Edited version of private advice

Authorisation Number: 1051985895682

Date of advice: 20 May 2022

Ruling

Subject: Employee share schemes

Question 1

Is the acquisition date of the share in the company equivalent to the deferred taxing point of the ESS interest, rather than the exercise date of the option, for the purposes of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the capital gains tax discount (for owning an asset longer than 12 months) applicable to the capital gain arising from the sale of the share under Division 115 of the ITAA 1997?

Answer

Yes.

Question 3

For another identifiable option (i.e., from the same grant) that has not yet been exercised, would any income tax or capital gains tax liability arise under the provisions of the ITAA 1997 at a future time when this option is exercised but not sold (noting that this option has already passed its deferred taxing point)?

Answer

No.

This ruling applies for the following periods:

Year of income ended 30 June 20XX to year of income ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In Autumn 20XX, an employee of a company was granted xxxx options to purchase shares in the company as part of an employee share scheme for the purposes of Division 83A of the ITAA 1997. The options were granted with an exercise price equal to the market value at that time. The company was privately held at that time. The company was not eligible for the start-up concession under section 83A-33 of the ITAA 1997.

In Autumn 20XX, the options reached their deferred taxing point at 7 years after grant under Subdivision 83A-C of the ITAA 1997. At that point in time, the employee had not exercised any of the options, there was no real risk of forfeiting the options and the scheme no longer genuinely restricted disposal of the options.

Accordingly, in the year of income ended 30 June 20XX, the year of income in which the deferred taxing point occurred, the employee included in their assessable income the discount, being the difference between the option's fair market value at the deferred taxing point and the option's exercise price and was assessed to income tax on that discount amount, totalling $xxxx in respect of the options granted to the employee, pursuant to section 83A-110 of the ITAA 1997. This is reflected in the employee share scheme statement issued to the employee.

In Spring 20XX, the company became publicly listed.

In Autumn 20XX, one option was exercised by the employee to provide ownership of one share. The share was immediately sold at the current market price of $xxxx. More than 12 months elapsed between the deferred taxing point and the exercise of the option and the sale of the share.

Further options, issued under the same original grant, remain for future exercise and subsequent sale of shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 section 83A-110

Income Tax Assessment Act 1997 section 83A-120

Income Tax Assessment Act 1997 section 83A-125

Income Tax Assessment Act 1997 Division 115

Reasons for decision

Question 1

Is the acquisition date of the share equivalent to the deferred taxing point of the ESS interest, rather than the exercise date of the option, for the purposes of the ITAA 1997?

Summary

Under section 83A-125 of the ITAA 1997, the share and the option to purchase the share, which both meet the definition of an "ESS interest", is taken to have been acquired "immediately after" the ESS deferred taxing point for the interest for its market value, for the purposes of the ITAA 1997 (other than Division 83A). For this reason, the acquisition date of the share is equivalent to the deferred taxing point of the ESS interest, rather than the exercise date of the option, for the purposes of the ITAA 1997.

Detailed reasoning

Section 83A-10 of the ITAA 1997 contains a definition of "ESS interest". Under subsection 83A-10(1), an ESS interest, in a company, is a beneficial interest in:

(a) a share in the company; or

(b) a right to acquire a beneficial interest in a share in the company.

The beneficial interest in the share acquired by the employee in the company is an ESS interest, as well as the right to acquire the beneficial interest in the share in the company, pursuant to the option to purchase the share granted to him.

The ESS deferred taxing point for an ESS interest that is a beneficial interest in a right to acquire a beneficial interest in a share (which includes an option to purchase a share) is determined under section 83A-120 of the ITAA 1997. Subsection 83A-120(2) states that the ESS deferred taxing point for the ESS interest is the earliest of the times mentioned in subsections (4), (6) and (7).

Under subsection 83A-120(4) of the ITAA 1997, the first possible taxing point is the earliest time when:

(a) you have not exercised the right; and

(b) there is no real risk that, under the conditions of the employee share scheme, you will forfeit or lose the ESS interest (other than by disposing of it, exercising the right or letting the right lapse); and

(c) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately disposing of the ESS interest - the scheme no longer so restricts you.

Under subsection 83A-120(6) of the ITAA 1997 (maximum period for deferral), the second possible taxing point is the end of the 15-year period starting when you acquired the interest.

Under subsection 83A-120(7) of the ITAA 1997 (no restrictions on disposing of a share after exercising the right), the third possible taxing point is the earliest time when:

(a) you exercise the right; and

(c) there is no real risk that, under the conditions of the scheme, after exercising the right, you will forfeit or lose the beneficial interest in the share (other than by disposing of it); and

(d) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately disposing of the beneficial interest in the share if you exercised the right - the scheme no longer so restricts you.

In the circumstances under consideration, the ESS deferred tax point for the ESS interest, being the option to purchase the share, is determined under subsection 83A-120(2) of the ITAA 1997 as being the first possible taxing point under subsection 83A-120(4) of the ITAA 1997, March 20XX. At that point in time, no option to purchase any share had been exercised, there was no real risk of forfeiting the options and the scheme no longer genuinely restricted disposal of the options. This is the earliest of the three possible taxing points.

The rule in subsection 83A-120(3) of the ITAA 1997, whereby the ESS deferred taxing point is, if the right to acquire shares is exercised - the time you dispose of the beneficial interest in the share, if that time occurs within 30 days after the time worked out under subsection 83A-120(2) of the ITAA 1997, does not apply here (as the option to purchase the share was not exercised until a year later in Autumn 20XX, with the share then being immediately sold).

Accordingly, in the year of income ended 30 June 20XX, the income year in which the ESS deferred taxing point occurs, the employee included in his assessable income the discount, being the difference between the option's fair market value at the deferred taxing point and the option's exercise price and was assessed to income tax on that discount amount, totalling $xxxx in respect of all the options granted to that employee, pursuant to section 83A-110 of the ITAA 1997. This is reflected in the employee share scheme statement issued to the employee.

Section 83A-125 deals with the tax treatment of ESS interests held after ESS deferred taxing points. It states: "For the purposes of this Act (other than this Division), the ESS interest (and the share or right of which it forms part) is taken to have been acquired immediately after the ESS deferred taxing point for the interest for its market value, unless the ESS deferred taxing point occurs at the time the interest is disposed of [emphasis added]."

Under section 83A-125 of the ITAA 1997, the share and the option to purchase the share, which both meet the definition of an "ESS interest" is taken to have been acquired "immediately after" the ESS deferred taxing point for the interest for its market value (rather than the exercise date of the option), for the purposes of the ITAA 1997 (other than Division 83A).

The ESS deferred taxing point does not occur at the time the interest is disposed of for the purposes of the exception in section 83A-125 of the ITAA 1997. As we have already established, the rule in subsection 83A-120(3) of the ITAA 1997, whereby the ESS deferred taxing point is, if the right to acquire shares is exercised - the time you dispose of the beneficial interest in the share, if that time occurs within 30 days after the time worked out under subsection 83A-120(2) of the ITAA 1997, does not apply here.

For this reason, the acquisition date of the share is equivalent to the deferred taxing point of the ESS interest, rather than the exercise date of the option, for the purposes of the ITAA 1997.

Question 2

Is the discount capital gain (for owning an asset longer than 12 months) applicable to the capital gain arising from the sale of the share under Division 115 of the ITAA 1997?

Summary

The discount capital gain (for owning an asset longer than 12 months) is applicable to the capital gain arising from the sale of the share under Division 115 of the ITAA 1997.

Detailed reasoning

Under Division 115 of the ITAA 1997, a discount capital gain remaining after the application of any capital losses and net capital losses from previous income years is reduced by the discount percentage when working out your net capital gain.

A capital gain from a CGT asset is a discount capital gain only if the entity making the gain acquired the asset at least a year before the CGT event causing the gain and no choice has been made to include indexation in the cost base of the asset.

As we established in question 1, the relevant CGT asset, the share (and the option to purchase the share) was acquired by the employee in Autumn 20XX, immediately after the deferred taxing point, pursuant to section 83A-125 of the ITAA 1997.

The relevant CGT event causing the capital gain occurred one year later in Autumn 20XX when the share was sold by the employee, immediately after he exercised the option to purchase the share.

In these circumstances, the relevant CGT asset had been held by the employee for the minimum 12-month period required for a discount capital gain to arise. This will then be reduced by the discount percentage when working out the net capital gain for the employee in the year of income ended 30 June 20XX.

Question 3

For another identifiable option (i.e., from the same grant) that has not yet been exercised, would any income tax or capital gains tax liability arise under the provisions of the ITAA 1997 at a future time when this option is exercised but not sold (noting that this option has already passed its deferred taxing point)?

Summary

No income tax or capital gains tax liability arises under the provisions of the ITAA 1997 at a future time when this option is exercised but not sold.

Detailed reasoning

As established in the facts and at our response to question 1, the discount received on the issue of all the options has already been included within the employee's assessable income and subject to income tax in the year of income ended 30 June 20XX, the year in which the deferred taxing point occurs. There is no further income tax liability in respect of the discount.

When the employee exercises the other option to acquire another share in the company, this will result in the relevant CGT asset, the share, being acquired at that time. No capital gain will arise from this share if it is not sold, as a capital gain will only arise upon its disposal.

Capital gains tax does not operate as a separate tax. Instead, you include your net capital gain or loss you made during the year in your total assessable income for that year in preparing your income tax return. If you have a net capital gain you pay income tax on the gain at your marginal income tax rate.