Edited version of private advice

Authorisation Number: 1052042469885

Date of advice: 6 October 2022

Ruling

Subject: Employee share schemes

Question 1

Will the irretrievable cash contributions by Company X to the trustee for a trust (Trustee) to fund the subscription for or acquisition on-market of ordinary shares in Company X (Shares) by the trust (Trust) for the purposes of employee share plans (the Company Plans) be assessable income of the Trust under section 6-5 or 6-10?

Answer

No.

Question 2A

Will capital gains tax (CGT) event E5 happen at the time when the employees become absolutely entitled to Shares held by the Trustee of the Trust under the Company Plans?

Answer

Yes.

Question 2B

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

Answer

Yes.

Question 2C

Will CGT event E7 happen in respect of Shares held by the Trustee when the Trustee transfers the Shares to the employees?

Answer

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

Question 2D

If CGT event E7 happens, 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 if the employees acquire the Shares at a price that is the same as, or less than, the cost base of the Shares in the hands of the Trustee?

Answer

Not applicable.

This private ruling applies for the following periods:

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

The scheme commences on:

In a particular income year

All legislative provisions are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise indicated.

Relevant facts and circumstances

Company X and its incentive plans

Company X is an Australian based company carrying on a business for the purpose of gaining or producing assessable income.

The objective of Company X's remuneration policy is to ensure its remuneration is competitive and appropriate for the results delivered.

As part of the overall remuneration policy, in addition to fixed remuneration, Company X offers shares to certain executives upon the satisfaction of certain performance conditions. This is implemented through the Company Plans. The scope of the ruling is limited to rights and options granted under the Company Plans to Australian tax-resident employees who engage in activities that derive income assessable in Australia.

The Company Plans

Broadly under the Company Plans, eligible employees are offered the opportunity to acquire rights or options for nil consideration, thereby becoming Participants in the Company Plans. When a Participant satisfies the relevant Performance Conditions and therefore the rights or options vest, each right or option entitles the Participant to one Share, or the cash equivalent to the value of one Share (i.e. cash settled).

Company X may use an employee share trust (EST) for the purpose of holding and delivering shares under the Company Plans. However, Company X will not use an EST for holding and delivering shares under the Company Plans where the rights or options are cash settled. For any rights or options that are cash settled, Company X will make the cash payments directly to the Participants.

The Trust

Company X established the Trust by Trust Deed. No trusts were used in connection with Company X's operation of the Company Plans prior to the establishment of the Trust.

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

In accordance with the Trust Deed, the Trust operates as follows:

•         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).

•         The Trust was established for the sole purpose of subscribing for, acquiring, holding and transferring Shares in connection with the Company Plans, for the benefit of the Participants in those Company Plans.

•         No company in Company X's group (Company Group) can be a beneficiary of the Trust.

•         No company in the Company Group may acquire any interest in the capital, or be entitled to any income, of the Trust.

•         No encumbrance may be granted over any assets of the Trust by any persons, including the Trustee or any companies in the Company Group.

•         The Trust will be funded by contributions from Company X. All funds (other than remuneration for the Trustee in respect of its office) received by the Trustee from Company X will constitute accretions to the corpus of the Trust and must not be repaid to the Company Group (other than when subscribing for Shares in accordance with the Trust Deed and the Plan Rules), and no Participant shall be entitled to receive such funds.

•         These funds will be used by the Trustee of the Trust to acquire the Shares either by an on-market purchase, an off-market transaction where the shares are acquired at market value, or via a subscription for new Shares, based on the notice provided by Company X for the benefit of the Participants under the Company Plans.

•         Unallocated Shares are held by the Trustee on trust for the benefit of Participants generally in accordance with the terms and conditions of the Trust Deed unless and until the Shares are allocated or transferred to Participants.

•         Upon being directed by the Board, the Trustee must allocate the specified number of Shares to the specified Participant, on the date as directed by the Board. The Participant will become the beneficial owner of the Allocated Shares.

•         The Trustee will hold any and all Allocated Shares (and all other benefits and privileges attached to or resulting from the holding of the Shares) on behalf of the Participant and agrees that the Participant is absolutely entitled to these Shares (and the aforementioned benefits and privileges). It is intended under the Trust Deed that such Participants have substantially the same rights in respect of those Allocated Shares (other than bare legal title) as if the Allocated Shares were registered in the names of the relevant Participants.

•         The Shares may be dealt with at any time after the Restrictive Period lapses by allocating Shares to each Participant by way of transfer into the name of the Participant (i.e. legal title) (or to a third party nominated by the Participant) upon notification by the Board.

•         The Trustee must not pay the proceeds of sale of any forfeited Shares or transfer the forfeited Shares to a company in the Company Group.

•         While the Trustee must sell any fractions of Shares, the proceeds of sale must be used for the future purchase of Shares and cannot be repaid to, or held for the benefit of, a company in the Company Group.

•         The Trust Deed does not confer on Company X any encumbrance, proprietary right or proprietary interest in the Shares acquired by the Trustee.

•         Cash dividends in respect of Allocated Shares must not be appropriated in or towards the repayment of any outstanding loan owed by the Participant to a company in the Company Group.

•         Amendments to the Trust Deed are subject to certain conditions, including that no amendments may be made if they:

o   confer on any company in the Company Group any rights to Shares or any other assets already in the hands of the Trustee at the time the amendments are made, or

o   which may prevent the Trustee from satisfying the requirements of subsection 130-85(4).

•         Upon termination of the Trust, the Trustee may transfer the remaining capital of the Trust to the Participants, another trustee of an EST established to administer a Company X incentive plan, a charity nominated by Company X, and/or pay certain costs and expenses incurred by the Trustee for the operation of the Trust. However, the Trustee must not provide any capital of the Trust to any company in the Company Group.

•         The Trustee is not entitled to receive from the Trust any fees, commission or other remuneration in respect of its office. Company X must pay such fees and reimburse such expenses incurred by the Trustee as agreed between Company X and the Trustee.

•         Trust expenses are paid in the first instance by the Trustee from cash dividends received in relation to Unallocated Shares or any cash held in the Trust. If there are any outstanding trust expenses, then these must be paid by Company X, and Company X must indemnify the Trustee in respect of all liabilities, costs and expenses incurred by the Trustee in the execution of the Trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95(1)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 83A-20

Income Tax Assessment Act 1997 section 83A-105

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-75(1)

Income Tax Assessment Act 1997 subsection 104-85(1)

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

Income Tax Assessment Act 1997 section 130-90

Reasons for decision

Question 1

Summary

The irretrievable cash contributions by Company X to the Trustee to fund the subscription for or acquisition on-market of Shares by the Trust for the purposes of the Company Plans will not be assessable income of the Trust under section 6-5 or 6-10.

Detailed reasoning

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 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 for section 6-10 purposes) are relevant in the present circumstances. Therefore, the irretrievable cash contributions made by Company X to the Trustee will not be assessable income of the Trustee under section 6-10.

The contributions made by Company X constitute accretions to the corpus of the Trust and are irretrievable and non-refundable in accordance with the Trust Deed (other than as consideration for Shares under the terms of 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 2A

Summary

CGT event E5 happens at the time when the employees become absolutely entitled to Shares held by the Trustee of the Trust under the Company Plans.

Detailed reasoning

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 applies) as against the trustee.

In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies.

Paragraph 41 of 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.

Under the Trust Deed, a Participant is the beneficial owner of and absolutely entitled to their Allocated Shares. Once allocated to them in accordance with the Trust Deed and the rules of the Company Plans, 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, and thus, pursuant to subsection 104-75(1), CGT event E5 happens.

Question 2B

Summary

A capital gain or capital loss made by the Trustee as a result of CGT event E5 happening will be disregarded under section 130-90 if the employees acquire the Shares at a price that is the same as, or less than, the cost base of the Shares in the hands of the Trustee at the time that CGT event E5 happens.

Detailed reasoning

Section 130-90

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

(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' (EST) operating an 'employee share scheme' (ESS) which provides an 'ESS interest' to which Subdivision 83A-B or 83A-C applies.

ESS Interest

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.

At the time the rights and options are granted under the Company Plans to the Participants, they are indeterminate rights that may be satisfied in cash instead of Shares pursuant to the Plan Rules. Therefore, they are not ESS interests within the meaning of subsection 83A-10(1).

However, where the indeterminate rights are ultimately satisfied with Shares instead of cash, section 83A-340 will operate to treat those rights and options to have always been ESS interests for the purposes of subsection 83A-10(1). Therefore, rights and options granted under the Company Plans that are ultimately satisfied with Shares are ESS interests.

Employee share scheme

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

The Commissioner accepts that the Company Plans are ESSs because they are schemes under which ESS interests (i.e. rights and options that are settled with Shares) are provided to the employees of Company X or its subsidiaries in relation to their employment with Company X or its subsidiaries. When the rights or options are exercised, the beneficial interest in the Share itself is also provided under an ESS because it is provided under the same scheme.

Employee Share Trust

Subsection 130-85(4) defines an EST 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).

In examining whether the requirements of subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that is relevant.

Paragraph 130-85(4)(a) and (b) are satisfied because:

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

•         The Trust ensures that ESS interests as defined in subsection 83A-10(1) (being the rights and options where they are not cash settled) are provided under an ESS (that is, the scheme established by the Company Plans) by allocating those ESS interests to employees of Company X or its subsidiaries in accordance with the Trust Deed and the Plan Rules.

Paragraph 130-85(4)(c) provides that a trustee can engage in activities that are merely incidental to those described in paragraphs 130-85(4)(a) and (b).

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 are not considered to be merely incidental.

In the present case, the Trust established by the Trust Deed contains only powers and/or duties that relate to the activities described in paragraphs 130-85(4)(a) and (b), or to activities that are merely incidental as required by subsection 130-85(4)(c).

Accordingly, the Commissioner is satisfied that the Trust is an EST under subsection 130-85(4).

Other requirements in subsection 130-90(1)

The other requirements in subsection 130-90(1) will be satisfied because:

•         At the time the Participant becomes absolutely entitled to the Shares as against the Trustee, CGT event E5 will happen (paragraph 130-90(1)(a))

•         CGT event E5 happens in relation to shares (paragraph 130-90(1A)(b))

•         The Participant acquired the Shares by exercising a right granted under the Company Plans (paragraph 130-90(1)(c)), and

•         As the rights and options are granted under the Company Plans for nil consideration, they are ESS interests (where they are not cash settled) to which Subdivision 83A-B applies, unless the conditions in subsection 83A-105(1) are satisfied, in which case Subdivision 83A-C applies - that is, they are ESS interests to which either Subdivision 83A-B or 83A-C applies (paragraph 130-90(1)(d)).

Note that, while Shares are also ESS interests under subsection 83A-10(1), they are not ESS interests to which Subdivision 83A-B or 83A-C applies pursuant to subsection 83A-20(2) and paragraph 83A-105(1)(a).

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

Question 2C

Summary

CGT event E7 does not happen in respect of Shares held by the Trustee, because the specified scheme does not include any facts that give rise to CGT event E7 happening.

Detailed reasoning

Under subsection 104-85(1), 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.

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 2D

Summary

This question is not applicable, because CGT event E7 does not happen under the specified scheme.

Detailed reasoning

As CGT event E7 does not happen under the specified scheme, 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 is disregarded under section 130-90.