Edited version of private advice

Authorisation Number: 1052056753078

Date of advice: 22 November 2022

Ruling

Subject: Employee share schemes

Question 1

Will the irretrievable cash contributions made by Company X Limited (Company X) to Company Y Limited as trustee for the Company X Group Employee Incentive Plan Trust (the Trustee) to fund the subscription for, or acquisition on-market of, shares in Company X (Shares) be assessable income of the Trustee under sections 6-5 or section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a capital gain or capital loss made by the Trustee as a result of CGT event E5 happening in respect of Shares held by the Trustee and allocated pursuant to the Company X Employee Incentive Plan (Plan) 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 Company X Group Employee Incentive Plan Trust (Trust)?

Answer

Yes.

Question 3

Will dividends and other income received by the Trustee in respect of Shares held by the Trustee but not yet allocated to employees (Unallocated Shares):

(a)  be included in the calculation of the net income of the Trust under section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) and

(b)  be assessed to the Trustee under section 99A of the ITAA 1936?

Answer

Yes.

Question 4

Will the Trustee be entitled to a tax offset for the franking credits attached to the franked dividend on the Unallocated Shares under Subdivision 207-B of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

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

The scheme commences:

In a particular income year

Relevant facts and circumstances

Company X Limited

1.     Company X is the head company of the Company X income tax consolidated group (the Company X Group).

2.     Company X carries on a business for the purpose of gaining or producing assessable income.

The Company X Employee Incentive Plan

3.     Company X established the Plan as part of its remuneration strategy which encourages eligible employees to acquire Shares.

4.     Under the Plan:

a)   Eligible employees (Participants) were provided with a letter setting out the terms and conditions of a grant of Rights under the Plan (Offer Letter)

b)   Rights automatically vest on the vesting date provided that the Participant continues to hold office as a non-executive director or remain in employment with Company X up until that date

c)   Upon vesting, Rights will be exercised automatically and each Right entitles the Participant to one Share

d)   Participants pay no consideration for the grant of Rights or for the issue of Shares upon the vesting of Rights under the Plan

e)   Unless Company X determines or the Offer Letter provides otherwise, the Participant must not deal in any Shares under the Plan during the restriction period

f)    Company X may settle some or all of a Participant's Rights (whether before, at or after vesting of those Rights) in cash rather than Shares, resulting in the Participant receiving, in lieu of the relevant Shares, a cash payment equal to the market value of those Rights or Shares

g)   Company X may use a trust for the purpose of acquiring, holding and allocating Shares under the Company Plan

h)   The Trust will not be used to cash settle any Rights.

The Company X Group Employee Incentive Plan Trust

5.     Company X established the Trust by executing the Company X Employee Incentive Plan Trust Deed (the Trust Deed).

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

7.     Company X provided the Trust Deed which contains clauses that detail the obligations of Company X and the Trustee to facilitate the acquisition, holding and delivering of Shares for the purposes of the Plan.

8.     Broadly, the Trust operates as follows in accordance with the Trust Deed:

a)   The Trust Deed expressly states that Company X and the Trustee agree that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of section 130-85(4) of the ITAA 1997.

b)   The Trustee will use the Trust funds to acquire Shares either on-market, off-market or via subscription for new Shares based on written instructions from Company X.

c)   If the Trust has insufficient funds, Company X must provide the Trust with all the funds required to acquire Shares in accordance with the Plan and all funds provided to the Trustee will constitute accretions to the corpus of the Trust and will not be repayable by the Trustee other than as consideration for Shares under the terms of the Trust Deed.

d)   The Trust Deed requires the Trustee to hold Shares as Shares in respect of a Participant(s) as instructed by Company X, i.e. on an allocated basis, although the Participants will be the beneficial owner of and absolutely entitled to their allocated Shares. As beneficiaries, Participants will only have a present, vested and indefeasible entitlement to any income, including dividends, derived from allocated Shares.

e)   Unallocated Shares are held by the Trustee for the general purpose of the Trust. If the Trustee receives any income, including dividends, deriving from Unallocated Shares, the income becomes Trust property and the Trustee holds that income on trust for the general purposes of the trust.

f)    The Trust Deed does not contain any clauses which allow any Trust funds to be returned to Company X from the Trust for purposes other than acquiring Shares to implement the Plan.

g)   Company X must pay all Trust expenses, unless already paid out of Trust property.

h)   The Trustee is not entitled to receive from the Trust any fees, commission or other remuneration for operating or administering the Trust. However, Company X may also pay such fees and other amounts and reimburse such expenses to the Trust from its own resources as Company X and the Trustee agree from time to time. Such costs would include ongoing administration costs such as brokerage fees, bank charges and legal, tax and accounting advice. Ongoing administration costs does not include any establishment costs.

9.     The Trustee will hold the Unallocated Shares at risk for a period of not less than 45 days and will not make a related payment in respect of the dividend.

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 6-10 of the ITAA 1997

Section 10-5 of the ITAA 1997

Subdivision 83A-B of the ITAA 1997

Subdivision 83A-C of the ITAA 1997

Subsection 83A-10(1) of the ITAA 1997

Subsection 83A-10(2) of the ITAA 1997

Subsection 83A-105(1) of the ITAA 1997

Section 83A-340 of the ITAA 1997

Subsection 104-75(1) of the ITAA 1997

Subsection 130-85(4) of the ITAA 1997

Paragraph 130-85(4)(a) of the ITAA 1997

Paragraph 130-85(4)(b) of the ITAA 1997

Paragraph 130-85(4)(c) of the ITAA 1997

Section 130-90 of the ITAA 1997

Subsection 130-90(1) of the ITAA 1997

Paragraph 130-90(1)(a) of the ITAA 1997

Paragraph 130-90(1)(b) of the ITAA 1997

Paragraph 130-90(1)(c) of the ITAA 1997

Paragraph 130-90(1)(d) of the ITAA 1997

Division 128 of the ITAA 1997

Subdivision 207-B of the ITAA 1997

Section 207-45 of the ITAA 1997

Subsection 207-50(4) of the ITAA 1997

Subsection 207-150(1) of the ITAA 1997

Subsection 44(1) of the ITAA 1936

Division 6 of the ITAA 1936

Section 95 of the ITAA 1936

Subsection 95(1) of the ITAA 1936

Section 97 of the ITAA 1936

Section 98 of the ITAA 1936

Section 99A of the ITAA 1936

Paragraph 99A(4)(a) of the ITAA 1936

Paragraph 99A(4)(b) of the ITAA 1936

Paragraph 99A(4)(c) of the ITAA 1936

Paragraph 99A(4A)(a) of the ITAA 1936

Paragraph 99A(4A)(b) of the ITAA 1936

Paragraph 99A(4A)(c) of the ITAA 1936

Division 1A of the former Part IIIAA of the ITAA 1936

Former section 160APHO of the ITAA 1936

Reasons for decision

Question 1

All legislative references are to the ITAA 1997 unless otherwise specified.

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 both income under ordinary concepts (sections 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 ATOID 2002/965 Income Tax - Trustee not assessable on employer contributions made to it under the employer's employee share scheme).

Question 2

All legislative references are to the ITAA 1997 unless otherwise specified.

CGT Event E5

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.

Under the Plan, upon vesting, Rights will be exercised automatically and Shares will be allocated to the Participant.

Under the Trust Deed, the Trustee must allocate the specified number of Shares to a Participant as instructed by Company X and a Participant is absolutely entitled to all Shares allocated to it and any other Shares of which it becomes the beneficiary.

At this point, the Participant (i.e. the beneficiary) becomes absolutely entitled to the Shares (i.e. the CGT asset of the Trust) as against the Trustee, and thus, pursuant to subsection 104-75(1), CGT event E5 happens.

However, any capital gain or loss made by the Trustee if CGT event E5 happens, is disregarded if section 130-90 applies. To qualify for the exemption in section 130-90, there must be an employee share trust (EST).

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).

An employee share scheme (ESS) is defined in subsection 83A-10(2) as a scheme under which ESS interests in a company are provided to employees of the company, or a subsidiary of the company, in relation to the employee's employment.

Under subsection 83A-10(1), an 'ESS interest' in a company is a beneficial interest in:

(a)  a share in the company, or

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

At the time the Rights are granted under the Plan to the Participants, they are indeterminate rights that may be satisfied in cash instead of Shares pursuant to the Plan. 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 to have always been a right to acquire a beneficial interest in shares, and therefore ESS interests for the purposes of subsection 83A-10(1).

The Plan is an ESS as defined in subsection 83A-10(2) as it is a scheme under which ESS interests (that is, the Rights that are settled with Shares) in a company (i.e. Company X) are provided to employees of Company X, in relation to the employee's employment with Company X. When the Rights are exercised, the beneficial interest in the Share itself is also provided under an ESS because it is provided under the same scheme.

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

(a)  acquires Shares in a company, namely Company X, and

(b)  ensures that ESS interests (being the Rights that are settled with Shares and the beneficial interest in the Share that is acquired pursuant to the exercise of the Right) are provided under an ESS (that is, the scheme established by the Plan) by allocating those Shares to Participants in accordance with the Trust Deed and Plan.

Paragraph 130-85(4)(c) of the definition of an EST 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'?.

The Commissioner is satisfied that the Trust established pursuant to the Trust Deed contains only powers and/or duties that are merely incidental, as required by subsection 130-85(4)(c).

Therefore, the Trust established pursuant to the Trust Deed satisfies the definition of an EST in subsection 130-85(4).

Other requirements in subsection 130-90(1)

Relevantly to Company X' case, the other requirements in subsection 130-90(1) will be satisfied because:

(a)  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))

(b)  CGT event E5 happens in relation to the Shares (paragraph 130-90(1)(b))

(c)   the Participants acquire the Shares by exercising a right granted under the Plan (paragraph 130-90(1)(c)), and

(d)  as the Rights are granted under the Plan for nil consideration, they are acquired by the employees at a discount and therefore 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. Therefore, they are ESS interests to which either Subdivision 83A-B or 83A-C applies (paragraph 130-90(1)(d)).

As such, any capital gain or capital loss that arises for the Trust established pursuant to the Trust Deed at the time when CGT Event E5 happens in relation to Shares acquired by the grant of Rights under the Plan will be disregarded under section 130-90, if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trust.

Question 3

All legislative references are to the ITAA 1936 unless otherwise specified.

Section 95

Net income is defined by section 95 to mean the total assessable income of the trust estate calculated under Division 6 as if the trustee were a resident taxpayer in respect of that income, less allowable deductions.

Under subsection 44(1), the assessable income of a resident shareholder in a company includes dividends that are paid to the shareholder by the company out of profits derived by it from any source.

Under the Trust Deed, Unallocated Shares are held by the Trustee for the general purpose of the Trust, and if the Trustee receives any income, including dividends, deriving from Unallocated Shares, the income becomes Trust property and the Trustee holds that income on trust for the general purposes of the Trust.

As such, dividends and other income received by the Trustee in respect of Unallocated Shares will be included in the calculation of the net income of the Trust under section 95.

Section 99A

Under section 99A, the trustee of a trust estate is assessed and liable to pay tax on the part of the net income of the trust estate:

•         that is not included in the assessable income of a beneficiary of the trust estate under section 97 (paragraphs 99A(4)(a) and 99A(4A)(a))

•         in respect of which the trustee is not assessed and is not liable to pay tax under section 98 (paragraphs 99A(4)(b) and 99A(4A)(b)), and

•         that does not represent income to which a beneficiary is presently entitled that is attributable to a period when the beneficiary was not a resident of, and is also attributable to sources out of, Australia (paragraphs 99A(4)(c) and 99A(4A)(c)).

The critical requirement for these three exclusion categories is that a beneficiary is presently entitled to a share of the income of a trust estate.

Under the Trust Deed, a beneficiary is only absolutely entitled to Allocated Shares, and the beneficiary only has a present, vested and indefeasible entitlement to any income, including dividends, derived from Allocated Shares.

Therefore, as a beneficiary is not presently entitled to any income derived from Unallocated Shares, none of the three exclusion categories apply, and the Trustee will be assessed and liable to pay tax under section 99A on any dividends and other income received by the Trustee in respect of Unallocated Shares.

Question 4

All legislative references are to the ITAA 1997 unless otherwise specified

Tax offset

Section 207-45 provides that trustees, who are liable to be assessed under section 99A of the ITAA 1936 and to whom a franked distribution flows indirectly, are entitled to a tax offset for that income year equal to its share of the franking credits attached to the distribution.

Pursuant to subsection 207-50(4), a franked distribution will be taken to flow indirectly to the trustee of a trust where, relevantly, the trustee is liable to be assessed on all or part of the trust's net income for that year under section 99A of the ITAA 1936.

As determined above, the Trustee will be liable to be assessed under section 99A of the ITAA 1936 in relation to dividends received by the Trustee in respect of Unallocated Shares. Therefore, the requirements of section 207-45 are satisfied and the Trustee will be entitled to a tax offset equal to its shares of the franking credits attached to the dividends.

Qualified Person

However, subsection 207-150(1) denies a tax offset otherwise available under section 207-45 where the person is not a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Broadly, a person will be taken to be a qualified person in respect of a dividend paid on shares if the shares are held at risk for a period of 45 days and the person or an associate does not make a related payment in respect of the dividend (former section 160APHO of the ITAA 1936).

It is accepted that no related payment will be made by the Trustee in respect of the dividend. It is also accepted that the Trustee will hold the Unallocated Shares at risk for a period of not less than 45 days during the period beginning the day after the Trustee acquires the Unallocated Shares and ending on the 45th day after the Unallocated Shares become ex-dividend. Therefore, it is accepted by the Commissioner that the Trustee will be a 'qualified person' for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Therefore, the Trustee will be entitled to a tax offset under Subdivision 207-B equal to the franking credits attached to the franked dividends received in respect of Unallocated Shares.