Edited version of private advice

Authorisation Number: 1052020177333

Date of advice: 11 August 2022

Ruling

Subject:Employee Share Scheme - Commissioner's discretion

Question

Will the Commissioner exercise his discretion under paragraph 83A-45(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the minimum holding period for Options granted under the Option Plan to end immediately prior to when 100% of the membership interests in the Applicant are disposed of under the Proposed Acquisition?

Answer

Yes, the Commissioner will exercise his discretion under paragraph 83A-45(5)(a) of the ITAA 1997 to allow the minimum holding period for Options granted under the Option Plan to end immediately prior to when 100% of the membership interests in the Applicant are disposed of under the Proposed Acquisition.

This ruling applies for the following period:

Year of income ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Applicant is an Australian resident company for tax purposes and is not listed on a stock exchange.

The Applicant did not have an aggregated turnover exceeding $XX million in any tax year preceding a year in which the Options were granted.

The Applicant implemented the Option Plan with the objective to incentivise and retain key employees and contractors (the Participants).

The Options granted under the Option Plan were intended to qualify for the Employee Share Scheme start-up concessions contained in Subdivision 83A-Bof the ITAA 1997.

Under the Option Plan, Options in the Applicant were granted periodically to the Participants. The Relevant Options pursuant to this ruling application continue to be subject to the 3-year disposal restriction under the Plan.

The Option Plan and offer letters detail the vesting, disposal and other relevant conditions for the Options. In particular, the Option Plan imposes the 3 year disposal restrictions to all Participants as follows:

Unless an Option holder Disposes of an Option or an Option Share under an arrangement which meets the requirements in section 83A-130 of the Tax act, a legal or beneficial interest in an Option or an Option Share may not be Disposed of until the earlier of:

1)    Three years after the issue of the Option or such earlier time as the Commissioner of Taxation allows in accordance with section 83A-45(5) of the Tax Act; and

2)    Where the Option holder becomes a leaver.

Proposed Acquisition

The Applicant engaged in discussions with Company A to enter into a commercial arrangement whereby Company A would invest by way of a convertible note into the Applicant (Convertible Note).

Company A was also granted a call option entitling Company A to acquire XX% of the Applicant's shares. The Call Option was provided for exercise within XX months of Company A's investment in the Applicant.

The board of Company A has authorised Company A proceeding to negotiate an acquisition of the Applicant and Company A is currently undertaking financial, legal and tax due diligence to support this (the Proposed Acquisition). Company A has conveyed in principle that it is supportive of acquiring the Applicant. The purchase is not expected to occur pursuant to an exercise of the Call Option, but rather under a negotiated Share Purchase Agreement which is signed by all of the Applicant's shareholders. No term sheet has been exchanged, but principals have discussed the key terms and Company A is preparing a draft Share Purchase Agreement.

The Applicant is applying for this ruling, in advance of the Proposed Acquisition, to request that the Commissioner of Taxation allow the minimum holding period to end immediately prior to if and when 1XX% of the Applicant's membership interests are disposed of under the Proposed Acquisition.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 subsection 83A-45(4)

Income Tax Assessment Act 1997 subsection 83A-45(5)

Income Tax Assessment Act 1997 paragraph 83A-45(5)(a)

Income Tax Assessment Act 1997 paragraph 83A-45(5)(b)

Income Tax Assessment Act 1997 section 83A-130

Reasons for decision

Question

Summary

Yes, the Commissioner will exercise his discretion under paragraph 83A-45(5)(a) of the ITAA 1997 to allow the minimum holding period for Options granted under the Option Plan to end immediately prior to when the XX% of the membership interests in the Applicant are disposed of under the Proposed Acquisition.

Detailed reasoning

The Applicant has made grants of Options to Participants that were intended to qualify for the start-up concessions under Subdivision 83A-B of the ITAA 1997.

The Applicant has operated the Plan (in accordance with the Plan Rules and the offer letter) such that all Options and Shares would not be permitted to be disposed of during the minimum holding period in accordance with the requirement in subsections 83A-45(4) and 83A-45(5) of the ITAA 1997.

All Options issued by the Applicant were issued in the ordinary course of business and consistent with prior practice.

Recently, the board of Company A authorised Company A proceeding to negotiate an acquisition of XX% of the membership in the Applicant and Company A is currently undertaking financial, legal and tax due diligence to support this (the Proposed Acquisition). Company A has conveyed in principle that it is supportive of acquiring the Applicant. The purchase is not expected to occur pursuant to an exercise of the Company A Call Option, but rather under a negotiated Share Purchase Agreement which is signed by all of the Applicant's shareholders. No term sheet has been exchanged, but principals have discussed the key terms and Company A is preparing a draft Share Purchase Agreement. There is no Proposed Acquisition agreed date at this stage.

Immediately prior to completion of the Proposed Acquisition, the Option holders will exercise their Options and be issued shares by the Applicant and the Option holders will sell their shares to the purchaser on completion of the Proposed Acquisition at a fair market value.

All of the issued shares in the Applicant will be sold to the purchaser, which will acquire XX% of the membership interests in the Applicant on completion of the Proposed Acquisition.

The exercise of the Options in connection with completion will fall within 3 years of the grant of all Options issued under the Plan.

The Applicant has requested that the Commissioner exercise his discretion under paragraph 83A-45(5)(a) of the ITAA97 to allow the minimum holding period for all Options granted under the Plan to be reduced, such that the Options can be cancelled at the earlier time in connection with the completion of the Proposed Acquisition without breaching the minimum holding period condition.

In order to qualify for the ESS start-up concessions under section 83A-33 of the ITAA 1997, the options must meet all of the conditions set down in subsection 83A-33(1).

One of the conditions is the minimum holding period condition detailed in subsections 83A-45(4) and 83A-45(5) of the ITAA 1997 is satisfied. These provisions provide that:

83A-45(4)

The minimum holding period condition is satisfied if the scheme is operated so that every acquirer of an ESS interest (the scheme interest) under the scheme is not permitted to dispose of:

(a)  the scheme interest; or

(b)  a beneficial interest in a share acquired as a result of the scheme interest;

during the scheme interests minimum holding period.

83A-45(5)

An ESS interest's minimum holding period is the period starting when the interest is acquired under the employee share scheme and ending at the earlier of:

(a)  3 years later, or such earlier time as the Commissioner allows if the Commissioner is satisfied that:

(i)            the operators of the scheme intended for subsection (4) to apply to the interest during the 3 years after the acquisition of the interest; and

(ii)           at the earlier time that the Commissioner allows all membership interests in the relevant company were disposed of under a particular scheme:

(b)  when the acquirer of the interest ceases being employed by the relevant employer.

Provided that all the membership interests in the Applicant will be acquired under the Proposed Acquisition as stated by the Applicant then the only remaining consideration is whether the operators of the scheme intended for subsection 83A-45(4) of the ITAA 1997 to apply to the interest during the 3 years after the acquisition of the interest.

The operators of the scheme would fail the test if they had either allowed a Participant to dispose of their interest prior to the end of its minimum holding period or there is objective evidence that the scheme was not, or will not be, operated to prevent the Participants from doing so.

The Option Plan imposes the 3-year disposal restrictions to all Participants as follows:

Unless an Optionholder Disposes of an Option or an Option Share under an arrangement which meets the requirements in section 83A-130 of the Tax act, a legal or beneficial interest in an Option or an Option Share may not be Disposed of until the earlier of:

1)    3 years after the issue of the Option or such earlier time as the Commissioner of Taxation allows in accordance with section 83A-45(5) of the Tax Act; and

2)    Where the Option holder becomes a leaver.

As the rules of the Plan specifically prevent disposals under these circumstances and there is no evidence that any such disposal has been allowed the only remaining consideration is whether there is objective evidence that the scheme was not, or will not be, operated to prevent the Participants from disposing of their interests before the end of the minimum holding period.

At the time the final tranche of Options were granted there was no expectation that the Proposed Acquisition of the Applicant would proceed. All Options were granted before there was any agreement or negotiation for the sale between Company A and the Applicant. Whilst Company A was granted the Call Option, there was no reasonable expectation this would be exercised by Company A at that time or in the near future. At the time the Call Option was entered into, and at the time each of the Options was issued, there was no intention or reasonable expectation from the Applicant that a XX% sale of the Applicant would occur and the Applicant had a reasonable expectation that the Relevant Options so issued would be held by employees for not less than 3 years.

The Applicant required additional cash for its working capital imminently and engaged in discussions with Company A and other third parties for an additional investment. Company A and the Applicant have recognised that there are synergies in their respective businesses and Company A has subsequently made indications that it wishes to acquire XX% of the Applicant. Company A has since engaged in due diligence of the Applicant, however, no formal offer has been made by Company A to acquire the Applicant with negotiations are ongoing.

The Assumptions included for the purposes of this ruling include that:

1.    A third party will acquire 100% of the membership interests in the Applicant (the Proposed Acquisition) during the Ruling Period;

2.    Up to and including the time when the Proposed Acquisition is implemented, the Applicant will operate the employee share option plan (the Option Plan) such that the requirements of subsection 83A-45(4) of the ITAA 1997 are satisfied, including that:

a.    The Applicant will not allow an employee or contractor that has been issued interests under the Option Plan (the Participants) to dispose of their interests prior to the earlier of:

                                          i.    the end of 3 years of the date when those interests were acquired; or

                                         ii.    the time when the Proposed Acquisition is implemented.

b.    No interests have been, or will be, issued under the Option Plan after the time that it became clear that the Proposed Acquisition will be implemented such that there was not, or will not be, a genuine intention for the interests to be held for 3 years from the date of acquisition of the interests.

3.    The minimum holding period may end when the acquirer of the interest ceases being employed by the relevant employer - per paragraph 83A-45(5)(b).

As the objective evidence, and the Assumptions included for the purposes of this ruling, indicate that the operators of the Option Plan have been operating it, and will operate it, to prevent the Participants from disposing of their interests before the end of the minimum holding period, the Commissioner will exercise his discretion to allow the reduced minimum holding period to apply.