Edited version of private advice

Authorisation Number: 1052036433855

Date of advice: 7 February 2023

Ruling

Subject: Employee share trust

Question 1

Will the irretrievable cash contributions by Company A to the Trustee to fund the acquisition of, or subscription for, Company A shares by the Trust for the purposes of providing Awards under the Incentive Plan, the Legacy Plan, the Offer C and the Offer D 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 a capital gain or capital loss that arises for the Trustee at the time when CGT Event E5 happens in relation to Company A shares to be held by the Trustee 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

This ruling applies for the following periods:

Income tax year ended 30 June 20XX

Income tax year ended 30 June 20XX

Income tax year ended 30 June 20XX

Income tax year ended 30 June 20XX

Income tax year ended 30 June 20XX

Relevant facts and circumstances

This private ruling is based on the facts stated in the description of the scheme that is set out below, including the following documents, or relevant parts of them, which are to be read with the description:

The Company A Employee Share Trust Deed (the Trust Deed) as provided to the Commissioner on XX XXX 20XX

The plans rules provided to the Commissioner on XX XXX 20XX consisting of:

•         The Plan Rules relating to the Company A Incentive Plan (the Plan Rules)

•         Legacy Long Term Incentive Plan Rules relating to the Company A Long Term Incentive Plan (the Legacy Plan Rules)

The sample participant invitation letters provided to the Commissioner on XX XXX 20XX for grants of:

•         Offer A

•         Offer B

•         Offer C and Offer D, and

•         Offer E

If your circumstances are different from these facts, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background

Company A is in the banking sector and is a fully authorised deposit-taking institution.

Company A is listed on the Australian Securities Exchange (ASX).

Company A's remuneration framework is guided by the notions of rewarding performance, retaining talent and motivating employees. Company A wishes to enhance company and individual performance by aligning the longer term interests of key management employees with shareholders by providing an opportunity to key management and employees (Participants) to receive an equity interest in Company A. The Participants include only tax residents of Australia.

The details of the Plan and Legacy Plan and the Offer C and Offer D made by Company A are outlined below. The Awards provided to employees as per these plans/Offer C and Offer D have a market value above nil at the time of grant.

The Plan

The Plan is a long term incentive scheme, which was designed to reward and incentivise the Company A's key management and employees, and align their interests with those of the Company A's shareholders.

The Plan enables Company A the flexibility to offer rights to Company A shares (Deferred Share Rights), options over Company A shares (Options), cash awards or other such instruments as determined by the board of the Company (Board). The Plan broadly operates as follows in accordance with the Plan Rules:

•         Participants may receive the awards for no consideration. The offer must be in writing through a letter to the participants (Invitation Letter) and outlines the following but is not limited to:

(a)  the number and type of awards offered;

(b)  the issue price of those awards;

(c)   the grant date;

(d)  any performance hurdles or vesting conditions associated with the award;

(e)  in the case of an option, the exercise price, exercise period and any exercise restrictions;

(f)    the expiry date; and

(g)  any disposal restrictions attaching to the shares received as a result of the exercise of the awards.

•         The awards can only be applied for and acquired by an Eligible Person, as defined in the Plan Rules. An associate or nominee cannot apply for, or acquire the Award, unless the Board determines otherwise in accordance with the Plan Rules.

•         In respect of the awards, the issue price (if any) will be determined by the Board as outlined in the Invitation Letter.

•         The vesting conditions which apply to the awards are set out in the Invitation Letter for each individual Participant and will need to be met before the Participant's awards can vest.

•         Once the vesting conditions have been determined by the Board as being met, the Board will notify the Participant of the number of awards that have vested or lapsed through a Vesting Notice.

•         All shares issued under the Plan to settle the Deferred Share Rights or Options are fully paid ordinary shares (Shares) and will rank equally with all other shares of the same class for the time being on issue by the Company where the record date is after the date of their issue, in accordance with the Plan Rules.

•         At the discretion of the Board, the Deferred Share Rights or Options may be settled in shares or a cash equivalent value of the shares upon vest / exercise, unless otherwise indicated in the Invitation Letter.

•         The Board may at any time and in its absolute discretion, determine to adjust downwards the number of unvested awards held by a Participant.

•         In respect of the Options:

o   the exercise price of the options (which may be nil) will be determined by the Board;

o   the Participant may request the Company to net settle the aggregate exercise price in relation to the vested Awards, as specified in the Plan Rules. However, the Company also has the discretion to accept or reject this request. In the latter case, the Participant must pay the exercise price to exercise their vested awards;

o   if the parties agree to net settle the vested Awards then the employee will receive the number of shares as per calculation method in the Plan Rules. Where the Trust provides these shares to the employee, the funding will be provided to the Trust so it can acquire the reduced number of shares for the employee and the employee will not be required to pay an exercise price for them;

o   once the option has vested, the Participant must return a completed exercise notice to Company A in order to exercise their Options. Company A may establish periods (Exercise Windows) during which Shares will be allocated to Participants who have returned a completed exercise notice.

• In respect of the Deferred Share Rights:

o   once the rights vest, they are automatically exercised and Participants will be allocated one Share for each right that vests.

• If a Participant ceases employment with the Company, and they are:

o   Good Leaver:

                                                              i.        all vested Awards; and

                                                             ii.        a portion of their unvested awards will be retained by the Participant, calculated based on the amount of time between the date the awards were granted and the date the Participant became a Leaver relative to the total vesting period; or

                                                            iii.        such higher number of unvested awards as determined by the Board in accordance with the Plan Rules.

o   not a Good Leaver:

                                                              i.        all vested awards will be retained by the Participant; and

                                                             ii.        all unvested awards will immediately expire and be forfeited, unless otherwise determined by the Board in accordance with the Plan Rules

• In the case of a Trigger Event, as defined in the Plan Rules, the Board may buy-back, purchase, redeem or require the Participant to sell some or all of their unvested awards at a price determined under the Plan Rules.

Employee Share Trust (EST)

The Plan allows the Company to implement an employee share trust for the purpose of delivering and holding Shares on behalf of Participants in accordance with the Plan Rules.

The following offers have been made or are intended to be made shortly under the Plan:

(a)  Offer A;

(b)  Offer B; and

(c)   Offer E

In respect of these offers, the Participants may receive Deferred Share Rights or Options (collectively, the Awards) for no consideration. However, if the Award has an issue price, this will be determined by the Board and outlined in the letter of offer (Invitation Letter).

Details of the above offers made to Participants

Detailed below are the offers that have been made under the Plan and are currently on foot or intended to be made shortly. However, this list is not exhaustive and there may be future offers of Division 83A awards made by Company A under the terms and conditions of the Plan.

(a)  Offer A

• Participants are granted either Deferred Share Rights, cash or a combination dependent on the employee's grade.
• The Deferred Share Rights are indeterminate rights until they vest as:
  • they may be settled in shares or a cash equivalent value; and
  • the Board has the discretion at any time to adjust downwards the number of unvested Deferred Share Rights prior to vesting.
• The Deferred Share Rights are subject to a service vesting condition that varies depending on the Participant's grade and the Board being satisfied that the Participant has at all times satisfied the risk, values and conduct requirements of the Company.
• Upon vesting, to the extent the Board determines to settle the Deferred Share Rights in shares, the Deferred Share Rights will automatically convert to shares and be issued to the Participant. Otherwise, the Participant will receive a cash equivalent value of the Shares.
• The Deferred Share Rights are subject to a disposal restriction whilst they remain subject to vesting conditions. The resulting Shares can only be disposed of subject to the Company's share trading policy, for example, subject to blackout trading periods.

(b)  Offer B

• Participants are granted Options which have an exercise price set at a premium to the share price of the Company (Premium Priced Option).
• To date, the Premium Priced Options granted have a premium of XX% above the share price.
• The Premium Priced Options should be considered to be indeterminate rights until they vest as:
  • the Board has the discretion at any time to adjust downwards the number of unvested Deferred Share Rights prior to vesting.
• The Premium Priced Options are subject to a service condition and the Board being satisfied that the Participant has at all times satisfied the risk, values and conduct requirements of the Company.
• The invitation letters for offers made under Offer B do not include a discretion to cash settle the Options. Accordingly, the Options will be settled in Shares.
• Once the vesting conditions have been satisfied, the Participant may exercise their options, either by requesting the company to net settle (that is, Participants choose not to pay the exercise price of their options in exchange for receiving a lower number of Shares) their options, or if that is rejected by the Company, pay the exercise price as stated in the Invitation Letter.
• No Premium Priced Options can be disposed of while they are subject to a vesting condition.
• The resulting Shares can only be disposed of subject to the Company's share trading policy, for example, subject to blackout trading periods.
• Despite being called Premium Priced Options, the strike price was not set at a sufficient premium to have a taxable value of nil under the Income Tax Assessment (1997 Act) Regulations 2001 (Income Tax Regulations).

(c)   Offer E

• Key executives were granted a mix of Deferred Shares Rights and Premium Priced Options subject to a service condition of 5 years.
• The Board has an absolute discretion at any time to adjust downwards the number of unvested Awards prior to vesting.
• Upon vesting:
  • the Deferred Share Rights are automatically exercised into shares; and
  • the Premium Priced Options require the Participant to pay the exercise price in order to exercise their options.
• The Invitation Letters for offers made under the Offer E do not include a discretion to cash settle the Premium Price Options. Accordingly, they will be settled in shares.
• The Awards are subject to a disposal restriction whilst they remain subject to any vesting conditions.
• Any Participant who is offered the Awards under this offer is a Leaver if they cease employment prior to the service condition being met. Accordingly, all their Awards will lapse except at the absolute discretion of the Board.

This offer of Deferred Share Rights and Premium Priced Options, despite being called Premium Priced Options, the strike price was not set at a sufficient premium to have a taxable value of nil under the Income Tax Regulations.

The Legacy Plan

The Legacy Plan was designed to reward and incentivise the Company's key management and employees and align their interest with those of the Company's shareholders.

Detailed below are the offers that have been made under the Legacy Plan and are currently on foot:

(a)  Offer F; and

(b)  Offer G

In respect of these offers, the Participants received Options for no consideration. The offers under the Legacy Plan were made on the same terms as follows:

• The exercise price was set at the market value of Company A's shares at the time of grant, as determined by the Board.
• In most cases, the Offer F and Offer G have a minimum holding period of 3 years (i.e. Participants are not able to dispose of their options or resulting shares until the earlier of 3 years from the date of grant and cessation of employment).
• The vesting conditions which apply to the Offer F and Offer G were set out in the invitation letter for each Participant. Company A decided to accelerate the vesting of most of the options granted under the Legacy Plan. However, the vesting is subject to a clawback such that Company A has the ability to compel the forfeiture of the vested options or resulting shares following exercise if within a 12 month period, the Participant leaves for an ASX listed competitor of Company A. Currently on foot, there are Offer F and Offer G on foot that are subject to performance conditions and/or service conditions. Some of these Offer F and Offer G are subject to disposal restrictions that prohibit disposal of the Options until the first anniversary.
• All shares issued to satisfy the offers made under the Legacy Plan are fully paid ordinary shares and will rank equally with all other shares of the same class for the time being on issue the Company where the record date is after the date of their issue, in accordance with the Legacy Plan Rules.
• Once an option has vested, the Participant must return a completed exercise notice to the Company, where upon receipt by the Company, the Company will issue the relevant number of Shares to the Participant.
• Company A, also provided a mechanism for Participants to be able to request the Company to net settle their Options.
• The Legacy Plan allows the Company to implement an EST for the purpose of delivering and holding shares on behalf of Participants in accordance with the Legacy Plan Rules.

Offer C and Offer D

The following offers were made by Company A:

(a)      Offer C; and

(b)      Offer D

(a)           Offer C

• Deferred Share Rights were granted to all employees employed in 20XX, excluding the Management Board in recognition of their individual contributions.
• The Deferred Share Rights vested immediately upon a certain event.
• Six months after the date of grant, the Deferred Share Rights automatically exercised and the Participants received a Share in the Company for each Deferred Share Right, subject to a disposal restriction of 6 months from the date of grant and forfeiture where the Participant leaves for an ASX listed competitor of Company A during the period.

(b)          Offer D

• Participants were able to acquire shares in Company A at a discount to the share price.
• The Offer D Offer was a once-off offer of shares in the Company granted to all employees of the Group.
• Participants could acquire shares with their own funds, representing approximately a X% discount to the share price. Participants were guaranteed a minimum allocation of shares and a maximum allocation.
• There are no restrictions on these shares.

Company A Employee Share Trust

The Trust was established in 20XX as a sole purpose trust for the purpose of acquiring, holding and transferring shares in connection with equity incentive plans established by the Company A for the benefit of participants of those plans (see the Trust Deed).

The Trust is only used to administer shares relating to the Awards already on offer under the Plan and the Legacy Plan, or any future plans or offers of equity to employees of the Group that Company A wishes to implement.

The Trust provides Company A with greater flexibility to accommodate the incentive arrangements of Company A both now and into the future as the group continues to expand its operations. The Trust provides capital management flexibility for Company A, in that the Trust can use the contributions made by Company A either to acquire shares in Company A on market, or alternatively to subscribe for new shares in Company A.

Similarly, it provides an arm's length vehicle through which shares in Company A can be acquired and held in Company A on behalf of employees. In effect, this aspect allows Company A to satisfy Corporations Law requirements relating to companies dealing in their own shares.

Company B, an independent third party, is the Trustee of the Trust, and will operate the Trust in accordance with Company A Capital Holdings Limited Employee Share Trust Deed (Trust Deed).

Broadly, the Trust Deed operates as follows:

•         Company A must provide the Trustee with the funds required for the purchase of shares in accordance with the Plan (refer to the Trust Deed).

•         The Trustee must not repay Company A any amount received as contributions of funds for the acquisition of shares (refer to the Trust Deed) and on termination the Trustee must not pay any remaining assets to Company A or subsidiaries (refer to the Trust Deed).

•         These funds are used by the Trustee to purchase or subscribe for the requisite number of shares in Company A based on written instructions from Company A (refer to the Trust Deed).

•         Where Company A instructs the Trustee to allocate unallocated shares to a Participant, the Trustee must allocate the Participant the number of shares as specified in the notice (refer to the Trust Deed.)

•         Company A may notify the Trustee to acquire shares to be held by the Trustee on trust for the Participants or beneficiaries of the Trust generally.

•         The Trust is precluded from exercising voting rights in relation to the unallocated Shares (refer to the Trust Deed).

•         The Trustee and Company A agree that 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 (refer to the Trust Deed).

•         The Trustee is not permitted to carry out activities which are not matters or things which are connected to, or for the purpose of, a Company A ESS plan (refer to the Trust Deed).

•         On termination of the Trust, the Trustee must apply the trust assets in whole or in part towards the full repayments of all outstanding liabilities, distributions to Participants or the application of Trust capital, an employee share trust established and maintained for the benefit of the employees of the Company; or any charity nominated by the Trustee (refer to the Trust Deed)

Contributions to the Trust

To date, Company A has made a cash contribution to the Trust in respect of the Offer C offer, as well as, in respect of the Offer F and Offer G granted under the Legacy Plan that were exercised.

Company A may wait until the Awards vest, and to receive the exercise notice from Participants (where relevant), before providing the Trust with the cash necessary to acquire shares to satisfy the acquisition or subscription of shares related to those Awards. It is noted that some of the Awards already on foot (that is. the Offer F and Offer G under the Legacy Plan and the Offer E and Offer B offers under the Plan) must be settled with newly issued shares. However, if the Offer E and Offer B offers are net settled, those offers may be satisfied by an on-market purchase of Shares.

However, where it makes commercial sense to do so, Company A may make cash contributions to the Trust prior to the Awards vesting or being exercised by the Participant. In this case, Company A will contribute to the Trust enough funding to enable the purchase of shares through either new issue or purchase on-market (in accordance with the plan documentation) in advance of when Awards are likely to vest or be exercised. This allows the Trustee to have sufficient shares in the Trust ahead of when they need to be allocated to Participants and avoids delays in certain times, such as blackout trading periods.

Company A incurs various costs in the on-going administration of the Trust. For example, Company A incurs costs associated with the services provided by the Trustee of the Trust, such as:

•         Employee plan record keeping;

•         Production and dispatch of holding statements to employees;

•         Costs incurred in the acquisition of shares on market, such as brokerage costs and the allocation of such shares to Participants; and

•         Other trustee expenses such as the annual audit of the financial statements and annual income tax return of the Trust.

Where an ESS interest does not eventuate because it is ultimately satisfied by a payment of a cash equivalent to the Shares, the outgoing will not flow through to the Trustee.

Reasons for decision

Legislative references in this Ruling are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997), unless otherwise indicated.

Question 1

The total assessable income of a trust estate is calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936)).

The assessable income of a taxpayer includes income under ordinary concepts (section 6-5) or statutory income (section 6-10).

None of the provisions listed in section 10-5 (list of provisions about assessable income that is not ordinary income) are relevant in the present circumstances. The irretrievable cash contributions made by Company A to the Trustee of the Trust will therefore not be included in the assessable income of the Trustee under section 6-10.

The contributions made by Company A are irretrievable and non-refundable to it in accordance with the Trust Deed. The funds provided to the Trustee are used in accordance with the Trust Deed and Plan Rules for the sole purpose of the employee share schemes (see the Trust Deed). Therefore, the contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10. (ATO Interpretative Decision ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme).

Question 2

Subsection 130-90

Broadly, section 130-90 applies to disregard any capital gain or capital loss made by an employee share trust when providing shares or rights to shares in the trust to a beneficiary as a part of the operation of an employee share scheme subject to certain conditions. Relevantly,

•         the Trust must be an Employee Share Trust

•         the event must be regarding an ESS interest to which Subdivision 83A-B or 83A-C applied/applies

•         the CGT event must be E5 or E7

•         the beneficiary must not acquire the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time the CGT event happens.

Employee Share Trust

To determine whether the Trust is an 'employee share trust' for the purposes of subsection 130-85(4) an analysis of what the Trustee actually does and its powers and duties that are prescribed in the Trust Deed is required. However, as indicated in the facts the Trustee will exercise its powers and obligations as set out in the Trust Deed. Therefore, it meets the definition of subsection 130-85(4) as:

•         The Trust acquires shares in a company, namely Company A

•         The sole purpose being the acquisition, holding, and ongoing administration of holding Company A shares under its ESS plans for the benefit of the Participants (see the Trust Deed)

•         The Trustee is not permitted to carry out activities that are not connected to or for the purpose of an ESS Plan established by Company A (the Trust Deed)

•         The Commissioner accepts that the other activities undertaken by the Trustee will be merely incidental to this purpose; paragraph 130-85(4)(c)

•         The Trust ensures that ESS interests as defined in subsection 83A-10(1) are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating those shares to the employees in accordance with the Trust Deed and Company A's ESS Plans

•         The Trust Deed indicates that Company A and the Trustee agree the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purpose of subsection 130-85(4) (the Trust Deed)

ESS interest to which Subdivision 83A-B or 83A-C applied/applies

Under the Plan, the Legacy Plan and the Once-off Offers Participants acquire an ESS interest as defined in subsection 83A-10(1) as they acquire either a beneficial interest in a share in Company A or a beneficial interest in a right to acquire a beneficial interest in the share in Company A. All of the ESS interests provided through the Trust are provided at a discount and therefore the Commissioner accepts that 83A-B or 83A-C applies.

The CGT event must be E5 or E7

Subsection 104-75(1) provides that CGT event E5 happens when a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee.

On satisfying any vesting conditions, an interest-holder will have an unconditional right to receive a Company A share. At this point, they will be absolutely entitled to that share (being a CGT asset of the Trust) as against the Trustee and CGT event E5 will happen (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).

Conclusion

Therefore, as shown above the conditions of section 130-90 have been met such that where the beneficiary does not acquire the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time the CGT event happens, the capital gain or loss made by the Trustee will be disregarded.