Edited version of private advice

Authorisation Number: 1052058819300

Date of advice: 29 November 2022

Ruling

Subject: Employee share schemes

Question 1

Will Company X be entitled to deduct an amount under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of irretrievable cash contributions made by it to the trustee for the Company X Trust (the Trustee) to fund the subscription for, or acquisition on-market of, Company X shares (Shares) to satisfy the issue of Shares pursuant to employee share plans (Plans)?

Answer

Yes.

Question 2A

Will Company X be entitled to deduct an amount under section 8-1 of the ITAA 1997 for costs incurred by it in relation to the on-going administration of the Company X Trust (the Trust)?

Answer

Yes.

Question 2B

Will Company X be entitled to deduct an amount under subsection 25-5(1) of the ITAA 1997 for costs incurred in relation to legal, tax and accounting advice in respect of managing the tax affairs of the Trust?

Answer

Yes.

Question 3

Will the irretrievable cash contributions made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares by the Trustee to satisfy Company X's obligations with respect to the issue of Shares pursuant to the Plans, be deductible to Company X at the time determined by section 83A-210 of the ITAA 1997, if those contributions are made before the acquisition of the rights issued under the Plans (Rights)?

Answer

Yes.

Question 4

If the Trustee satisfies its obligations under the Plans by subscribing for new Shares, will the subscription proceeds be included in the assessable income of Company X under section 6-5 or 20-20, or trigger a CGT event under Division 104, of the ITAA 1997?

Answer

No.

Question 5

Will the provision of Rights by Company X to its employees under the Plans constitute a 'fringe benefit' within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No.

Question 6

Will the irretrievable cash contributions made by Company X to the Trustee, to fund the subscription for, or acquisition on-market of, Shares constitute a 'fringe benefit' within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

Question 7

Will the Commissioner seek to make a determination that section 67 of the FBTAA applies to increase the fringe benefits taxable amount to Company X by the amount of tax benefit gained from irretrievable cash contributions made by Company X to the Trustee, to fund the subscription for, or acquisition on-market of, Shares by the Trustee pursuant to the Plans?

Answer

No.

Question 8

Will the Commissioner seek to make a determination under section 177F that Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies to deny, in part or in full, any deduction claimed by Company X in respect of the irretrievable cash contributions made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares by the Trustee, pursuant to the Plans?

Answer

No.

This ruling applies for the following periods:

For Questions 1 to 4 and 8:

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

Questions 5 to 7:

Fringe benefit tax years ended 31 March 20XX to 31 March 20XX

The scheme commences:

In a particular income year

Relevant facts and circumstances

Company X Limited

1. Company X is an Australian public company and its shares are listed on the Australian Securities Exchange.
2. Company X carries on a business for the purpose of gaining or producing assessable income.

The Plans

3. Company X operates the Plans which form part of its remuneration strategy to assist in the reward, retention and motivation of employees.
4. For the purposes of this Ruling, an eligible employee who has been granted one or more Rights is referred to as a Participant.
5. Under the Plans:

a)    Company X may offer any number of Rights to a Participant on terms the board decides, in the form of an offer at any time

b)    a Right is a right to be issued, transferred or allocated one Share, subject to the satisfaction of vesting conditions and disposal restrictions

c)    when the Rights vest, Participants can exercise their Rights during the exercise period and, once exercised, will be issued, transferred or allocated Shares

d)    a Participant is not required to pay for the grant of any Rights or the issue, transfer or allocation of Shares

e)    Rights granted to Participants cannot be sold or transferred

f)     any sale of Shares issued, transferred or allocated in respect of Rights is governed by Company X's Share Trading Policy

g)    Company X may utilise a trust for the purposes of holding and delivering Shares to Participants

h)    the board may decide, in its absolute discretion, to substitute the issue, transfer or allocation by the Trust of Shares with the payment to the Participant of a cash amount, and

i)      the Trust will not be used to cash settle any Rights.

6. The Participants of the Plans are limited to Australian residents within the meaning of subsection 6(1) of the ITAA 1936.

Company X Employee Share Plan Trust

7. The Trust was established by execution of a Trust Deed (the Trust Deed).
8. The Trustee is an external trustee acting in an independent capacity on behalf of beneficiaries of the Trust.
9. Broadly, the Trust operates as in accordance with the Trust Deed as follows:

a)    the Trustee must perform its duties under the Trust and exercise its powers at all times so as to be an employee share trust (EST) as defined in section 130-85 of the ITAA 1997, and this requirement is not capable of amendment

b)    the Trustee will use the trust funds to acquire, by purchase or subscription, the number of Shares based on instructions from Company X

c)    all funds provided to the Trustee by Company X 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 Trustee must allocate the relevant number of Shares to each Participant based on instructions from Company X. A Participant is absolutely entitled to any shares allocated to it (Allocated Shares), which continue to be held by the Trustee unless transferred to the Participant

e)    prior to individual Participants being absolutely entitled to Shares, they will be considered 'Unallocated Shares' and held in an unallocated account. A Participant has no entitlement to these shares or to the income being derived from these shares. Where the Trustee receives any income from these shares, the Trustee can hold or invest this income in shares or rights for the general purposes of the Trust as it sees fit

f)     the Trustee must not use any part of the trust fund as security

g)    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

h)    Company X is required to pay the Trustee for all costs associated with the administration of the Trust. 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, and

i)      the Trustee is not remunerated for administering the Trust unless agreed upon in writing by Company X and the Trustee.

Relevant legislative provisions

Part IVA of the ITAA 1936

Subsection 177D(2) of the ITAA 1936

Section 177F of the ITAA 1936

Section 6-5 of the ITAA 1997

Section 8-1 of the ITAA 1997

Paragraph 8-1(1)(b) of the ITAA 1997

Paragraph 8-1(2)(a) of the ITAA 1997

Section 8-10 of the ITAA 1997

Division 12 of the ITAA 1997

Section 20-20 of the ITAA 1997

Section 20-30 of the ITAA 1997

Section 25-5 of the ITAA 1997

Subsection 25-5(1) of the ITAA 1997

Division 83A of the ITAA 1997

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

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

Subdivision 83A-B of the ITAA 1997

Subdivision 83A-C of the ITAA 1997

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

Section 83A-210 of the ITAA 1997

Section 83A-340 of the ITAA 1997

Section 102-20 of the ITAA 1997

Division 104 of the ITAA 1997

Paragraphs 104-35(5)(c) of the ITAA 1997

Paragraph 104-155(5)(c) 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

Subsection 974-75(1) of the ITAA 1997

Subsection 136(1) of the FBTAA

Paragraph 136(1)(f) of the FBTAA

Paragraph 136(1)(h) of the FBTAA

Paragraph 136(1)(ha) of the FBTAA

Section 67 of the FBTAA

Reasons for decision

Question 1

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

Under paragraph 8-1(1)(b), you can deduct from your assessable income any loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

However, by virtue of paragraph 8-1(2)(a), you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of a capital, or of a capital nature.

In Magna Alloys & Research Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia [1980] FCA 180, the Full Federal Court stated that an outgoing is necessarily incurred in carrying on a business where, viewed objectively, it is reasonably capable of being seen as desirable or appropriate from the point of view of the pursuit of the business ends of the business being carried on for the purpose of earning assessable income.

Company X carries on a business which produces assessable income and operates the Plans as part of its remuneration strategy.

Pursuant to the Plans, Company X may use a trust for the purpose of acquiring, holding and allocating Shares under the Plans and Company X must provide the Trustee with all the funds required to acquire and transfer those Shares to Participants.

Therefore, there is a sufficient nexus between the cash contributions made by Company X to the Trustee and Company X's remuneration arrangement with its employees, which directly relate to the business carried on by Company X for the purpose of producing Company X's assessable income.

However, for the cash contribution made by Company X to the Trustee to be deductible under section 8-1, the contribution must be a permanent loss or outgoing to which Company X has definitely committed itself and there should be no circumstance in which Company X can retrieve any of the contributions (Pridecraft Pty Ltd v Federal Commissioner of Taxation [2004] FCAFC 339 and Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCA 650 (Spotlight).

The cash contributions made by Company X to the Trustee are irretrievable and non-refundable to Company X as 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 Plans.

Therefore, the cash contributions made to the Trustee are necessarily incurred by Company X in carrying on its business.

The advantage provided by each payment to the Trustee does not have a lasting quality because it forms part of the overall remuneration of Company X's employees. Furthermore, the contributions are a recurring outlay (rather than a once-off payment). Therefore, it can be concluded that the payments are not capital, or of a capital nature (Sun Newspapers Limited v Federal Commissioner of Taxation [1938] HCA 73 and Spotlight at paragraph 71).

Based on the above analysis, Company X will be entitled to a deduction under section 8-1 in respect of the irretrievable cash contributions made by it to the Trustee to fund the subscription for, or acquisition on-market, of Shares to satisfy the issue of Shares to the Participants pursuant to the Plans.

Question 2A

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

As discussed above in Question 1, subsection 8-1 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital nature.

As explained above, Company X carries on a business which produces assessable income and operates the Plans as part of its remuneration framework.

Company X will incur various on-going administration costs associated with the services provided by the Trustee in respect of the Plans. These would include costs such as brokerage fees and bank charges. Ongoing administration costs would not include any establishment costs.

Under the Trust Deed, Company X must pay the Trustee for all costs and expenses incurred by the Trustee in the execution of the Trust.

Therefore, Company X's ongoing administrative costs of the Trust are necessarily incurred in carrying on its business for the purpose of producing its assessable income.

Furthermore, the costs are not capital in nature given the advantage sought by the costs are not to add to its profit-making structure, the expenses are regular and recurrent, and their essential character is that of a working expense of the business.

Accordingly, Company X will be entitled to deduct costs incurred in relation to the on-going administration of the Trust under section 8-1 (Taxation Determination TD 2022/8 Income tax: deductibility of expenses incurred in establishing and administering an 'employee share scheme).

Question 2B

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

Section 8-10 states that if more than one provision applies, the most appropriate provision should be used.

Division 12 sets out particular types of deductions that are dealt with by a specific provision of either the ITAA 1936 or the ITAA 1997. Section 25-5 is such a provision listed in Division 12 dealing with tax-related expenses, such as managing a taxpayer's tax affairs (subsection 25-5(1)).

Accordingly, to the extent that Company X incurs costs in managing the tax affairs of the Trust, including obtaining accounting, tax and legal advice in relation to the Plans, Company X will be entitled to deduct these tax-related expenses under subsection 25-5(1).

Question 3

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

Section 83A-210 applies to determine the timing of the deduction of contributions provided under an employee share scheme (ESS), but only if the contribution is made before the ESS interest is acquired by the ultimate beneficiary under the ESS.

The effect of section 83A-210 is to deem the timing an employer incurred the outgoing to be the time when the ESS interest is acquired by the ultimate beneficiary, rather than the time when the employer makes the contribution to the trust (ATO Interpretative Decision ATOID 2010/103 Income Tax - Employee share scheme: timing of deduction for money provided to the trustee of an employee share trust).

An 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 in relation to the employee's employment.

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 are acquired by the Participants, they are not ESS interests but are indeterminate rights pursuant to section 83A-340. This is because the board has the discretion to satisfy the Rights by either a Share or by making a payment of a cash equivalent amount under the Plans.

Once the board determines that it will not exercise this discretion and the Rights will be satisfied by provision of Shares, section 83A-340 operates to treat the indeterminate right as if it had always been a right to acquire a beneficial interest in shares, and therefore an ESS interest for the purposes of section 83A-210.

Therefore, the Plans satisfy the definition of an ESS in subsection 83A-10(2) as they are schemes under which ESS interests in Company X (that is, Rights that are settled with Shares) are provided to the employees of Company X in relation to their employment with Company X.

Where Company X makes a cash contribution to the Trustee in an income year before the income year in which the Rights are granted to Participants under the Plans and those Rights are settled with Shares, then section 83A-210 will apply to modify the timing of any deduction claimed by Company X to the time the Rights are acquired by the Participants.

Question 4

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

Section 6-5 provides that a taxpayer's assessable income includes income according to ordinary concepts. The term "income according to ordinary concepts" is not a defined term. However, case law has identified certain factors to be taken into consideration.

The characterisation of the subscription proceeds received by Company X from the Trustee can be determined by the character of the right or thing disposed of in exchange for the subscription proceeds (GP International Pipecoaters v. Federal Commissioner of Taxation [1990] HCA 25). Where Company X issues the Trustee with new shares in itself, the character of the newly issued share is one of capital. Therefore, the receipt of the subscription proceeds takes the character of share capital, which is of a capital nature.

Accordingly, the subscription proceeds should not be treated as ordinary income assessable in the hands of Company X under section 6-5.

Section 20-20

Section 20-20 relevantly provides for the assessment of recoupments received by way of insurance or indemnity, or if it is a recoupment of a loss or outgoing that is deductible because of a provision listed in the table in section 20-30.

The subscription proceeds received by Company X from the Trustee would not represent an amount received by way of insurance or indemnity as there is no insurance contract and the receipt does not arise because of a statutory or contractual right of indemnity nor in the nature of compensation.

None of the provisions listed in section 20-30 are relevant to a receipt of subscription proceeds.

Therefore, the subscription proceeds received by Company X from the Trustee does not constitute an assessable recoupment under section 20-20.

Division 104

A capital receipt will only be included as an assessable net capital gain if it arises as a result of a CGT event (section 102-20).

The only CGT events that may have possible application to the receipt of the subscription proceeds are CGT event D1 (Creating a contractual or other rights) and/or CGT event H2 (Receipt for event relating to a CGT asset).

However, paragraphs 104-35(5)(c) and 104-155(5)(c) respectively provide that CGT event D1 and CGT event H2 do not apply if a company issues or allots equity interests or non-equity shares in the company.

As the ordinary shares of Company X constitute 'equity interests' (per subsection 974-75(1)), neither CGT event D1 nor CGT event H2 will occur.

Accordingly, the subscription proceeds will not be assessable as a capital gain to Company X under Division 104.

Question 5

All legislative references are to the FBTAA unless otherwise specified.

A 'fringe benefit' is defined in subsection 136(1) as being a benefit provided to an employee or an associate of an employee 'in respect of the employment of the employee.' However, certain benefits are excluded from being fringe benefits under paragraphs 136(1)(f) to (s).

Paragraph 136(1)(h) provides that a fringe benefit does not include:

...a benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which Subdivision 83A-B or 83A-C of that Act applies...

As discussed above, at the time the Rights are granted under the Plans, they are indeterminate rights that may be satisfied in cash instead of Shares pursuant to the rules of the Plans.

However, where the indeterminate rights are ultimately satisfied with Shares instead of cash, section 83A-340 of the ITAA 1997 will operate to treat those Rights to have always been ESS interests within the meaning of subsection 83A-10(2) of the ITAA 1997. In these circumstances, the Plans will constitute an ESS within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is 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.

As the Rights are granted under the Plans for nil consideration, they are acquired by the Participants at a discount and therefore they are ESS interests to which subdivision 83A-B of the ITAA 1997 applies, unless the conditions in subsection 83A-105(1) of the ITAA 1997 are satisfied, in which case subdivision 83A-C of the ITAA 1997 applies.

Accordingly, the provision of Rights by Company X to its employees under the Plans, where those Rights are satisfied with Shares, will not constitute a 'fringe benefit' within the meaning of subsection 136(1) by virtue of paragraph 136(1)(h) (ATO Interpretative Decision ATO ID 2010/142 Fringe Benefits Tax Employee Share Scheme: indeterminate rights not fringe benefits).

For completeness, where the indeterminate rights are ultimately satisfied with cash instead of Shares, the granting of the Right will be viewed as a series of steps in the payment of salary or wages which are also excluded from the definition of a fringe benefit by paragraph 136(1)(f).

Question 6

All legislative references are to the FBTAA unless otherwise specified.

Paragraph 136(1)(ha) provides that a benefit constituted by the acquisition of money or property by an EST (within the meaning of the ITAA 1997) does not constitute a fringe benefit.

Subsection 130-85(4) of the ITAA 1997 provides that an EST is 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 Company X's case, paragraphs 130-85(4)(a) and (b) of the ITAA 1997 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) are provided under an ESS (that is, the scheme established by the Plans) by allocating Shares to Participants in accordance with the Trust Deed and the Plans.

Paragraph 130-85(4)(c) of the ITAA 1997 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 view on the type of activities that are and are not merely incidental is 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) of the ITAA 1997.

Further, Company X has confirmed that where vested Rights are to be cash settled, any cash payments will be made by Company X directly to the Participant and will not flow through the Trust.

Therefore, the Trust does satisfy the definition of an EST in subsection 130-85(4) of the ITAA 1997.

Accordingly, the irretrievable cash contributions made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares will not constitute a 'fringe benefit' within the meaning of subsection 136(1) on the basis of the application of paragraph 136(1)(ha).

Question 7

All legislative references are to the FBTAA unless otherwise specified.

Section 67 involves arrangements to avoid or reduce fringe benefits tax. Essentially, it is the general anti-avoidance provision in the FBTAA and its operation is comparable to Part IVA of the ITAA 1936, in that the section requires the identification of an 'arrangement' and a 'tax benefit', includes a sole or dominant purpose test and is activated by the making of a determination by the Commissioner.

As determined above, the irretrievable cash contributions made by Company X to the Trustee do not constitute fringe benefits within the meaning of subsection 136(1), nor would the grant of ESS interests (or cash payments) to Participants under the Plans if an EST was not used. Therefore, the fringe benefits liability is not any less than it would have been but for the existence of the arrangement (i.e. the EST).

Therefore, the Commissioner will not seek to make a determination that section 67 applies to increase the fringe benefits taxable amount to Company X by the amount of tax benefit gained from irretrievable cash contributions made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares by the Trustee pursuant to the Plans.

Question 8

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

Part IVA is the general anti-avoidance provision which allows the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would but for section 177F be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

The Commissioner generally accepts that a deduction may be available where an employer provides money or other property to an EST where the conditions of Division 83A of the ITAA 1997 are met.

In this case, the scheme does not contain the elements of artificiality or unnecessary complexity and the commercial drivers sufficiently explain the entry into the use of the EST arrangement

Therefore, having regard to the factors listed in subsection 177D(2), it cannot be concluded that the scheme was entered into or carried out for the dominant purpose of enabling Company X to obtain a tax benefit.