Edited version of private advice

Authorisation Number: 1052117906580

Date of advice: 12 May 2023

Ruling

Subject: Employee share trust

Question 1

Will the irretrievable cash contributions made by the Entity A Group to the Trustee to fund the subscription for Entity A shares by the Trust for the purposes of the employee incentive plan be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a capital gain or capital loss that arises for the Trustee at the time when the eligible employees (Participants) become absolutely entitled to Entity A shares be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee?

Answer

Yes.

Question 3

Will contributions by Entity A or any subsidiary member to the Trustee to fund the subscription for Entity A shares by the Trust for the purposes of the Plan be treated as a deemed dividend within the meaning of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 4a

If the Trustee receives and accumulates dividends on unallocated Shares held in the Trust, will the dividend and any franking credit be taxable to the Trustee?

Answer

Yes.

Question 4b

If the Trustee receives and accumulates dividends on unallocated Shares held in the Trust, will the Trustee be entitled to a tax offset for any franking credits attaching to the dividend?

Answer

Yes.

Question 5a

If the Trustee receives a dividend on Allocated Shares held for a Participant in the Trust during an income year and applies Trust property representing it for the benefit of the Participant by the end of the income year, will the dividend and any franking credit be included in the Participant's assessable income?

Answer

Yes.

Question 5b

If the Trustee receives a dividend on Allocated Shares held for a Participant in the Trust during an income year and applies Trust property representing it for the benefit of the Participant by the end of the income year, will the Participant be entitled to a tax offset for any franking credits attaching to the dividend?

Answer

Yes.

This ruling applies for the following periods:

1 January 20XX to 31 December 20XX

1 January 20XX to 31 December 20XX

1 January 20XX to 31 December 20XX

1 January 20XX to 31 December 20XX

1 January 20XX to 31 December 20XX

The scheme commenced on:

1 January 20XX

Relevant facts and circumstances

This private ruling is based on the facts and circumstances set out below. If your facts and circumstances are different from those set out below, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Entity A is an Australian private company.

Entity A is the parent company of an income tax consolidated group.

Entity A conducts a business.

The Entity A Group remunerates employees by evaluating comparable positions in similar companies and industries.

The Entity A Group is seeking to implement the employee share scheme (ESS) to reward certain key employees for their contribution to the company's success and share in the growth of the company. Employees within the Entity A Group will be eligible to participate in the Plan and may be granted stock options that can be exercised to receive shares in Entity A, subject to satisfying the vesting conditions.

The Plan

The Employee Share Option Plan (the Plan) is a plan to which Subdivision 83A-B of ITAA 1997 applies.

The Plan rules broadly operate to provide eligible employees (Participants) with the opportunity to acquire stock options to receive shares in Entity A. In order to receive shares, the Participant must satisfy all relevant vesting criteria in accordance with the Plan rules.

Where the vesting criteria are satisfied, then following payment of any exercise price, the Participant will be entitled to shares in Entity A (one ordinary share for every stock option). The exercise price will be at least equal to the fair market value of the underlying share on the date of grant, unless otherwise stated in the Offer Letter.

The Board intends to nominate the Trust for the purposes of administering the Plan. Those shares will be held under the Trust on behalf of the Participant subject to conditions as specified in the Plan rules. Once those conditions are satisfied, the Participant can withdraw the shares from the Trust.

The Plan must be operated in accordance with the terms of the EST Trust Deed and the Rules of this Plan.

The Trustee must follow the directions given to it by the Board of Entity A or the Group in relation to the rules of this Plan.

The Plan rules bind each Group Taxpayer and each Participant. Unless the Board of Entity A or the Group so decides, the following will apply:

•         Invitations to participants who, subject to approval from trustee and Board, are invited to apply for and participate in the Plan through the issue of an Offer Letter for eligible employees.

•         The Trustee will allocate shares to each Participant according to the rules in this Plan Rules and the EST Trust Deed.

•         The Board shall determine the terms and conditions of any Offer.

•         the Acquisition Price will, unless otherwise determined, be equal to the Fair Market Value of the Shares the subject of the Offer.

•         No payment is required for the grant of the Options.

•         Subject to these Rules and the EST Trust Deed, the Trustee appointed shall have the power to:

o   Grant the Plan offer to Eligible Employees.

o   The vesting of a Participant's Options is subject to the satisfaction of the vesting conditions being performance and time related.

o   Where the vesting criteria are satisfied, then following payment of any exercise price, the Participant would be entitled to one ordinary Share of Entity A for every option.

o   The Trustee to subscribe for, acquire and allocate to the Participant one Share for each option exercised and hold those shares in the EST on behalf of the Participant.

o   Trustee upon receiving the funds from the Taxpayer will subscribe for, and/or acquire Shares to be held on behalf of the Participants under the Plan.

o   Those Shares will be held under the EST on behalf of Participants, subject to conditions which will be specified in the rules in this document and the EST Trust Deed. Once conditions are satisfied, the Trust would distribute Entity A's Shares to the Participant.

o   All ordinary Shares that are issued on the exercise of a Stock Option should rank equally with other ordinary shares in Entity A.

o   Participants will be entitled to dividends from the date vesting conditions are satisfied and ordinary Shares under the Plan are issued to the Participant.

o   The Trustee must transfer the legal title of the shares to the Participants.

o   The Trustee must not accept any Share rights entitlement in respect of the Plan which are not allocated to any Participants.

o   If the Trustee holds the Share on behalf of a Participant and an accretion arises other than by way of cash distributions, bonus shares or share rights, then, subject to the Law, the relevant Participant is absolutely entitled to that accretion and the Trustee must follow the decision of the Board to transfer, or provide the benefit of, all or any part of the accretion to the Participant.

•         immediately upon granting the shares to the Participant, no one Participant may hold a beneficial interest in more than 10% of the shares.

•         the share options must be held for at least 3 years 'minimum holding' period (unless termination of employment).

•         the EST must be administered in such a way to comply with the sole activities test.

•         the trustee is not to pass dividends to Participants if the shares owned by the Trust is not yet allocated to the Participants. Income derived by the Trust through dividends paid on Entity A's shares held by the Trust can only be passed to the Participants who have been allocated the shares.

•         if the Participant decides not to exercise any Option(s), the unexercised Option(s) will lapse on the Expiry Date.

•         The Participant is not permitted to transfer, sell, assign or otherwise dispose of any Options (Vested or Unvested) or any Shares acquired as a result of exercising their Options, for the Minimum Holding Period of 3 years starting from the issue date or start date of the employee.

•         Unless otherwise determined by the Board, Entity A must pay all costs, charges and expenses relating to the establishment and operation of the Plan.

Employee share trust

The Trust has been established as a sole-purpose trust to acquire and hold shares on behalf of employees of Entity A and their associates (Participants) pursuant to the proposed and any future potential employee equity plans.

The Trust provides an arm's length vehicle through which shares in Entity A can be acquired and held on behalf of Participants. This allows Entity A to satisfy Corporations Law requirements relating to companies dealing in their own shares.

Broadly, the Trust will operate as follows:

•         The Trust is to be funded by irretrievable contributions from Entity A (or one of its wholly owned Australian resident subsidiaries). All funds received by the Trustee from Entity A will constitute Accretions to the corpus of the Trust and will not be repaid to Entity A or any subsidiary and no Participant will be entitled to receive such funds.

•         The funds are to be used by the Trustee to acquire shares in Entity A via the subscription for new shares in Entity A, based upon written instructions from Entity A.

•         Irretrievable cash contributions are to be made regularly and progressively to the Trust in accordance with the Plan Rules and the Trust Deed.

•         Shares acquired by the Trustee must be allocated to the relevant Participant and held on their behalf. Each Participant is the beneficial owner of the shares held by the Trustee on their behalf and is absolutely entitled to all other benefits and privileges attached to those shares.

•         After the vesting conditions are met (stock options vest and are exercised, or the holding period ends), the Trustee must transfer the relevant number of shares into the name of the Participant (i.e., legal title) upon direction from Entity A to the Trustee.

•         Entity A does not have any charge, lien, or other proprietary right or interest in the shares acquired by the Trustee according to the Trust Deed.

•         No member of Entity A, its subsidiaries, or the Trustee is entitled to obtain any beneficial interest in the Trust Assets.

•         Upon termination of the Trust, the Trustee must not pay any Trust Assets to Entity A or any of its subsidiaries.

•         Neither Entity A nor any of its subsidiaries are a beneficiary of the Trust.

•         The Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of subsection 130-85(4) of the ITAA 1997.

The Trust may acquire shares that are not allocated to Participants (unallocated Shares) to satisfy future obligations under the Plan to the extent that there are stock options granted to Participants that have not yet vested or vested stock options that have not yet been exercised.

Whilst Entity A intends to wait until the stock options vest and to receive the exercise notice and exercise price (if applicable) from Participants before providing the Trust with the cash necessary to acquire shares to satisfy the acquisition of or subscription for shares related to those stock options, Entity A may make cash contributions to the Trust prior to the stock options being exercised by the Participants.

This will allow the Trustee to have enough shares in the Trust ahead of the time they need to be allocated to Participants and avoids delays in times such as blackout trading periods and take advantage of any reductions in Entity A share price from time to time.

The Entity A Group will incur administration expenses for operating the ESS. These will form part of the consolidated income tax return that will be lodged by Entity A as the head company of the income tax consolidated group.

The Trust Deed states that:

•         the trust property is to be held by the Trustee on trust for the Participants from time to time in accordance with the terms of this deed.

•         defines the sole activities test as the test under subsection 130-85(4) of the ITAA 1997.

•         the Trustee must follow directions given to it by the Board of Entity A in relation to the rules and operation of the Trust.

•         the Trustee must not grant a Security Interest over any Plan Security.

•         Entity A must pay all Trust Expenses.

•         the Trustee has the power to undertake activities to operate the Trust described in paragraphs 130-85(4)(a), (b) and (c) of the ITAA 1997;

•         unless and until Plan Securities are allocated to a Participant, no Participant has any interest in any particular Plan Security or any other part of the Trust Property.

•         nothing in the Trust Deed confers, or is intended to confer, on any Taxpayer Group any Security Interest, proprietary right, proprietary interest or beneficial interest in the Plan Securities or any other Trust Property acquired by the Trustee in accordance with this deed or the Trust.

•         the Trustee must transfer Plan Securities to Participants as directed by Entity A.

•         on termination of the Trust, the Trustee must:

o   transfer to each Participant the number of Plan Securities held by the Trustee for that Participant;

o   if there is any Trust Property remaining following completion of the transfers deal with the remaining Trust Property in accordance with the written instructions of Entity A which cannot direct any remaining Trust Property to be transferred to itself or Entity A Group; and

o   wind the Trust up.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 44(1)

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Subsection 97(1)

Income Tax Assessment Act 1936 Section 98

Income Tax Assessment Act 1936 Section 99A

Income Tax Assessment Act 1936 Former Division 1A of Part III

Income Tax Assessment Act 1936 Former Section 160APHO

Income Tax Assessment Act 1936 Former Subsection 160APHO(3)

Income Tax Assessment Act 1936 Former Subsection 160APHM(2)

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 Division 67

Income Tax Assessment Act 1997 Subsection 67-25(1)

Income Tax Assessment Act 1997 Subsection 67-25(1B)

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Section 83A-10

Income Tax Assessment Act 1997 Subsection 83A-10(1)

Income Tax Assessment Act 1997 Subsection 83A-10(2)

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

Income Tax Assessment Act 1997 Paragraph 130-85(4)(a)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(b)

Income Tax Assessment Act 1997 Paragraph 130-85(4)(c)

Income Tax Assessment Act 1997 Subsection 130-90(1)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 Subsection 207-5(3)

Income Tax Assessment Act 1997 Subdivision 207-A

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1

Summary

The irretrievable cash contributions made by the Entity A Group to fund the acquisition of Entity A Shares by the Trust will not be assessable income of the Trust under sections 6-5 or 6-10 of the ITAA 1997.

Detailed reasoning

Irretrievable cash contributions

It must be determined as a conclusion of fact whether the contributions made by Entity A to the Trustee are irretrievable cash contributions.

The Trust Deed outlines that the Trustee holds the Trust Fund on trust for all beneficiaries, in the manner required by the Scheme Rules and that it may apply any part of the general trust property for the benefit of the beneficiaries. The Trustee must comply with any direction of the Board to acquire Shares on behalf of a Participant in accordance with the relevant Rules and must apply any amount paid to it by a Group Company or a Participant pursuant to the relevant Rules in accordance with any such direction of the Board.

The Trust Deed enables the Trustee to discharge its obligations under the Trust Deed and Scheme Rules and for no other purpose. Accordingly, a refund of any contributions by the Trustee would be in breach of the powers of the Trustee under the Trust Deed.

The Trust Deed states that Entity A and each of its group companies are not beneficiaries of the Trust and have no entitlement to any Shares forming part of the Trust Fund at any time. Accordingly, a contribution made to the Trust will not be refundable or retrievable by Entity A.

In conclusion, the above clauses support the conclusion that the cash contributions made by Entity A to the Trustee are irretrievable cash contributions.

Assessable income of the Trust under section 6-5 or 6-10

Section 95 of the Income Tax Assessment Act 1936 (ITAA 1936) defines net income in relation to a trust as follows, insofar as it is relevant:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions ...

Subsection 6-5(1) of the ITAA 1997 states:

Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Subsection 6-10(1) of the ITAA 1997 states:

Your assessable income also includes some amounts that are not ordinary income.

Note: These are included by provisions about assessable income. For a summary list of these provisions, see section 10-5.

The irretrievable cash contributions made by Entity A to the Trust are unlike those provisions listed in section 10-5 of the ITAA 1997. Therefore, irretrievable cash contributions made by Entity A to the Trust will not be assessable income under section 6-10. They will only be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6-5.

Pursuant to the Trust Deed, all contributions by Entity A to the Trust for the purposes of acquiring Entity A Shares constitute accretions to the corpus of the Trust. Furthermore, pursuant to the Trust Deed, the Trustee must, when directed by the Board, acquire Entity A Shares on behalf of the Participants and use the contributions made by Entity A (and the Participants) to do so.

The general powers granted to the Trustee in the Trust Deed are specifically restricted so that these powers must be exercised only for the purposes of the Trust and only to give effect to the Option Plan which the Trust supports. To this end, the contributions received from Entity A and the Participants must, therefore only be used to acquire Entity A Shares in accordance with the terms of the Trust Deed and the Scheme Rules. The Trust Deed states that Entity A (and each group company) is not a beneficiary and has no entitlement to any Shares forming part of the Trust Fund at any time. Accordingly, the irretrievable cash contributions made by Entity A to the Trustee to acquire Entity A Shares will not be assessable income under section 6-5 of the ITAA 1997 but constitute capital receipts of the Trustee.

Therefore, the irretrievable cash contributions made by Entity A to the Trustee of the Trust to fund the subscription for, or acquisition of Entity A Shares by the Trust in accordance with Trust Deed of the Trust will not be assessable income of the Trust pursuant to sections 6-5 or 6-10 of the ITAA 1997. This accords with the view expressed in ATO Interpretative Decision ATO ID 2002/965 Trustee not assessable on employer contributions made to it under the employer's employee share scheme. The Trust Deed provides that Entity A may pay from its own resources any fees, commission or remuneration and reimburse any costs or expenses incurred by the Trustee as Entity A and the Trustee may agree from time to time.

Note also that income derived by the employment of the property that is the fund of the corpus of the trust and which the Trustee holds on trust will be income according to ordinary concepts. (See Federal Commissioner of Taxation v Everett (1980) 143 CLR; 440; (1980) 10 ATR 608; 80 ATC 4076 for a discussion of the distinction between the trust income and corpus).

Question 2

Summary

A capital gain or capital loss that arises for the Trustee at the time when the Participants become absolutely entitled to Entity A Shares (CGT event E5) or when the Trustee disposes of the Shares to the Participants (CGT event E7) will be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee.

Detailed reasoning

Employee share trust

The term 'employee share trust' referred to in subsection 130-90(1) of the ITAA 1997 is defined in subsection 995-1 as having the meaning given by subsection 130-85(4).

Subsection 130-85(4) of the ITAA 1997 provides that an employee share trust for an employee share scheme (having the meaning given by subsection 83A-10(2)) is a trust whose sole activities are:

130-85(4) An employee share trust, for an *employee share scheme, 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).

The right to acquire a share and the beneficial interest in the share that is acquired pursuant to the exercise of the option are both ESS interests within the meaning of subsection 83A-10(1) of the ITAA 1997.

An employee share scheme is defined in subsection 83A-10(2) of the ITAA 1997 as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

The Plan is an employee share scheme within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which rights to acquire Shares in Entity A are provided to employees in relation to their employment.

Entity A has established the Trust to facilitate the Plan by acquiring Entity A shares and allocating those shares to Participants, in order to satisfy the Options acquired under the employee share scheme. The beneficial interest in the Entity A share is itself provided under an employee share scheme because it is provided under the same Scheme under which the Options to acquire the Entity A Shares are provided to the Participant in relation to the Participant's employment, being an employee share scheme as defined in subsection 83A-10(2) of the ITAA 1997.

Therefore, paragraphs 130-85(4)(a) and (b) of the ITAA 1997 are satisfied because:

•         the Trustee acquires Entity A Shares, and

•         the Trustee ensures that ESS interests as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in those Shares, are provided under an ESS, as defined in subsection 83A-10(2), by allocating those Shares to the Participants in accordance with the governing documents of the Scheme.

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will also require that the Trustee undertake incidental activities that are a function of managing the Trust.

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). 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? (TD 2019/13).

Paragraph 12 of TD 2019/13 list examples of activities which are merely incidental for the purposes of paragraph 130-85(4)(c) of the ITAA 1997 that include (but not limited to):

• the opening and operation of a bank account to facilitate the receipt and payment of money
• bookkeeping, preparing financial, tax and regulatory statements, and other record-keeping and administrative actions necessary to operate the trust and undertake the activities described in paragraphs 130-85(4)(a), (b) and (c)
• the receipt of dividends in respect of shares held by the trustee on behalf of a participating employee and their distribution to the employee
• borrowing money for the purpose of acquiring shares or rights in the employer company, where no security is provided over the trust assets and the interest payable on such a loan is not more than arm's length commercial rates
• the receipt of dividends in respect of unallocated shares and interest from bank accounts and using those funds to:
  • acquire additional shares for the purposes of the ESS
  • pay necessary and incidental costs of administering the trust and undertaking the activities described in paragraphs 130-85(4)(a), (b) and (c), for example costs relating to the audit of the trust, fees for professional services provided to the trustee in relation to the trust
  • pay interest on loans provided for the acquisition of shares or rights in the employer company, where the interest payable does not exceed arm's length commercial rates
• paying a dividend equivalent payment to a participating employee under the rules of the ESS, where
  • the amount paid is equal to or less than the amount of dividends paid to the trustee (net of tax paid by the trustee on the dividends), in relation to the number of shares being received by the participating employee, during the accumulation period, and
  • the payment is made at or around the time, and because, the shares vest or are transferred to the participating employee (as required by the ESS)
• dealing with shares forfeited under an ESS including the sale of forfeited shares and using the proceeds of sale for activities permitted under subsection 130-85(4)
• the transfer of shares to participating employees, or the sale of shares on behalf of such employees and the transfer to the employee of the net proceeds of the sale of those shares, when required under the rules of the ESS, and
• receiving and immediately distributing shares under a demerger or actions in order to participate in a takeover or restructure covered by section 83A-130.

Activities that result in employees being provided with additional benefits are not considered merely incidental.

Paragraph 13 of TD 2019/13 lists examples of activities that are not merely incidental for the purposes of paragraph 130-85(4)(c) of the ITAA 1997 that include (but not limited to):

• providing financial assistance, such as providing a loan to an employee to purchase shares or interests in the employer company
• payment of income or accrued capital from unallocated shares to any beneficiaries (or to employees who do not hold a beneficial interest in the employer company under the trust)
• waiving or relinquishing certain entitlements, such as waiving the right to be paid or credited dividends pursuant to a dividend waiver clause contained in the governing trust documents
• exercising a general discretion to make distributions of income or capital to pay a class of participating employees or other beneficiaries of the trust amounts unrelated to their ESS interests or entitlements under the ESS rules
• borrowing money:
  • for a purpose other than purchasing shares or rights in the employer company, or
  • with security provided over any of the trust's assets for the loan, or
  • where the interest payable on the loan is more than arm's length commercial rates
• investing in assets other than shares or rights to shares in the employer company
• engaging in trading activities in relation to shares in the employer company, other than purchasing and selling shares to satisfy obligations under the ESS
• distributing mainly cash payments to participating employees rather than shares or ESS interests under the ESS
• providing additional benefits to participants and/or employees, over and above the delivery of the ESS interests or resulting shares and any dividend equivalent payment that accrues directly from the employee's ESS interest.

Trust Deed also states that it will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the ITAA 1997.

The background section of the Trust Deed reinforces this as it states that Entity A has established a Trust for the purpose of administering the current and future employee incentive plans established by Entity A for the benefit of Participants in those plans.

The Trust Deed supports the conclusion that the Trustee can only use the contributions received from Entity A for the acquisition of Entity A Shares for Participants in accordance with the Plan. To this end, all other duties/general powers listed in the Trust Deed that meet the requirements in paragraph 12 of TD 2019/13 are considered to be merely incidental to the functions of the Trustee in relation to its dealing with Entity A Shares to be acquired for Participants of the Plan.

Accordingly, paragraph 130-85(4)(c) of the ITAA 1997 is also satisfied because the Trust satisfies the definition of an employee share trust in subsection 130-85(4), as the Trust Deed does not provide for the Trustee to participate in any activities which are not considered merely incidental to a function of managing the employee share scheme and administering the Trust.

Therefore, the Trust is an employee share trust, as defined in subsection 995-1(1) of the ITAA 1997, as the activities of the Trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) and its other activities (general powers) are merely incidental to those activities in accordance with paragraph 130-85(4)(c).

The operation of section 130-90

This provision provides that a capital gain or loss can be disregarded when a CGT event E5 or E7 occurs for options acquired as part of an employee share scheme. However the exercise price must not exceed the cost base of share at the time that the CGT event E5 or E7 occurs. It states:

Shares held to satisfy the future exercise of rights acquired under employee share schemes

130-90(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.

130-90(2) Subsection (1A) or (1) does not apply if the beneficiary acquired the beneficial interest in the *share for more than its *cost base in the hands of the *employee share trust at the time the *CGT event happens.

Paragraph 130-90(1)(a)

When the Participants become absolutely entitled to Entity A Shares - CGT event E5

Subsection 104-75(1) of the ITAA 1997 provides that 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. Subsection 104-75(3) provides that the trustee will make a capital gain if the market value of the asset (at the time of the event) is more than its cost base, but will make a capital loss if that market value is less than the asset's reduced cost base.

Subdivision 130-D of the ITAA 1997 treats an employee who acquires an ESS interest through an ESS to be 'absolutely entitled' to the share or right to which the ESS interest relates, from the time that they acquire the ESS interest (subsections 130-85(1) and 130-85(2)).

Under the Plan, where a Participant becomes absolutely entitled to Entity A Shares as against the Trustee, CGT event E5 will occur, and pursuant to subsection 104-75(3) of the ITAA 1997, the Trustee will make a capital gain or loss.

When the Trustee disposes of Entity A Shares to the Participants - CGT event E7

Subsection 104-85(1) of the ITAA 1997 provides that 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.

However, subsection 106-50(1) of the ITAA 1997 provides:

If you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), this Part and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.

The Participant, on allocation of Entity A Shares by the Trustee, becomes absolutely entitled to those Shares. In accordance with the Trust Deed each Participant is absolutely entitled to any allocated Shares held by the Trustee on their behalf, and is entitled to the same rights in those Shares as if he or she was the legal owner of the Shares (subject to the Plan and terms of participation).

Once the Participants are absolutely entitled to the Entity A Shares held on their behalf by the Trust, section 106-50 of the ITAA 1997 will deem the disposal of them by the Trustee to be done by the Participants.

Therefore, section 106-50 of the ITAA 1997 will apply, such that if the Trustee disposes of Entity A Shares under the Plan (by way of transfer to Participants), the Trustee will not make a capital gain or capital loss under CGT Event E7.

Paragraph 130-90(1)(b)

Subsection 995-1(1) of the ITAA 1997 defines a share to mean a share in the capital of a company. A share held by the Trustee of the Trust and to which a participant is entitled to upon the exercising of an option is a share in the capital of Entity A. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c)

Paragraph 130-90(1)(c) of the ITAA 1997 is satisfied as a participant will have acquired a beneficial interest in a share in Entity A by the exercising of an option granted under the plan.

Paragraph 130-90(1)(d)

Subsection 83A-20(1) of the ITAA 1997 states:

This Subdivision applies to an *ESS interest if you acquire the interest under an *employee share scheme at a discount.

The term 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997 as:

An employee share scheme is a *scheme under which *ESS interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:

(a)  the company;....

in relation to the employees' employment.

For the purposes of subsection 83A-10(2) of the ITAA 1997, section 995 defines the term 'scheme' as follows:

scheme means:

(a) any *arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest (i.e. a beneficial interest in a right to acquire a beneficial interest in a Share of Entity A), is provided to eligible employees in relation to their employment in Entity A in accordance with the Trust Deed.

The exercise price will be at least equal to the fair market value of the underlying share on the date of grant of the option, unless otherwise stated in the Offer Letter. You have advised that Entity A will pay the Trustee funds to acquire the Entity A shares for the Plan. That when the Trust acquires the Entity A shares it will do so at fair market value. As such, the exercise price paid by the Participant will not exceed the cost base when a CGT event E5 or E7 occurs. As the share price paid by the Trust to acquire those Shares will also be at least fair market value.

Accordingly, prima facie, Subdivision 83A-B will apply to the options acquired under the Plan as pursuant to subsection 83A-20(1) of the ITAA 1997, the ESS interest will be acquired under an employee share scheme at a discount (assuming the interest has appreciated over time).

It should be noted however that whether a Participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

Subsection 130-90(2)

Provided a Participant does not acquire the beneficial interest in the Share for more than its cost base in the hands of the Trust at the time that CGT event E5 happens, subsection 130-90(1) will apply to disregard any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening.

Conclusion

Accordingly, section 130-90 of the ITAA 1997 operates to disregard any capital gain or loss made by the Trustee on the Shares.

Question 3

Summary

Contributions made by Entity A or any subsidiary member to the Trustee will not be deemed dividends under section 109C of the ITAA 1936, as its operation would be excluded under subsection 109ZB(3).

Detailed reasoning

Division 7A of the ITAA 1936 deals with the circumstances under which certain payments made by a private company will be treated as dividends.

Payments treated as dividends

Subsection 109C(1) of the ITAA 1936 states that a private company is taken to pay a dividend to an entity if the private company makes a payment to the entity during the year and either:

•         the entity is a shareholder or an associate of the shareholder in the company at the time of the payment; or

•         a reasonable person would conclude that the payment was made because the entity has been a shareholder or associate at some time.

An entity is defined in subsection 960-100(2) of the ITAA 1997 and includes the trustee of a trust.

Upon initial set up of the Trust, due to timing events, the Trustee will not hold Shares when contributions are made by Entity A. Consequently the contributions would not be deemed to be a dividend under section 109C of the ITAA 1936.

However, the contributions made by Entity A to the Trustee would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Entity A Shares at the time the contribution is made. Subsection 109C(2) of the ITAA 1936 would then apply to treat the amount of the contributions to be a deemed dividend, subject to Entity A 's distributable surplus for the relevant income year.

Exception

Certain payments made by a private company to an entity are excluded from the operation of section 109C of the ITAA 1936.

Section 109ZB(3) of the ITAA 1936 provides that Division 7A does not apply to a payment made to a shareholder, or shareholder's associate, in their capacity as an employee or an associate of an employee.

Subsection 109ZB(3) of the ITAA 1936 appears within a provision designed to set an 'ordering' between Division 7A and the fringe benefits tax provisions in the FBTAA. Specifically, what is meant by 'an employee' for the purpose of this provision takes on the meaning it is given in the FBTAA. Paragraph 36 of Taxation Ruling TR 2018/07 Income tax: employer remuneration trusts, states that in considering benefits provided to employees or associates of employees in the context of the FBTAA (specifically, in the definition of a 'fringe benefit'), Edmonds J in FC of T v Indooroopilly Children Services (QLD) Pty Ltd [2007] FCAFC 16 [35] concluded that the reference to an employee is a reference to a particular employee.

The Trustee is an associate of any Entity A employee who is a beneficiary of the Trust as defined in sections 109ZD and 318 of the ITAA 1936. Contributions are made by Entity A to the Trustee once the Board resolves to provide a particular Participant a Share. At the time of each contribution, the Board will provide the Trustee a notice listing Entity A 's employees, for whom the contribution is being made, i.e. the portion of the contribution and the applicable number of Shares to be acquired in respect of each employee. As the contribution would be made to the Trustee in respect of a particular Entity A employee they would satisfy section 109ZB of the ITAA 1936.

Therefore, the contributions made by Entity A to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936, as its operation would be excluded under section 109ZB.

Question 4a

Summary

If the Trustee chooses to accumulate dividends on unallocated shares, instead of allocating the dividends for the benefit of eligible employees and distributing that income to the eligible employee, then the Trustee will pay tax on the dividend income. The franking credit attached to those dividends will be included in the assessable income of the trust.

Detailed reasoning

Subsection 95(1) of the ITAA 1936 defines 'net income', in relation to a trust estate, to mean the total assessable income of the trust estate calculated under the ITAA 1936 as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions.

Pursuant to subsection 44(1) of the ITAA 1936, the assessable income of a resident shareholder includes dividends that are paid to the shareholder by the company out of profits derived by it from any source.

Subsection 6-5(1) of the ITAA 1997 states that your assessable income includes income according to ordinary concepts, which is called ordinary income.

Subsection 6-10(1) of the ITAA 1997 states that your assessable income also includes some amounts that are not ordinary income.

Section 10-5 of the ITAA 1997 provides that dividends assessable under subsection 44(1) of the ITAA 1936 and credits on franked dividends pursuant to subsections 207-20(1), 207-35(1) and 207-35(3) are to be included in assessable income. Therefore, dividends and other income received by the Trustee on Unallocated Shares are required to be included in calculating the net income of the Trust as defined under subsection 95(1).

Subsection 97(1) of the ITAA 1936 determines the assessable, exempt and non-assessable non-exempt income of a beneficiary who is not under a legal disability and who is presently entitled to a share of the income of the trust estate. When no beneficiary is presently entitled to the income of a trust estate, the net income of the estate will be taxed in the hands of the trustee under either section 99 or 99A. Section 99A will apply unless excluded in accordance with subsection 99A(2).

Where no part of the net income of a resident trust estate is included in the assessable income of a beneficiary of the estate pursuant to section 97 of the ITAA 1936, the trustee is assessed and liable to pay tax on the net income (as defined in subsection 95(1) and pursuant to subsection 99A(4)).

The Trust Deed provides that unless and until Plan Securities are allocated to a Participant under clause 7.2, no Participant has any interest in any particular Plan Security or any other part of the Trust Property. The Participants would only be deemed to be presently entitled to franked distributions on unallocated Shares if the Trustee allocates those distributions to the Participants. If the Trustee does not allocate the distributions on unallocated shares to Participants, then the distributions would be accumulated as an accretion to the Trust Fund.

Accordingly, the Trustee will be assessed under section 99A of the ITAA 1936 on that part of the net income of the trust estate which relates to Unallocated Shares to the extent the net income is not included in the assessable income of a Participant.

Question 4b

Summary

The Trustee will be entitled to a tax offset for any franking credits attached to dividends received on unallocated shares and accumulated in the Trust, provided the Trustee holds the shares at risk for a continuous period of at least 45 days during the qualification period.

Detailed reasoning

Section 207-45 of the ITAA 1997 provides that an entity to whom a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution.

The note to section 207-45 of the ITAA 1997 explains that the entities in the section are the ultimate recipients of the distribution because the distribution does not flow indirectly through them to other entities and are the ultimate taxpayer to acknowledge the tax already paid in respect of the profits underlying the distribution.

Where a franked distribution is made to the Trustee and the Trustee is liable to a share of the trust's net income for that income year under section 99A of the ITAA 1936, a franked distribution is taken to flow indirectly to the trustee.

Where a franked distribution flows indirectly to a taxpayer, paragraph 207-150(1)(a) of the ITAA 1997 will deny a tax offset otherwise provided under section 207-45 if the taxpayer is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

The former section 160APHO of the ITAA 1936 sets out the definition of a qualified person for the purpose of Division 1A of the former Part IIIAA. Effectively, the Trustee will be a qualified person if they hold shares on which a dividend has been paid for a continuous period of not less than 45 days, during the period beginning the day after the Trustee acquires the shares and ending on the 45^th day after the shares become ex-dividend.

However, subsection 160APHO(3) of ITAA 1936 requires days during which an entity has a materially diminished risk be excluded. An entity is taken to have a materially diminished risk on a particular day if their net position on that day is less than 30% of the risks and opportunities relating to the shares.

The net position of a taxpayer or fund in relation to shares is calculated by adding the taxpayer's or fund's 'long position' in the shares and 'short position' in the shares. A long position includes shares in relation to themselves with a delta of +1. At the time the Trustee acquires the shares from Entity A their net position will be 1.

Under the Plan and Trust Deed, there are no further positions entered into over the shares which would affect the Trustee's net position. Therefore, provided the Trustee holds the shares at risk for the qualification period, the Trustee will be a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936, and be entitled to a tax offset for any franking credits attaching to the dividends on unallocated shares.

Refundable tax offsets

Subsection 67-25(1) of the ITAA 1997 states:

Tax offsets available under Division 207 (which sets out the effects of receiving a franked distribution) or Subdivision 210-H (which sets out the effects of receiving a distribution franked with a venture capital credit) are subject to the refundable tax offset rules, unless otherwise stated in this section.

Subsection 67-25(1B) of the ITAA 1997 provides that the tax offset is only subject to the refundable tax offset rules if the trustee entitled to the tax offset is not liable to be assessed under section 98 or 99A of the ITAA 1936.

As franked distributions flow indirectly to the Trustee of the Trust, the Trustee is entitled to a franking tax offset under section 207-45 of the ITAA 1997. However, the Trustee is assessed on the distributions received in respect of Unallocated Shares under section 99A of the ITAA 1936. Therefore, the tax offsets available to the Trustee are limited to the amount of tax payable and any excess franking tax offset is not refundable.

Accordingly, where a franked distribution is paid in respect of Unallocated Shares, the Trustee will include an amount equal to the franking credit on the distribution in its assessable income under section 207-35 of the ITAA 1997. Provided that the Trustee does not make a related payment in relation to the dividend paid on Unallocated Shares and holds the Unallocated Shares for a continuous period of not less than 45 days during the period beginning the day after the Trustee acquires the Unallocated Shares and ending on the 45^th day after the Unallocated Shares become ex dividend, then the Trustee will be a qualified person in respect of the distribution and be entitled to the benefit of the franking credits attached to franked distributions on Unallocated Shares to the extent of tax payable. Any excess franking tax offset is not refundable pursuant to section 67-25.

Question 5a

Summary

The participant's assessable income will include the dividends, and any franking credits on the dividends, received by the Trustee which are attributable to the participant's allocated shares.

Detailed reasoning

As stated in Question 4a, the net income of the trust is defined in section 95 of the ITAA 1936 to be the total assessable income of the trust estate calculated under Division 6 as if the trustee were a taxpayer in respect of that income, less all allowable deductions.

Subsection 44(1) of the ITAA 1936 includes in the assessable income of a resident shareholder dividends that are paid to the shareholder by the company out of profits derived by it from any source. Therefore, the dividends would be included in the Trustee's calculation of its net income for a year of income under section 95.

Under section 97 of the ITAA 1936, the beneficiary of a trust, who is not under any legal disability, is assessed on its share of the net income of the trust estate to which it is presently entitled to.

Pursuant to the Trust Deed, dividends on allocated shares must be held and applied by the Trustee for the benefit of the participant.

The Trust Deed provides that each participant is presently entitled to so much of the net income of the trust which is attributable to that participant's allocated shares.

Therefore the participant's assessable income will include the dividends received by the Trustee which are attributable to the participant's allocated shares. Further, in accordance with subsection 207-35(4) of the ITAA 1997 the participant will include any franking credits on the distributions attached to allocated shares held for their benefit in their assessable income.

Question 5b

Summary

The participant's assessable income will include the dividends, and any franking credits on the dividends, received by the Trustee which are attributable to the participant's allocated shares.

Detailed reasoning

Section 207-45 of the ITAA 1997 provides that an individual to whom a franked distribution flows indirectly in an income year is entitled to a tax offset for that income year that is equal to its share of the franking credit on the distribution.

Where a franked distribution is made to the Trustee and the beneficiary includes in their assessable income a share of the trust's net income for that income year under paragraph 97(1)(a) of the ITAA 1936, a franked distribution is taken to flow indirectly to the beneficiary.

Where a franked distribution flows indirectly to the taxpayer, paragraph 207-150(1)(a) of the ITAA 1997 will deny a tax offset otherwise provided under section 207-45 if the taxpayer is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

The participant, being a beneficiary of the trust, will only be a qualified person under former Division 1A of Part IIIAA of the ITAA 1936, if the Trustee is also a qualified person in relation to the dividends.

As stated in Question 4b, the Trustee will be a qualified person in relation to the dividends provided Trustee holds the shares at risk for a continuous period of at least 45 days during the qualification period.

Whether or not the participant is a qualified person in relation to the dividends depends on whether the trust is a widely held trust as defined in former section 160APHD of the ITAA 1936. A widely held trust is defined as a trust that is neither a closely held fixed trust nor a non-fixed trust.

As the Trust is a non-fixed trust, it is not a widely held trust. A beneficiary of a non-widely held trust is a qualified person in relation to the dividend 'if the taxpayer has held that interest at risk, not counting the day of acquisition or disposal, for a continuous period of at least 45 days'. However, any days where an entity has a materially diminished risk are excluded. An entity is taken to have a materially diminished risk on a particular day if their net position on that day is less than 30% of the risks and opportunities relating to the shares.

As the participant's interest in the share allocated to it is an employee share scheme security, disposal and forfeiture conditions are not considered to be a position for the purposes of former Division 1A of Part IIIAA of the ITAA 1936, and can be disregarded.

Former section 160APHL of the ITAA 1936 calculates the taxpayer's interest in the relevant share using a formula. It also provides that the taxpayer's interest in the relevant shares is a long position with a delta of +1 in relation to itself. For the purpose of subsection 160APHL(10) the additional short position required by this subsection is disregarded because the taxpayer's interest is an employee share scheme security. The participant's net position will be +1 in relation to their interest in the relevant share.

Therefore, the participants will be entitled to a tax offset for any franking credits attaching to distributions on shares allocated to them, provided they have held the interest in those shares at risk for a continuous period of at least 45 days, not counting the day of acquisition or disposal.