Edited version of private advice

Authorisation Number: 1051994299010

Date of advice: 15 June 2022

Ruling

Subject: Taxing point of options

Question

Is the date of the taxing point for the Options granted to the Taxpayer xx xx 20XX pursuant to Division 83A of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

xx xx 20XX

Relevant facts and circumstances

The Taxpayer was appointed as an Executive for the Company in a signed Executive Agreement (the agreement) dated xx xx 20XX.

The authorised signatory for the Company signed the agreement on xx xx 20XX. The Appointment clause (clause X) states that the Executive shall be employed in the Position with effect from the date of this agreement on the terms and conditions set out in this agreement.

As part of the Taxpayer's appointment, the Company proposed to issue the Taxpayer X number of Options to be issued in tranches and subject to shareholder approval.

Clause X of the agreement states that the key terms applicable to the executive are set out in the Terms Sheet attached as a Schedule of this agreement.

The Schedule of the agreement defines the Commencement Date as the meaning given in Item X of the Term Sheet. Item X of the Term Sheet states that the Commencement Date is xx xx 20XX.

Item x of the Term Sheet states the remuneration as from the Commencement date, comprises a base salary and superannuation guarantee payments.

Item x of the Term Sheet states:

Options, subject to shareholder approval, to be sought at the next annual general meeting of the Company, the Executive will be granted X unlisted options, to be issued in x tranches as detailed below:

.....

The Schedule of the agreement defines Options as unlisted options to subscribe for ordinary shares in the Company.

There were no other conditions specified for vesting (other than what was outlined in the Term Sheet subject to shareholder approval).

The Taxpayer commenced their employment with the Company on xx xx 20XX.

The Options were approved by a shareholders' resolution at the Company's Annual General Meeting that was held after employment commenced.

The Options were issued for nil consideration.

The Options granted to the Taxpayer were not granted under the company employee share option plan.

The agreement contains no reference to taxation or that Division 83A-C applies to the Options.

No other documents were signed regarding the Options for the Taxpayer.

At the date of this application, X of the Options have been exercised.

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-340 of the Income Tax Assessment Act 1997

Section 83A-105 of the Income Tax Assessment Act 1997

Reasons for decision

Summary

The date of the taxing point for the Options granted to the Taxpayer is xx xx 20XX pursuant to section 83A-340 of the Income Tax Assessment Act 1997.

Consideration of an indeterminate right

Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997) applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

Section 83A-1 states that your assessable income includes discounts on shares, rights and stapled securities you (or your associate) acquire under an employee share scheme.

An ESS interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 to mean a beneficial interest in either:

          (a)        a share in the company; or

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

Subsection 83A-10(2) defines an employee share scheme as a scheme under which ESS interests in a company are provided to employees, or associates of employees, (including past or prospective employees) of:

          (a)        the company; or

          (b)        subsidiaries of the company;

in relation to the employees' employment.

It is considered that the grant of rights being an ESS interest (as defined in subsection 83A-10(1)) for the Taxpayer as outlined in their agreement and the Notice of AGM is an ESS as defined in subsection 83A-10(2) as it is a scheme provided to the Taxpayer as an employee in relation to their employment with the Company.

The granting of an indeterminate right may give rise to the application of section 83A-340 if a beneficial interest in a right is acquired and that right later becomes a right to acquire a beneficial interest in a share, Division 83A applies as if the right had always been a right to acquire the beneficial interest in the share (that is, it is treated as having always been an ESS interest).

The conditions that need to be satisfied, in order for subsection 83A-340(1) to apply are outlined in paragraph 1 of Taxation Determination TD 2016/17 Income Tax: in what circumstances does a contractual right, which is subject to the satisfaction of a condition, become a right to acquire a beneficial interest in a share for the purposes of subsection 83A-340(1) of the Income tax assessment Act 1997? (TD 2016/7) which are:

          (a)        you acquire a right under a contract;

          (b)        at the time you acquire it, the right is not a right to acquire a beneficial interest in a share;

           (c)        at a later time, and because a condition in the contract is satisfied, the right 'becomes' a different right; and

          (d)        at this later time, the right is a right to acquire a beneficial interest in a share (a right to acquire a share).

Subsection 83A-340(1) of the ITAA 1997 provides two examples.

Example 1:

You acquire a right to acquire, at a future time:

(a) shares with a specified total value, rather than a specified number of shares; or

(b) an indeterminate number of shares.

Example 2:

You acquire a right under which the provider must provide you with either ESS interests or cash, whichever the provider chooses.

Once the conditions outlined above are satisfied, pursuant to subsection 83A-340(2), the ESS provisions will apply as if the right had always been a right to acquire the beneficial interest in the share.

This is explained in the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009 (EM) at paragraphs 1.367 as follows:

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.

Options granted under the agreement represent a right to acquire shares when the Options are exercised. Therefore, the Options will be 'indeterminate rights' under section 83A-340 and they will be treated as if they had always been ESS interests when the company decides to satisfy the exercise of the Options by issuing shares.

The discount given in relation to an ESS interest acquired under an employee share scheme is included in an employee's assessable income in the income year in which the interest is acquired under Subdivision 83A-B unless Subdivision 83A-C of the ITAA 1997 applies. If Subdivision 83A-C applies to the ESS interest, the employee will include an amount in the income year in which the ESS deferred taxing point for the ESS interest occurs.

Consideration of deferred taxation

Subdivision 83A-C applies, instead of Subdivision 83A-B, to an ESS interest when the conditions in subsection 83A-105(1) are met. If the ESS interest is a right, the condition under paragraph 83A-105(1)(d) and subsections 83A-105(3) or (6) requires that when the employee acquires the interest:

•         there is a real risk that, under the conditions of the employee share scheme, the employee will forfeit or lose the ESS interest (other than by disposing of it, exercising the right or letting the right lapse); or

•         there is a real risk that, under the conditions of the employee share scheme, if the employee exercises the right, they will forfeit or lose the beneficial interest in the share (other than by disposing of it); or

•         the scheme genuinely restricted the employee immediately disposing of the right and the governing rules of the scheme expressly states that 83A-C applies to the scheme (subject to the requirements of this Act).

In respect to real risk of forfeiture or loss of the ESS interest, the vesting requirement is linked to the Taxpayer's entitlement to exercise the Options. They are not entitled to exercise the Options until xx xxl 20XX. There were no other conditions specific for vesting mentioned in the agreement besides the lapse date of xx xx 20XX. It is accepted that the Taxpayer was not at risk at any time of losing or forfeiting the Options (other than the expiry of the lapse date).

In determining whether there is a genuine disposal restriction on the acquisition of the options, there were no disposal restrictions on the Options at the time of acquisition or the later shares.

As there is no real risk of forfeiture and/or no genuine disposal restrictions, Subdivision 83A-C would not apply to defer the taxing point of the Options for the Taxpayer.

However, if it were considered that there was a genuine disposal restriction on the options, there are no governing rules that expressly state that 83A-C applies to the options in any documentation. It is considered that the taxing point will be at the time of acquisition pursuant to section 83A-340.

As Subdivision 83A-C does not apply, the ESS interest acquired under the ESS is included in the employee's assessable income in the income year in which the interest is acquired under Subdivision 83A-B.

Consideration of when right to Options first arose

Options granted under the agreement represent a right to acquire shares when the Options are exercised. Once the conditions in 83A-340(1) are satisfied, pursuant to subsection 83A-340(2), the ESS provisions will apply as if the right had always been a right to acquire the beneficial interest in the share. They will be treated as if they had always been ESS interests when the company decides to satisfy the exercise of the Options by issuing shares.

Paragraph 2 of TD 2016/17 states:

A right that becomes a right to acquire a share when a condition of the contract is satisfied must be enforceable against the other party under the terms of the contract, even if only to the extent of the condition. The relevant condition can be one to be fulfilled by either the employee or the employer. However, the condition to be satisfied must be an essential or required precondition for the right to acquire a share being provided. That is, its satisfaction must directly cause the employee to have a right to acquire a share. This condition is a condition 'precedent to performance'.

In Davies v DFC of T [2015] FCA 773; 2015 ATC 17443 the formation of an agreement was considered. The case states that it is the time at which the execution of documents and the formation of agreement that gives right to an obligation (ATC 17449 para 42; ATC 17456 para 85).

In the Taxpayer's case, they signed the agreement on xx xx 20XX. However, the representative for the Company signed the contact on xx xx 20XX. The Commissioner has determined that it would be the formation of the agreement when the agreement was executed by both parties that the enforceable right against the other party under the terms of the contract arose.

Conclusion

It is considered that the grant of rights being an ESS interest (as defined in subsection 83A-10(1)) for the Taxpayer as outlined in their agreement and Notice of AGM is an ESS as defined in subsection 83A-10(2) as it is a scheme provided to the Taxpayer as an employee relation to their employment with the Company.

The Options will be 'indeterminate rights' under section 83A-340 and they will be treated as if they had always been ESS interests when the company decides to satisfy the exercise of the Options by issuing shares.

The taxing point for the indeterminate rights granted to the Taxpayer under the agreement is xx xx 20xx being the acquisition date of the rights to enforce the ESA.