time that the original right to an employment benefit was acquired if and when it becomes clear that the right to the employment benefit will result in the receipt of a definite number of ESS interests. [Schedule 1, item 1, section 83A-340]

1.368 This is to ensure that employment benefits provided in the form of discounted shares or rights to shares are taxed consistently and appropriately under the employee share scheme rules.

1.369 This provision will apply, for example, to an employment benefit that is a right to an indeterminate number of shares, or to a benefit that may be received in shares, in cash, or in some other form.

1.370 When the nature of the right to an employment benefit as an ESS interest becomes clear, the Commissioner may amend an employee's income tax assessment for the income year in which the taxing point for the ESS interest occurred (based on the treatment of the right as an ESS interest from the time of its acquisition). The Commissioner can amend an assessment relating to an employee share scheme at any time, for the purposes of a taxing an employment benefit which becomes an ESS interest. [Schedule 1, item 19, item 35 in the table in subsection 170(10AA) of the ITAA 1936]

The EM explains the ESS rules will only apply if the form of payment chosen for the remuneration is the grant of shares in a company or a right to acquire a share in a company.

Application to your circumstances

In your case, there's an expectation that you would receive Company A Shares if you elected that your deferred amounts were to be nominally invested on Company A Matching Stock Fund. However, your employer had not elected to pay your remuneration in the form of Company A Shares.

Rather, under the Income Deferral Program, your employer gave you an opportunity to defer your remuneration (salary and bonuses) at a date specified or when you end your services with the Company and make profits on the deferral.

The Income Deferral Program does not provide you will be issued with a 'right' for no consideration; or the right is issued to you at a discount. The Program does not provide nor guarantee an employment right. Your participation in the Program is not construed as giving you any right to be retained in the employ of Company A. These terms are expressly provided in the Income Deferral Program documentation you provided to the ATO. Effectively, this means the Program is not an employee share scheme within the meaning of subsection 83A-10(2).

For these reasons, it is considered that you do not have an indeterminate right to acquire a share in the Company for the purposes of section 83A-340. Therefore, the deferred compensation stock is not an ESS interest within the meaning given by subsection 83A-10(1).

Questions 2 and 3

Summary

The amounts of deferred compensation payments you received under the Income Deferral Program are assessable to you under section 6-5.

CGT event C2 in section 104-25 happened when you received the amounts of deferred compensation payments in satisfaction of your entitlements under the Program. Any capital gain you made from the event would be reduced by the amount otherwise assessable under section 6-5.

Detailed reasoning

Income Deferral Program

The Income Deferral Program allows you to defer receipt of a portion of your income. This reduces your current income taxes and enables you to enjoy tax-deferred investment returns on the amounts you choose to defer.

As an eligible employee, you can choose to defer your eligible income. (Only income paid in foreign currency is eligible). Eligible income includes base salary and bonus. You can defer up to 85% of your base salary and 100% of your bonus.

Deferral Election Timing

Bonus - a decision to defer your bonus must be made no later than June 30th of the year prior to the year in which the income will be paid.

Base salary - a decision to defer your base salary must be made no later than the prescribed time prior to the year in which the salary will be paid.

Effect of Deferrals on Taxes

The Income Deferral Program's requirements for advance elections permit your deferrals, as well as any investment returns that are credited to your deferral account, to be sheltered from income taxes until you receive that income.

Deferred compensation

In Blank v. Federal Commissioner of Taxation (2016) 258 CLR 439; [2016] HCA 42; (2016) 104 ATR 41 (Blank case), it was held that payments of 'deferred compensation' that was expected to be paid after termination of employment for services provided after the agreement commenced were ordinary income.

The Commissioner applied the Blank case decision in Taxation Ruling 2018/7 Income tax: employee remuneration trusts (TR 2018/7) where it explains what is considered remuneration.

TR 2018/7 states that an employee remuneration trust (ERT) arrangement involves a trust being established to facilitate the provision of payments and/or other benefits to employees of an employer. The trustee provides the benefits at the direction of, or by arrangement with, the employer.

Example 10 in TR 2018/7 refers to a payment from the trustee in relation to employment where it explains:

62. An ERT operates to acquire shares for the benefit of the employees of the employer, a company. The trustee acquires shares in the Company and the employees acquire an interest in the ERT where shares are notionally allocated to that interest.

63. The employee acquires an interest in the ERT. This interest does not entitle the employee to any income of the ERT during the vesting period. Once the employee satisfies vesting conditions (which is to remain employed for a minimum of three years and to meet key performance targets), the employee can redeem the interest and receive the growth in value of the interest. The value is determined by the market value of the notionally allocated shares attached to that interest.

64. In addition the employee, once vesting conditions are satisfied, also will be entitled to an additional payment from the ERT, known as a 'dividend equivalent payment'. The entitlement to this payment arises from an agreement entered into with the Company. The value of the payment equates to the dividends that the trustee has received on the notionally allocated shares acquired by it over the vesting period (three years), less the tax paid by the trustee on those dividends. The payment can be made by the trustee from the capitalised income it received during the vesting period when it held the shares and received dividend payments; or it can be made directly by the Company.

65. Whether the payment is made by the trustee or the Company is irrelevant for the purpose of determining whether the receipt is remuneration. However, given the requirement that the employee remain in employment, meet certain key performance targets before receiving the payment, and considering the contractual agreements between the parties, it is apparent that the payment is made in respect of the member's employment. It is payment of an additional benefit, the consideration for which comes from the employment services provided to the Company. While the quantum of the payment reflects a dividend equivalent, had the employee acquired the shares at the outset of the arrangement, this is merely a calculation mechanism and does not reflect the character of the payment in the recipient's hands. The character of the payment in the employee's hands is remuneration.

Examples of ERT arrangements are set out in Taxation Ruling TR 2010/6 Income tax: Pay As You Go Withholding and fringe benefits tax: tax consequences on the issue, holding and redemption of bonus units as part of an employee benefits trust arrangement (TR 2010/6).

Although TR 2010/6 refers to PAYG Withholding and Fringe Benefits Tax (FBT), it explains certain concepts in relation to salary or wage income and the term 'connection with employment', where it states:

•         An employee does not derive ordinary or statutory income from the provision of personal services until the income either has been received by them or is taken by subsections 6-5(4) or 6-10(3) to have been received by them (paragraph 8).

•         A payment to an employee will be employment-related income of the employee where the employee receives the payment in their capacity as an employee (paragraph 68).

•         If the payment is in respect of the employment of the individual, it is not relevant who actually made the payment (paragraph 73).

Receipt of ordinary income

Subsection 6-5(2) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

In FCT v. Clarke (1927) 40 CLR 246 at 261; [1927] HCA 49, Isaacs J said that 'derived' simply means 'obtained' or 'got' or 'acquired' and that 'all income is derived from something and by someone'. Isaacs J also added in FCT v. Thorogood (1927) 40 CLR 454 at 458; [1927] HCA 36 that 'derived' does not necessarily mean actually received, although receipt is the ordinary mode of derivation.

Essentially, income is derived when it 'comes in' or 'comes home', in whatever sense is most appropriate in the particular circumstances: Commissioner of Taxes (SA) v. Executor Trustee and Agency Co of South Australia Ltd (1938) 63 CLR 108; [1938] HCA 69.

The time at which an amount of ordinary income is 'derived' depends on the tax accounting method used by the taxpayer to report the amount as income, i.e. whether the amount should be reported as income on a cash basis (receipts) or an accruals (earnings) basis.

Cash v Accruals

A taxpayer must adopt the method that, in the circumstances of the case, is the most appropriate. A method of accounting is appropriate if it 'gives a substantially correct reflex of income': paragraph 17 of Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings. However, the receipts method is likely to be appropriate to determine income derived by an employee whereas the earnings method is, in most cases, appropriate to determine business income derived from a trading or manufacturing business: paragraphs 18 and 20 of TR 98/1.

The cash basis of accounting is the method used by most individuals. Under this method, income is returned in the year when it is actually or constructively received, either in the form of cash or its equivalent, or other property.

Paragraph 42 of TR 98/1 states that income from employment would normally be assessable on a 'receipts' basis. Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period.

This is the case even if the service to which the salary relates was performed before the taxpayer became an Australian resident (Re Clement Kam Man Tong and Commissioner of Taxation [2007] AATA 1234; 2007 ATC 2139; (2007) 66 ATR 412).

To the extent that the amounts represent ordinary income, it appears appropriate to consider their assessment in the year in which they were received that is, on a cash (receipts) basis.

As such under domestic taxation law, the amounts received by a resident taxpayer were derived in the income year the taxpayer received the payment.

However, there is a complication because the amounts being derived by a resident of Australia were in relation to employment services performed overseas by the taxpayer. This would mean that because the taxpayer is a resident of Australia when the income was derived, Australia has taxing rights over the income; and because the services were performed overseas, the income is deemed to have a foreign source and the foreign country may also tax the income.

The relevant Double Tax Agreement (DTA) would need to be examined as to whether an Australian resident shall be entitled to a credit for the foreign tax paid in accordance with the agreement, whether directly or by deduction, in respect of income derived by that person in that foreign country.

Receipt of capital

A participant's rights under the Income Deferral Program are legally enforceable rights and therefore, in their totality, a CGT asset according to the definition in section 108-5.

Upon payment of the participant's entitlements under the Income Deferral Program, the participant's ownership of the contractual rights under the Program comes to an end by reason of those rights being discharged or satisfied - subsection 104-25(1).

The separate recognition of the participant's rights under the Income Deferral Program for CGT purposes may be consistent with the decision of the High Court of Australia in FC of T v. Orica Limited (formerly ICI Australia Limited) (1998) 194 CLR 500; 39 ATR 66; 98 ATC 4494. In that case, the Court held unanimously that the right to performance of an executory contract (in that case, an 'in substance' debt defeasance arrangement) was an asset for CGT purposes. It was further held that the asset was realised for CGT purposes when the other party gave performance of its obligations.

A 'look through' or 'underlying asset approach' to the CGT treatment of the rights is not available in certain circumstances - see for example Taxation Determination TD 2008/22.

CGT consequences of becoming a resident

The CGT consequences of a non-resident individual becoming a resident for taxation purposes are set out in section 855-45.

For each CGT asset that is not taxable Australian property within the meaning of section 855-15, the asset is taken to be acquired by the individual at the time of becoming a resident; and the first element of the cost base and reduced cost base of the asset is its market value at that time.

Section 118-20 provides that a capital gain is reduced to the extent that the amount is otherwise assessable by another provision outside the CGT provisions.

Application to your circumstances

The amounts of deferred compensation you received under the Income Deferral Program are assessable to you under section 6-5.

It is noted that under the Income Deferral Program's requirements for advance elections permit your deferrals, as well as any investment returns that are credited to your deferral account, to be sheltered from income taxes until you receive that income. This lends support to the view that the amounts you received under the Program were derived in the income year you received the payment.

Your contractual right under the Income Deferral Program is a CGT asset. When you became a resident of Australia for taxation purposes, you were taken to have acquired that right for its market value at that time.

CGT event C2 in section 104-25 happened when you received the deferred compensation payments in satisfaction of your entitlements under the Income Deferral Program.

The total payments would be capital proceeds for the right to be paid of your entitlements under the Program. You make a capital gain if the capital proceeds are more than the cost base. You make a capital loss if the capital proceeds are less than the reduced cost base.

Your capital gain would be reduced by the amount otherwise assessable under section 6-5.

Questions 4 and 4(a)

Summary

The exercise of the Stock Options (Rights) would be subject to the capital gains tax (CGT) rules. When the Rights are exercised, CGT Event C2 in section 104-25 happened but the event is ignored by the application of subsection 134-1(4).

It is assumed the Rights are not taxable Australian property as defined in section 855-15. Upon recommencing Australian tax residency, for CGT purposes you were taken to have acquired the Rights at that time for its market value as first element of the cost base and reduced cost base.

Detailed reasoning

ESS is short for employee share scheme. Subsection 995-1(1) provides that an ESS interest in a company has the meaning given by subsection 83A-10(1).

Subsection 83A-10(1) defines 'ESS interest' in a company as a beneficial interest in:

•         A share in the company, or

•         A right to acquire a beneficial interest in a share in a company.

An employee share scheme is a scheme under which ESS interests in a company are provided to employees, or associates of employees, (including past or prospective employees) of the company; or subsidiaries of the company; in relation to the employees' employment - subsection 83A-10(2).

The taxing point of an ESS interest will be either immediate or deferred.

The deferred taxing point for a right is the earliest of the following per ATO document QC 47629:

•         when there is no real risk of forfeiting the right and the scheme no longer genuinely restricts disposal of the right,

•         when the employee ceases their employment in respect of which they acquired the right,

•         for ESS interests acquired after 30 June 2015:

­   when the employee exercises the right, there is no real risk of forfeiting the resulting share and the scheme no longer genuinely restricts disposal of that share

­   15 years after your employee acquired the right

•         for ESS interests acquired before 1 July 2015

­   when there is no real risk of forfeiting the right or underlying share, and the scheme no longer genuinely restricts exercise of the right or disposal of the resulting share

­   seven years after the employee acquired the right.

Right sold or retained for more than 30 days before exercising it

If the right was sold; or retained for more than 30 days before exercising it, the relevant asset for the purposes of section 83A-125 and Subdivision 130-D is the right.

Under the ESS rules, the right is deemed to have been acquired at market value immediately after the deferred taxing point (sections 109-60 and 83A-125).

Capital gains tax (CGT) consequences

The CGT consequences of a non-resident individual becoming an Australian resident are set out in section 855-45. This section provides that if an individual becomes an Australian resident, each CGT asset owned by the individual that is not taxable Australian property is taken to be acquired by the individual, at the time of becoming resident and the first element of the cost base and reduced cost base of the asset is its market value at that time.

The exception in subsection 855-45(4) referring to ESS interest, does not apply if the deferred taxing point for the ESS interest has already occurred.

The meaning of taxable Australian property is provided in section 855-15.

Generally, the Right will be held on capital account. Potentially the rules in Division 134 referring to options may apply when the Right is exercised.

Note: In this case, the quality of the Right is comparable to an option.

Subsection 134-1(4) provides that a capital gain or loss you make from exercising the option will be disregarded. So, while there may be a CGT Event, the gain or loss is ignored.

The Table in subsection 134-1(1) provides that the cost base of the relevant CGT Asset (being the shares acquired on exercise of the option, not the option itself, will include the amounts paid to acquire the option, together with the amount paid to exercise the option.

Note 3 accompanying the Table in subsection 134-1(1) provides that Item 1 of the Table is modified for ESS Interests acquired under an employee share scheme (see Division 83A and section 112-97).

Section 112-97 contains a table; item 32 of the table provides that where you acquire an ESS Interest and Subdivision 83A-B or 83A-C applies to the interest, the first element of the cost base is affected (by sections 83A-30 or S83A-125). Therefore, both section 83A-30 and 83A-125 take precedence over the table in subsection 134-1(1) in relation to the first element of the cost base, but only where subdivisions 83A-B or A-C apply to the interest.

Note 4 to the Table in subsection 134-1(1) also provides that Division 134 has no application in relation to an option acquired under an ESS if the ESS Interest (being the Option) is exercised before the deferred taxing point for the option. In these instances, Division 83A applies instead.

Therefore, where we have an option that is subject to deferred taxation, Division 83A operates and applies to the exclusion of CGT provisions until the deferred taxing point.

Where the deferred taxing point arises on cessation of employment, the option is deemed to have been acquired (for CGT purposes) immediately after this deferred taxing point and at market value.

When the option is subsequently exercised, CGT Event C2 is ignored by application of subsection 134-1(4). The cost base of the shares acquired by exercising the Option includes the market value of the option at the deferred taxing point plus amounts paid to exercise the option.

Application to your circumstances

The Rights granted to you under the Company Share Plan are considered ESS interests within the meaning of subsection 83A-10(1).

As discussed earlier, the taxing points for an ESS interest will be either immediate or deferred. The deferred taxing point for a right is summarised in ATO document QC 47629 as listed above.

It is submitted in the ruling application that regardless of whether the taxing point is deferred or immediate, on the basis that the Rights were granted to you between 20XX and 20XX, a taxing point would have arisen before you commenced Australian tax residency. Accordingly, Division 83A will not apply to you upon exercise of the Rights.

Where a taxing point has arisen, you are deemed to have acquired the Rights immediately after the taxing point and at market value.

During our phone meeting, your tax agent accepted the assumption that the Rights are not taxable Australian property as defined in section 855-15. As such when you became an Australian tax resident, for CGT purposes you were taken to have acquired the Rights at that time for its market value as first element of the cost base and reduced cost base.

The exercise of the Rights by you would have CGT consequences.

When the Rights are exercised, CGT Event C2 in section 104-25 happens but the event is ignored by the application of subsection 134-1(4).

The cost base of the shares acquired by exercising the Rights would include the market value of the Rights at the time you became a tax resident plus amounts you paid to exercise the Rights.

Question 5

Summary

Based on the assumptions stated above, section 305-70 would apply to superannuation lump sum cash payment you received from the Retirement Plan, where the payment was made more than six months after you became an Australian tax resident and/or after separation from foreign employment.

The portion of the lump sum cash payment treated as the 'applicable fund earnings' to be included as part of your assessable income is worked out under section 305-75.

Detailed reasoning

The following ATO IDs provide guidance in calculating the applicable fund earnings that will be assessable to you.

>ATO ID 2012/48

ATO ID 2012/48 explains that section 305-70 applies to superannuation lump sums received by an individual from a foreign superannuation fund more than six months after the individual either becomes an Australian resident or terminates their foreign employment.

In accordance with subsection 305-70(2), an individual who receives a superannuation lump sum from a foreign superannuation fund must include in their assessable income, so much of the lump sum as equals their 'applicable fund earnings'. The assessable portion is effectively subject to tax at the individual's marginal tax rate. In accordance with subsection 305-70(3), the remainder of the superannuation lump sum is not assessable income and is not exempt income.

The amount of an individual's 'applicable fund earnings' is worked out under section 305-75 of the ITAA 1997. In general terms, this amount is the earnings that have accrued to the individual in the foreign superannuation fund since the person became an Australian resident.

Where an individual becomes an Australian resident after the start of the period to which the lump sum relates (but before they receive it), the amount of their 'applicable fund earnings' is worked out using the method in subsection 305-75(3).

ATO ID 2009/124

ATO ID 2009/124 explains the relevant periods which need to be considered when applying subsection 305-75(3). It states that when calculating the amount of 'applicable fund earnings' under the subsection, 'the period' referred to in paragraph 305-75(3)(c) is not the same as 'the period to which the lump sum relates' referred elsewhere in subsection 305-75(3) and in subsection 305-75(2).

Paragraph 305-75(3)(c) requires the amount derived from the application of paragraphs 305-75(3)(a) and 305-75(3)(b) to be multiplied by the proportion of the total days during the period when the taxpayer was an Australian resident. This requires identification of the nature of 'the period'.

ATO ID 2009/124 expresses the view that 'the period' referred to in paragraph 305-75(3)(c) must commence on the day within the period to which the lump sum relates on which the taxpayer first became a resident of Australia and conclude when the lump sum is paid.

By using paragraph 305-75(3)(c) in the formula, the residency proportion of that period, the formula will adjust or maintain the earnings amount calculated at paragraphs 305-75(3)(a) and 305-75(3)(b) so that it will represent the proportion of earnings attributable to the taxpayer's period(s) of Australian residency.

ATO ID 2015/7

For the purposes of working out the 'applicable fund earnings' in relation to a superannuation lump sum under section 305-75, the correct rule for translating foreign currency into AUD is the rule described in Item 11A of the table in subsection 960-50(6). Based on the facts and circumstances described in the ATO ID, each amount in a foreign currency that is an element in the calculation of the 'applicable fund earnings' is to be translated to AUD at the exchange rate applicable at the time of receipt of the relevant superannuation lump sum.

Application to your circumstances

During phone conversations with the ATO, the assumptions made in respect of the Retirement Plan were accepted by your tax agent.

Your tax agent confirmed that they're able to calculate the portion of the lump sum cash payment treated as the 'applicable fund earnings' for inclusion in your assessable income.