Edited version of private advice

Authorisation Number: 1052062632348

Date of advice: 23 November 2022

Ruling

Subject: Employee share scheme

Question 1

Will Company X be entitled to deduct an amount under section 8-1 of theITAA 1997 for irretrievable cash contributions made by Company X to the Trustee (Trustee) of the Employee Share Trust (Trust) to fund the subscription for, or acquisition on-market of, ordinary shares in Company X (Shares) to satisfy 'ESS interests' (as defined in subsection 83A-10(1) of the ITAA 1997) issued pursuant to the Company Plans (as defined in the relevant facts and circumstances) to Participants whose activities are related to generating assessable income for Company X?

Answer

Yes.

Question 2A

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 ESS interests issued pursuant to the Company Plans, be deductible to Company X under section 8-1 of the ITAA 1997 at the time determined by section 83A-210 of the ITAA 1997, if the contributions are made before the acquisition of the relevant ESS interests by the ultimate beneficiaries?

Answer

Yes.

Question 2B

Will the irretrievable contributions made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares by the Trustee to satisfy ESS interests issued pursuant to the Company Plans, be deductible to Company X under section 8-1 of the ITAA 1997 in the income year when the contributions are made, if the contributions are made after the acquisition of the relevant ESS interests by the ultimate beneficiaries?

Answer

Yes.

Question 3

Will the Commissioner seek to make a determination 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 for the irretrievable cash contributions made to the Trust to fund the subscription for, or acquisition on-market of, Shares by the Trustee, to satisfy ESS interests issued pursuant to the Company Plans?

Answer

No.

Question 4

Will the provision of ESS interests to employees of Company X under the Company Plans constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

Question 5A

Will the irretrievable cash contributions made by Company X to the Trustee pursuant to the Original Trust Deed (as defined in the relevant facts and circumstances), to fund the subscription for, or acquisition on-market of, Shares pursuant to the Company Plans, constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

Question 5B

Will the irretrievable cash contributions made by Company X to the Trustee pursuant to the Amended Trust Deed(as defined in the relevant facts and circumstances), to fund the subscription for, or acquisition on-market of, Shares pursuant to the Company Plans, constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA?

Answer

No.

This ruling applies for the following periods:

For ruling questions 1 to 3, the income tax years ended 30 June 20XX to 30 June 20XX.

For ruling questions 4 to 5B, the fringe benefit tax years ended 31 March 20XX to 31 March 20XX.

Relevant facts and circumstances

Company X carries on a business which produces assessable income.

Company X established employee incentive plans (collectively the Company Plans) as part of its remuneration and reward program for its employees.

Under the Company Plans:

•         Eligible employees may be invited to apply for and be granted Awards or Rights at a discount. An Award is a right to acquire one Share, and a Right is an option to acquire one Share.

•         The invitation letters issued to the eligible employees will provide the relevant terms and conditions attached to the Awards and/or Rights, including any vesting conditions and other conditions.

•         Subject to the Board's determination, the participant may also receive a cash equivalent value upon the vesting of an Award allocated to the employee.

•         It is intended that Rights issued vest and automatically exercise. Shares acquired by participants upon exercise of the Rights are subject to certain disposal restrictions.

The Company Plans allow Company X to operate a share trust for the purpose of delivering and holding Shares on behalf of participants. However, if any Awards or Rights were cash settled under the Company Plans, Company X will make the cash payment directly to the participant and the Trust will not be involved in making that cash payment.

Pursuant to the Original Trust Deed, Company X established the Trust for the sole purpose of acquiring and holding Shares or rights to acquire Shares, providing beneficial interests in those Shares or rights to acquire Shares under the Company Plans to participants, and conducting other necessary activities merely incidental to the aforementioned activities.

Prior to the Amendment Date, the trust operated under the Original Trust Deed in a particular way.

Company X subsequently made amendments to the Original Trust Deed by way of the Amended Trust Deed, with effect on and from the Amendment Date. The amendments broadly reduced the flexibility of certain clauses in the Original Trust Deed and corrected and clarified other clauses in the deed.

Company X did not act upon any clauses in the Original Trust Deed prior to the Amendment Date which would have caused the Trustee to breach the requirements of subsection 130-85(4) of the ITAA 1997.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Income Tax Assessment Act 1936 subsection 170(10AA)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 83A-105

Income Tax Assessment Act 1997 section 83A-210

Income Tax Assessment Act 1997 section 83A-340

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

Reasons for decision

Question 1

Summary

Yes, Company X will be entitled to deduct under section 8-1 the irretrievable cash contributions it made to the Trustee of the Trust to fund the subscription for, or acquisition on-market of, Shares to satisfy ESS interests issued pursuant to the Company Plans to Participants whose activities are related to generating assessable income for Company X.

Detailed reasoning

Subsection 8-1(1) allows you to 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, pursuant to subsection 8-1(2), you cannot deduct a loss or outgoing to the extent that it is a loss or outgoing of capital, or of a capital nature.

Sufficient Nexus

For a deduction to be allowable under subsection 8-1(1), there must be sufficient nexus between the loss or outgoing and the gaining or producing of assessable income.[1]

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

Under the Company Plans, Company X grants Awards or Rights to Participants of the Company Plans and each vested Award or Right entitles the Participant to one Share (or, for Awards, a cash payment equivalent to the value of one Share as determined by the Board). Company X may utilise a trust for the purposes of acquiring, holding and delivering Shares under the Company Plans. Company X makes cash contributions to the Trust to enable the Trustee to acquire Shares either on-market or by subscription for allocation to Participants.

Where the Awards granted under the Company Plans are determined by the Board to be satisfied by cash settlement, the cash payments are made directly to the Participants and do not involve the Trust.

Therefore, the cash contributions made by Company X to the Trustee for the acquisition of Shares by the Trustee to satisfy its obligations under the Company Plans arise as part of Company X's remuneration arrangements with its employees. As such, they have a sufficient nexus with the business carried on by Company X and directly relate to the production of its assessable income.

Incurred in carrying on a business

For the cash contributions 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.[2]

Broadly, an employer incurs the contribution made to an employee share trust (EST) only when the ownership of that contribution passes from the employer to the Trustee and there is no circumstance in which the employer can retrieve any of the contribution.[3]

The contributions made by Company X to the Trust are irretrievable and non-refundable to Company X in accordance with the Trust Deed as:

•         The Company may not acquire any interest in the Capital (or corpus) and may not become entitled to any Income of the Trust Fund.

•         The Company cannot be a beneficiary of the Trust.

•         Nothing in the Trust Deed confers, or is intended to confer, on the Company any Encumbrance, proprietary right or proprietary interest in the Shares acquired by the Trustee. Also, neither the Trustee nor the Company may grant an Encumbrance over any assets in the Trust.

•         Any rights or interests, including Shares, forfeited in accordance with the relevant Rules by an Allocated Beneficiary will be held as General Trust Property unless the Company Plan Rules provide otherwise. Relevantly, no Rules of the Company Plans provide that any forfeited rights or interests, including Shares, are to be transferred or returned to the Company.

•         Proceeds from selling fractions of Shares must not be paid to the Company or otherwise be held for the benefit of the Company.

•         No amendments to the Trust Deed may be made which confers on the Company any right to any money or Shares already in the hands of the Trustee at the time the alteration is made. No amendments may also be made if the amendment results in the Trustee no longer satisfying subsection 130-85(4).

•         Upon termination of the Trust, the Trustee may transfer the remaining Trust Fund or proceeds of sale of the Trust Fund to the Participants, another trustee of an employee share trust established to administer a Plan, a charity nominated by the Trustee, and/or pay certain costs and expenses incurred by the Trustee for the operation of the Trust.

Therefore the cash contributions made by Company X to the Trust are part of an on-going series of payments in the nature of remuneration of Company X's employees.

Not capital or of a capital nature

Generally, a contribution made by an employer to a trust established to provide incentive payments to participating employees will be on revenue account and is not capital or capital in nature.[4]

The costs will be an outgoing incurred for periodic funding of grants of Awards and Rights for Company X employees. The costs incurred are likely to be in relation to more than one grant of Awards or Rights (rather than being one-off), and Company X intends to satisfy outstanding Awards or Rights using shares acquired by the Trust. This indicates that the irretrievable contributions to the Trust are ongoing in nature.

The advantage provided by each payment to the Trustee does not have a lasting quality because it forms part of the broader remuneration expenditure for Company X's employees. As stated by the Federal Court in Spotlight:[5]

...the advantage to be obtained was giving staff an incentive to greater effort from year to year and was thereby related to the profitability of the taxpayer from year to year.

Therefore, the payments are not capital or of a capital nature, so paragraph 8-1(2)(a) is not satisfied.

Question 2A

Summary

Yes, if the irretrievable cash contribution made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares to satisfy ESS interests issued pursuant to the Company Plans were made before the acquisition of the relevant ESS interests by the ultimate beneficiaries, then such irretrievable cash contributions will be deductible under section 8-1 by Company X at the time determined by section 83A-210.

Detailed reasoning

Section 83A-210 applies to determine the timing of the deduction of contributions provided under an employee share scheme (ESS) arrangement, but only if the contribution is made before the ESS interest is acquired by the ultimate beneficiary under an 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. Further information is available in ATO Interpretative Decision ATO ID 2010/103 Income Tax - Employee share scheme: timing of deduction for money provided to the trustee of an employee share trust.

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 a company. The Awards and Rights issued under the Company Plans are ESS interests (if they are ultimately satisfied with Shares instead of cash settled).

The Company Plans are ESSs for the purposes of subsection 83A-10(2) as they are schemes under which ESS interests (i.e. Awards or Rights) are provided to employees (i.e. Participants) in relation to their employment with Company X.

Therefore, as section 83A-210 applies, the irretrievable cash contribution are deducted from the assessable income of Company X in the income year when the relevant ESS interest is acquired by the Participant under the Company Plans.

Indeterminate rights

However, the Awards granted under the Company Plans are indeterminate rights for the purposes of section 83A-340. That is because the Awards can be settled by either Shares or by making a payment of a cash equivalent amount. Therefore, the Awards are not rights to acquire a beneficial interest in Shares unless and until the time when it is determined by the Board that they will be satisfied by the provision of Shares.

Once it is determined that they will be satisfied by the provision of shares, section 83A-340 operates to treat these Awards as though they had always been rights to acquire beneficial interests in shares (therefore, an ESS interest) for the purposes of section 83A-210.

Section 83A-210 applies equally to contributions made in respect of ESS interests and indeterminate rights. Therefore, an irretrievable cash contribution in respect of an indeterminate right is taken to have been paid at the acquisition time of the ESS interest. If an indeterminate right becomes an ESS interest, deductible contributions made in respect of those rights can be claimed in the income year when the ESS interest is deemed to have been acquired under section 83A-340 (this will be the year in which the indeterminate right was granted to the employee). Once this has been established, such contributions can be matched to ESS interests issued to the employee and where necessary the relevant earlier income year assessments may be amended to allow the deduction (table item 28 of subsection 170(10AA) of the ITAA 1936).

It is important to note that an indeterminate right which is satisfied by the provision of cash never becomes an ESS interest and the contribution to the Trust in respect of the provision of that Award is permanently deferred. However, where that Award is subsequently issued to another Participant, this Participant becomes the 'ultimate beneficiary', and the deduction is available in the income year that this Participant acquired this Award.

Question 2B

Summary

Yes, if the irretrievable cash contribution made by Company X to the Trustee of the Trust to fund the subscription for, or acquisition on-market of, Shares to satisfy ESS interests issued pursuant to the Company Plans were made after the acquisition of the relevant ESS interests by the ultimate beneficiaries, then such irretrievable cash contributions will be deductible by Company X under section 8-1 in the income year in which the contributions were made.

Detailed reasoning

Consistent with the analysis in the reasons for Questions 1 and 2A, where the contribution is made after the acquisition of the relevant ESS interests, irretrievable cash contributions made by Company X to the Trustee to fund the subscription for, or acquisition on-market of, Shares by the Trust to satisfy the ESS interests granted to Participants will be deductible under section 8-1 in the income year in which the irretrievable cash contributions were made, because section 83A-210 does not apply to such contributions to modify the timing of the deduction.

Question 3

Summary

No, the Commissioner will not seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or in full, any deduction claimed by Company X for the irretrievable cash contributions made to the Trust to fund the subscription for, or acquisition on-market of Shares by the Trustee, to satisfy ESS interests issued pursuant to the Company Plans.

Detailed reasoning

Part IVA of the ITAA 1936 is a general anti-avoidance provision which gives the Commissioner the power to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA of the ITAA 1936 applies.

The Commissioner generally accepts that a general deduction may be available where an employer provides money or other property to an EST where the conditions of Division 83A 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 an arrangement that requires an EST.

Therefore, having regard to the eight factors set out in subsection 177D(2) of the ITAA 1936, the Commissioner has concluded that the scheme is not being entered into or carried out for the dominant purpose of enabling Company X to obtain a tax benefit.

Question 4

Summary

No, the provision of ESS interests to employees of Company X under the Company Plans will not constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

Detailed reasoning

An employer's liability to fringe benefits tax (FBT) arises under section 66 of the FBTAA, which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer for the relevant year of tax.

In general terms, a 'fringe benefit' is defined in subsection 136(1) of the FBTAA 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 a fringe benefit by virtue of paragraphs (f) to (s) of the definition of fringe benefit.

In particular, paragraph (h) of the definition of fringe benefit excludes the following from being a fringe benefit:

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

As discussed above, the Commissioner accepts that the Company Plans are ESSs. Specifically, the Awards and Rights provided under the Company Plans (that are ultimately satisfied with Shares instead of cash) are ESS interests for the purposes of subsection 83A-10(2) by virtue of section 83A-340 and the Company Plans are schemes under which ESS interests in Company X are provided to the Company X employees in relation to their employment with Company X.

As the ESS interests (Awards and Rights) are granted under the Company Plans at a discount, Subdivision 83A-B applies to the ESS interests, unless the conditions in subsection 83A-105(1) are satisfied, in which case Subdivision 83A-C applies.

Accordingly, the provision of Awards and Rights under the Company Plans (that are ultimately satisfied with Shares) will not constitute a fringe benefit by virtue of paragraph (h) of the definition of fringe benefit in subsection 136(1) of the FBTAA.

In addition, the later exercise of an Award or Right will not give rise to a fringe benefit as defined in subsection 136(1) of the FBTAA as any benefit received by the employee (i.e. the beneficial interest in a Share) would be in respect of the exercise of the Award or Right under the Company Plans and not in respect of employment (refer to ATO Interpretative Decision ATO ID 2010/219 Fringe Benefits Tax Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme).

For completeness, where a Participant's Awards granted under the Company Plans are ultimately satisfied with cash instead of Shares, the granting of the Awards will be viewed as a series of steps in the payment of salary or wages which are excluded from being a fringe benefit by paragraph (f) of the definition of fringe benefit in subsection 136(1) of the FBTAA.

This outcome is consistent with ATO Interpretative Decision ATO ID 2010/142 Fringe Benefits Tax Employee share scheme: indeterminate rights not fringe benefits.

Question 5A

Summary

No, the irretrievable cash contributions made by Company X to the Trustee pursuant to the Original Trust Deed, to fund the subscription for, or acquisition on-market of, Shares pursuant to the Company Plans, will not constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

Detailed reasoning

Another type of benefit excluded from being a fringe benefit, pursuant to paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA, is a benefit constituted by the acquisition of money or property by an EST within the meaning of the ITAA 1997.

Therefore, for the irretrievable cash contributions made pursuant to the Original Trust Deed to be excluded from the definition of fringe benefit, the Trust must be an EST as defined in subsection 130-85(4).

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. To qualify as an EST, a trustee's activities must be limited to:

•         obtaining shares or rights in a company (paragraph 130-85(4)(a))

•         ensuring that ESS interests in the company that are beneficial interest in those shares or rights are provided under the ESS to employees, or to associates of employees, of the company or a subsidiary of the company (paragraph130-85(4)(b)), and

•         other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b) (paragraph 130-85(4)(c)).

•         Paragraphs 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 Awards where they are not cash settled and the Rights) are provided under an ESS (that is, the scheme established by the Company Plans) by allocating those ESS interests to Company X employees in accordance with the Trust Deed and the Rules of the Company Plans.[6]

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.

Paragraph 6 of TD 2019/13 states that, whilst the relevant trust documents may include powers and/or duties that are broad reaching, the mere existence of those powers or duties in the trust documents does not, of itself, mean that the trustee has breached the requirements to be an employee share trust. Prior to the Trust being amended by the Amended Trust Deed with effect on and from the Amendment Date, whilst the Original Trust Deed contained certain clauses that provided broad flexibilities, the Trustee has not undertaken any activities under the Original Trust Deed which would have caused the Trust to fail the requirements of subsection 130-85(4).

Accordingly, the Commissioner is satisfied that the Trust as operated under the Original Trust Deed is an EST as defined in subsection 130-85(4).

Therefore, the irretrievable cash contributions made Company X pursuant to the Original Trust Deed will not constitute a fringe benefit within the meaning of section 136(1) of the FBTAA as they are excluded by paragraph (ha) of the definition of fringe benefit under subsection 136(1) of the FBTAA.

Question 5B

Summary

No, the irretrievable cash contributions made by Company X to the Trustee pursuant to the Amended Trust Deed, to fund the subscription for, or acquisition on-market of, Shares pursuant to the Company Plans, will not constitute a fringe benefit within the meaning of subsection 136(1) of the FBTAA.

Detailed reasoning

Consistent with the reasons for Question 5A, for the irretrievable cash contributions made pursuant to the Amended Trust Deed to be excluded from the definition of fringe benefit, the Trust as operated under the Amended Trust Deed must continue to be an EST as defined in subsection 130-85(4).

The Trust as operated under the Amended 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 as operated under the Amended Trust Deed is an EST as defined in subsection 130-85(4).

Therefore, the irretrievable cash contributions made by Company X pursuant to the Amended Trust Deed will not constitute a fringe benefit within the meaning of section 136(1) of the FBTAA as they are excluded by paragraph (ha) of the definition of fringe benefit under subsection 136(1) of the FBTAA.

[1] Ronpibon Tin NL v Commissioner of Taxation (Cth) [1949] HCA 15.

[2] Commissioner of Taxation (Cth) v James Flood Pty Ltd [1953] HCA 65. See also Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions and Taxation Ruling TR 94/26 Income tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance.

[3] Pridecraft Pty Ltd v. Federal Commissioner of Taxation [2004] FCAFC 339 (Pridecraft) and Spotlight Stores Pty Ltd v. Commissioner of Taxation [2004] FCA 650 (Spotlight).

[4] See Spotlight which was affirmed by the Full Federal Court in Pridecraft.

[5] Spotlight at paragraph 71.

[6] Note that the beneficial interest in the share acquired on exercise of the rights is itself provided under an ESS because it is provided under the same ESS under which the rights are provided to the employee in relation to the employee's employment.