Edited version of private advice

Authorisation Number: 1051993048426

Date of advice: 27 September 2022

Ruling

Subject: Employee share trust

Question

Will any capital gain or loss, that arises for the Trustee of the Trust at the time an Employee becomes absolutely entitled to ordinary shares in Company A (Shares) under the Plan under capital gains (CGT) event E5 in section 104-75 of the Income Tax Assessment Act 1997 (ITAA 1997), be disregarded under section 130-90 of the ITAA 1997 if the Employee acquires the Shares for the same or less than the cost base of the Shares in the hands of the Trustee?

Answer

Yes.

Reasons for decision

All legislative references are to provisions of the ITAA 1997.

Question

Detailed reasoning

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

CGT event E5

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 a 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 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 (subsection 104-75(3)).

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 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.

An Employee will become absolutely entitled to the Share Rights in accordance with the Plan when those rights have vested and been exercised (if applicable), and the restrictions in respect of the Shares have ceased or no longer apply. Upon the cessation of all the restrictions, the Participant has the right to request the Trustee to transfer the Shares into their name and deal with the Shares in their own will. At this point, the Participant will become absolutely entitled to the Shares as against the Trustee, and CGT event E5 happens pursuant to subsection 104-75(1).

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

Shares held to satisfy the future exercise of rights: subsection 130-90(1)

Subsection 130-90(1) applies to disregard any capital gain or loss made by an employee share trust if all of the following apply:

Employee share trust

In examining whether the requirements of an employee share trust in subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that are relevant. To qualify as an employee share trust, a trustee's activities must be limited to:

The Trust Deed provides:

Without limiting the generality of clause 4.3, the Company and the Plan Trustee agree that the Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of section 130-85(4) of the ITAA 1997.

Paragraph 130-85(4)(a) is satisfied because the sole activities of the Trust include obtaining shares in a company, namely Company A (recital A of the Trust Deed).

Paragraph 130-85(4)(b) is satisfied because the Trust has been established to acquire Shares and to allocate those Shares to Participants to satisfy Share Rights acquired by Participants under the Plan which subsequently vest and, if applicable, are exercised (with each Share Right constituting an ESS interest as defined in subsection 83A-10(1)).

The Plan is an ESS within the meaning of subsection 83A-10(2) as it is a scheme under which rights to acquire Shares are provided to employees, or associates of employees in relation to the employees' employment.

In respect of paragraph 130-85(4)(c), the phrase 'merely incidental' takes its ordinary meaning, with further guidance drawn from the context and purpose of the legislation in which it appears. 'Merely incidental' is not defined in the legislation and has not been judicially considered in the context of subsection 130-85(4). The Macquarie Dictionary defines 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'.

The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13 Income tax: what is an 'employee share trust'?

Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental.

In the present case, the Trust Deed provides that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of section 130-85(4), including paragraph 130-85(4)(c) as the other activities undertaken by the Trustee are merely incidental to managing the Plan.

Paragraph 130-90(1)(a)

CGT event E5 will apply under the terms of the Plan when the Participant becomes absolutely entitled to the Shares as against the Trustee. Therefore, paragraph 130-90(1)(a) will be satisfied.

Paragraph 130-90(1)(b)

Subsection 995-1(1) defines a share to mean a share in the capital of a company. A Share held by the Trustee and to which a Participant is entitled upon the vesting (or exercise if applicable) of a Share Right is a share in the capital of a company. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a Share by the vesting of and, if applicable, having exercised a Share Right granted under the Plan.

Paragraph 130-90(1)(d)

Subsection 83A-20(1) is the key condition that an ESS interest must meet for Subdivision 83A-B or 83A-C to apply. Subsection 83A-20(1) states:

This Subdivision applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

The Share Right in the Plan is an 'ESS interest' under paragraph 83A-10(1)(b) because it is a beneficial interest in a right to acquire a share in Company A.

Subsection 83A-10(2) defines an ESS as being a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

The Plan is an ESS within the meaning of subsection 83A-10(2) because it is a scheme under which Share Rights to acquire beneficial interests in shares in Company A are provided to employees in relation to the employee's employment. Each Share Right is acquired for no cost.

As the Participant acquires the Share Right for no cost, the ESS interest is acquired by the Participant at a discount. Therefore, Subdivision 83A-B or 83A-C applies to the Share Rights granted under the Plan.

Accordingly, all the conditions in subsection 130-90(1) have been satisfied.

Subsection 130-90(2)

Subsection 130-90(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 (subsection 130-90(2)).

Provided a Participant does not acquire the beneficial interest in the Share for more than its cost base in the hands of the Trust at the time that CGT event E5 happens, subsection 130-90(1) will apply to disregard any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening.