Edited version of private advice

Authorisation Number: 1052006133000

Date of advice: 15 July 2022

Ruling

Subject: Income tax - CGT - employee share schemes

Question 1

Will the irretrievable cash contributions by Company X or any member of the Company X income tax consolidated group (Company X TCG), to the trustee of the Company X Trust (Trustee) to fund the acquisition of Company X shares by the Company X Employee Share Trust (Trust) for the purposes of the Plans be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will CGT event E5 happen at the time when the employees become absolutely entitled to Shares held by the Trustee of the Trust?

Answer

Yes

Question 3

If CGT event E5 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E5 happening be disregarded under section 130-90 of the ITAA 1997 if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee?

Answer

Yes

Question 4

Will CGT event E7 happen in respect of Shares held by the Trustee of the Trust?

Answer

No - the scheme does not include any facts that gives rise to CGT event E7 happening.

Question 5

If CGT event E7 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the ITAA 1997 if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee?

Answer

Not necessary to rule

This ruling applies for the following periods:

Income tax years ended 30 June 20XX to 30 June 20XX

The scheme commences on:

In a particular income year

Relevant facts and circumstances

Company X

1.     Company X is an Australian incorporated company involved in a particular industry.

2.     Company X is the head company of the Company X income tax consolidated group (Company X TCG) consisting of itself and its wholly owned Australian subsidiaries.

3.     Company X's remuneration policy aims to embody transparency, competitiveness and reasonableness, with the goal of retaining key talent in alignment with business and shareholder objectives.

4.     As part of the overall remuneration and retention strategy, in addition to fixed remuneration, Company X offers employees and executives, the opportunity of equity ownership upon the satisfaction of certain service and performance conditions. This is implemented through the Plans.

a.     Plan 1

b.     Plan 2

c.     Plan 3; and

d.     Plan 4.

5.     The Plans also allow access to Participants who are non-residents. Contributions to the Trust may be made to acquire Shares in relation to rights and awards granted to non-resident Participants. The consideration of contributions made with respect to non-resident Participants (and any associated Australian tax implication for Company X) is outside the scope of this ruling.

6.     Company X and a number of wholly owned subsidiaries of the Company X TCG are employers of individuals that participate in the Plans (Employer Entities):

Plan 1

7.     Plan 1 was adopted by Company X's board of directors (Board) on a certain date. The terms and conditions of Plan 1 are set out in the Plan 1 Rules.

8.     Broadly under Plan 1, eligible employees will be offered the opportunity to acquire Company X shares (Acquired Shares) on the basis that, after holding the Acquired Shares for a specified period, an Eligible Employee will be entitled to receive additional shares in Company X at no cost (Matched Shares), provided they continue to be employees of the Company X TCG during the specified period.

Under Plan 1 and the Plan 1 Rules there are a number of other conditions to satisfy.

Plan 2

9.     Plan 2 was approved by Company X's board of directors on a certain date. The terms and conditions of Plan 2 are set out in the Plan 2 Rules.

10.  Broadly under Plan 2, Company X may issue Restricted Shares to Eligible Participants or make Awards of Plan 2 Rights to Eligible Participants as a retention or attraction bonus (or other mechanism) to key employees and key contractors.

Under Plan 2 and the Plan 2 Rules there are a number of conditions to satisfy.

Plan 3

11.  Plan 3 was approved by Company X's board of directors on a particular date. The terms and conditions of Plan 3 are set out in the Plan 3 Rules.

12.  Broadly under Plan 3, Participants are offered Plan 3 Rights which do not automatically entitle a participant to a Company X share. The actual number of shares to which they may become entitled will depend on:

a.     the degree to which the performance measures are satisfied;

b.     satisfaction/waiver of the Vesting Conditions and exercise conditions; and

c.     the operation of the Plan 3 Rules.

13.  A Plan 3 Right is a conditional right which, upon the satisfaction or waiver of the relevant Vesting Conditions, and, if required by the Company X the exercise of that right, entitles its holder to receive one share.

Under Plan 3 and Plan 3 Rules there are a number of conditions to satisfy.

Plan 4

14.  The terms and conditions of Plan 4 are set out in the Plan 4 Rules.

15.  Broadly under Plan 4, eligible employees are issued annually up to x amount worth of ordinary fully paid shares in Company X for no cash consideration.

Under Plan 4 and Plan 4 Rules there are a number of conditions to be satisfied.

Company X Employee Share Trust (Trust)

16.  The Trust was established for the sole purpose of subscribing for, acquiring, allocating, holding and transferring shares for the benefit of Participants under the Plans.

17.  The trustee of the Trust (Trustee) is an external trustee acting in an independent capacity on behalf of the beneficiaries of the Trust.

18.  The Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the ITAA 1997.

19.  The Trust broadly operates as follows:

a.     Company X or its Related Body Corporate will provide the Trustee with the funds required for the purchase or subscription of shares in accordance with the Plans and funds provided to the Trustee will constitute accretions to the corpus of the Trust and will not be repayable by the Trustee other than to purchase or subscribe for shares.

b.     These funds will be used by the Trustee to acquire the shares in Company X either by on-market purchase or via a subscription for new shares in Company X based on the written instructions from Company X's Board.

c.     Allocated Shares acquired by the Trustee must be allocated to the relevant employees and held on their behalf as soon as reasonably practicable where required to do so, or permitted, by the relevant Plan Rules. Each Participant will be the beneficial owner of and absolutely entitled to their Allocated Shares and is entitled to the same rights in respect of those shares as they were the legal owner of the shares.

d.     Unallocated Shares must be held by the Trustee on behalf of Participants generally. The Trustee must deal with each Unallocated Share in the manner set out in a written instruction from the Board.

e.     The Trustee must not exercise any voting rights in relation to Unallocated Shares.

f.      At any time after expiry of the Restrictive Period, the Trustee must transfer the relevant number of Allocated Shares into the name of the relevant Participant or any third party nominated by the Participant (i.e. legal title) upon a Withdrawal Notice being lodged with and approved by the Board.

g.     The Trustee can sell Allocated shares on behalf of a Participant where permitted to do so by the Participant less any costs incurred by the Trustee to sell these shares, with Participant receiving the proceeds.

h.     The Trustee may deal with shares forfeited under the Plans.

i.       The powers of the Trustee in respect of the Trust are set out the Trust Deed and they include the power to open bank accounts and operate bank accounts.

j.       The Trustee is not entitled to receive from the Trust any fees, charges, commission or other remuneration for operating or administering the Trust. However, Company X may pay or reimburse to the Trustee from Company X's own resources any such fees, commission or other remuneration incurred by the Trustee, as Company X and the Trustee agree from time to time. The Trustee is entitled to retain for its own benefit any such renumeration or reimbursement.

k.     Company X will pay the Trustee's costs of operation to the extent they relate to the operation of the Trust used to facilitate Company X's Plans.

l.       Upon termination of the Trust, if there are any Trust Assets remaining in the Trust after distribution to Participants, then those Trust Assets must be applied for the benefit of an employee share or option trust established and maintained for the benefit of the employees of the Group and/or any charity nominated by the Trustee.

m.   In the event that the Trust is terminated, the Trustee must not pay any balance to any member of the Group. The Group is defined as Company X and any Related Body Corporate (as defined by the Corporations Act), not including the Trustee.

Associated costs

20.  Company X will incur various on-going administration costs associated with the services provided by the Trustee of the Trust in respect of the on-going administration and management of the Trust, such as:

a.     Employee plan record-keeping

b.     Production and dispatch of holding statements to employees

c.     Provision of annual income tax return information for employees

d.     Costs incurred in the acquisition of shares (e.g. brokerage costs and the allocation of shares to Participants)

e.     Management of employee termination

f.      Other trustee expenses such as the annual audit of the financial statements and preparation of annual income tax return of the Trust, and obtaining tax advice for the Trust (however, ongoing tax advice does not include legal/advisory fees incurred in amending the EST and ESS plan rules).

g.     Preparing the annual audit of the financial statements of the Trust

21.  Company X has and will incur on-going administration costs associated with the company's accounting and legal advisors in relation to the Plans.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 130-90

Income Tax Assessment Act 1997 subsection 130-85(4)

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 104-85

Reasons for decision

Question 1

Assessable income includes both ordinary income and statutory income according to sections 6-5 and 6-10 of the ITAA 1997. Ordinary income is income according to ordinary concepts. Statutory income is income that is not ordinary income but is included in assessable income because of a specific provision of the ITAA 1997 or Income Tax Assessment Act 1936 (ITAA 1936).

As Chief Justice Jordan noted in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 (Scott):

... what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of receipts.[1]

Ordinary income

Section 6-5 provides that a taxpayer's assessable income includes income according to ordinary concepts. The expression "income according to ordinary concepts" is not a defined term. However, case law has identified certain factors which may assist in determining whether a receipt is properly characterised as income according to ordinary concepts.

As a general rule, amounts received as a result of carrying on a business should represent ordinary income. However, receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

In GP International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124; (1990) 64 ALJR 392; (1990) 93 ALR 193; (1990) 21 ATR 1; 90 ATC 4413; [1990] HCA 25 (Pipecoaters), the High Court of Australia found that:

To determine whether a receipt is of an income or of a capital character, various factors may be relevant. Sometimes, the character of receipt will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

The contributions made by Company X or any other member of the Company X TCG to the Trust forms part of the corpus of the Trust that will be applied for the sole purpose of acquiring, or subscribing for, shares for the benefit of the Participants under the Plans. The cash contributions received by the Trustee are therefore of a capital character.

It is irrelevant that, from Company X's perspective, the cash contribution may be deductible under section 8-1 of the ITAA 1997 because whether a receipt is income or capital depends on its objective character in the hands of the recipient, rather than the payer. This is made clear in Pipecoaters, where the High Court held that:

...although the amount expended on the construction of the plant was a capital expenditure, it does not follow that the taxpayer's receipt of the establishment costs was a receipt of capital.[2]

From the Trustee's perspective, the irretrievable cash contributions made by Company X are capital in nature and therefore not assessable to the Trust under section 6-5 of the ITAA 1997.

Statutory income

Section 10-5 provides a list of provisions of assessable income for section 6-10 purposes. None of the provisions apply to a cash contribution made by an employer to a trust established under an employee share scheme (ESS).

Therefore, the irretrievable cash contributions made by Company X or any other member of the Company X TCG to the Trustee of the Trust to fund the acquisition of, or subscription to, Company X shares are also not assessable income of the Trust pursuant to section 6-10 of the ITAA 1997.[3]

Question 2

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

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 of the ITAA 1997 applies) as against the trustee. The time of the event is when the beneficiary becomes absolutely entitled to the asset.[4]

If CGT event E5 happens, the trustee may make a capital gain if the market value of the asset, at the time of the event, is more than its cost base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base.[5]

In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 of the ITAA 1997 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 (TR 2004/D25) 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.[6]

Pursuant to the Trust Deed, a Participant is the beneficial owner of and absolutely entitled to their Allocated Shares. Allocated Shares is defined as a Trust Share that is credited to the Trust Share Account of a Participant. Once credited, the Participant (i.e. the beneficiary) will become absolutely entitled to the Allocated Shares (i.e. a CGT asset of the Trust) as against the Trustee. Accordingly, pursuant to subsection 104-75(1), CGT event E5 happens.

Question 3

If CGT event E5 happens, any capital gain or loss that the Trustee makes is disregarded if section 130-90 applies. Section 130-90 provides as follows:

(1A) Disregard any *capital gain or *capital loss made by an *employee share trust to the extent that it results from a *CGT event, if:

(a)   immediately before the event happens, an *ESS interest is a *CGT asset of the trust; and

(b)   either of the following subparagraphs applies:

(i)             the event is CGT event E5, and the event happens because a beneficiary, of the trust becomes absolutely entitled to the ESS interest as against the trustee;

(ii)            the event is CGT event E7, and the event happens because the trustee *disposes of the ESS interest to a beneficiary of the trust; and

(c) Subdivision 83A-B or 83A-C (about employee share schemes) applies to the ESS interest.

(1) Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

(b) the CGT event happens in relation to a *share; and

(c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d) the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied.

(2) Subsection (1A) or (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.

To qualify for the exemption in section 130-90, there must be an 'employee share trust' and an 'ESS interest'.

Subsection 130-85(4) of the ITAA 1997 defines an employee share trust as a trust whose sole activities are:

(a) obtaining shares or rights in a company; and

(b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of:

(i) the company; or

(ii) a subsidiary of the company; and

(c) other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b).

An ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company, or a beneficial interest in a right to acquire a beneficial interest in a share in the company. Shares that are purchased by the Trustee to satisfy its obligation under the Plan, and subsequently allocated to Company X's Participants pursuant to the Plan, are ESS interests for the purposes of section 83A-10(1).

An 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997 as 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 employee's employment.

Company X's Plans each constitute an 'employee share scheme' because each are a scheme under which ESS interests in Company X are provided to the employees of Company X in relation to their employment with Company X.

Therefore, paragraphs 130-85(4)(a) and (b) of the definition of an employee share trust are satisfied because:

a.     The Trust acquires shares in a company, namely Company X; and

b.     The Trust ensures that ESS interests as defined in subsection 83A-10(1) are provided under an employee share scheme by allocating those shares to the employees of Company X in accordance with the Trust Deed and the Plan.

Paragraph 130-85(4)(c) of the definition of an employee share trust provides that a trustee can engage in activities that are merely incidental to those described in paragraphs 130-85(4)(a) and (b) of the ITAA 1997. 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'? (TD 2019/13).

However, whilst the relevant trust documents may include powers and/or duties that are broad reaching, the mere existence of those powers or duties in the trust document does not, of itself, mean that the trustee has breached the requirements to be an employee share trust. In examining whether the requirements of subsection 130-85(4) are met, it is necessary to examine the actual activities that the trustee has undertaken.[7]

The Trust Deed contains only powers and/or duties that are merely incidental, as required by subsection 130-85(4)(c) of the ITAA 1997. Therefore, the Trust established pursuant to the Trust Deed satisfies the definition of an employee share trust in subsection 130-85(4) of the ITAA 1997.

As the rights granted under the Plans will be acquired by the employees at a discount, they are ESS interests to which subdivision 83A-B of the ITAA 1997 applies.

As such, a capital gain or capital loss that arises for the Trustee of the Trust established pursuant to the Trust Deed at the time when CGT Event E5 happens in relation to Company X shares held by the Trustee will be disregarded under section 130-90 of the ITAA 1997, if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee.

Question 4

Under section 104-85 of the ITAA 1997, CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital. The timing of the event is when the disposal occurs.[8]

If CGT event E7 happens, the trustee may make a capital gain if the market value of the asset, at the time of the disposal, is more than its cost base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base.[9]

However, in relation to the scheme as set out in the 'Relevant facts and circumstances' section above, CGT event E7 does not occur. This is because the scheme does not include any facts that gives rise to CGT event E7 happening.

Question 5

As per the answer in Question 4 above, CGT event E7 does not arise. Therefore, it is not necessary to consider whether a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the ITAA 1997 if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee.

[1] Scott at 220.

[2] Pipecoaters at 4420.

[3] This view is consistent with ATO ID 2002/965 Income Tax - Trustee not assessable on employer contributions made to it under the employer's employee share scheme, whichfound that: 'The funds provided to the Trustee are used in accordance with the Trust Deed and Plan Rules for the sole purpose of and under the employee share scheme. The contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10 of the ITAA 1997'.

[4] Subsection 104-75(2).

[5] Subsection 104-75(3).

[6] Paragraph 41 of TR 2004/D25.

[7] Paragraph 6 of TD 2019/13.

[8] Subsection 104-85(2).

[9] Subsection 104-85(3).