Edited version of private advice

Authorisation Number: 1052154471500

Date of advice: 10 August 2023

Ruling

Subject: Employee share scheme - minimum holding period

Question

Will the Commissioner allow the minimum holding period for ESS interests to be reduced in accordance with paragraph 83A-45(5)(a) of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Company is an Australian resident private company.

The Company is not in the business of acquiring, selling or holding shares, securities or other investments and has not entered into any transactions of this nature.

The Company established its ESS in 20XX to provide options to acquire ordinary shares in the Company at market value to eligible persons so that they would be rewarded for their contribution to the Company and incentivised to remain employed with the Company in the medium term.

The ESS was created with the intention that it would comply with all of the conditions under the 'start-up concession' in Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997).

Options have been issued under the Plan Rules.

The relevant clause in the Plan Rules prevents option holders from disposing of their options or shares for a minimum period of three years (or earlier cessation of employment) in accordance with the minimum holding requirement under subsection 83A-45(5) of the ITAA 97.

Purchaser first contacted the Company in 20XX expressing interest in acquiring the Company.

While the Company founders were prepared to discuss the matter with Purchaser, they had no intention at that time of selling the business and their strong preference was raising additional equity from existing or new investors.

The following year, Purchaser issued a non-binding indicative offer to acquire the Company.

Around the same time the Company received a term sheet from an entity proposing to become an investor (Investor) in the Company. This was the preferred option for the Company founders and existing investors.

Purchaser withdrew their offer. There was no indication at that time that Purchaser had any continuing interest in acquiring the Company.

At this point, the founders of the Company were actively engaged in securing an investment from Investor.

The Company later received an unexpected revised non-binding indicative offer from Purchaser. The Company founders however were still primarily focused on securing investment from Investor.

Investor subsequently withdrew their proposal.

Withdrawal of Investor's deal necessitated a reassessment of the Company's direction.

The Company issued unallocated options to longstanding employees. At this time the Company had not decided to sell to Purchaser.

The Company shareholders (including the option holders) subsequently signed a share sale and purchase agreement with Purchaser (the agreement).

The agreement was completed on the Completion Date.

All vested and un-lapsed options were converted to ordinary shares just prior to completion and transferred to Purchaser under the agreement.

The exercise of the options in connection with completion of the agreement fell within 3 years of the grant of all options issued under the ESS.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 subsection 83A-45(4)

Income Tax Assessment Act 1997 subsection 83A-45(5)

Income Tax Assessment Act 1997 section 83A-130

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997.

In order to qualify for the ESS start-up concessions under section 83A-33, the ESS interest must meet all of the conditions set down in subsection 83A-33(1).

One of the conditions is the minimum holding periodcondition detailed in subsections 83A-45(4) and 83A-45(5).

83A-45(4)

The minimum holding periodcondition is satisfied if the scheme is operated so that every acquirer of an ESS interest (the scheme interest) under the scheme is not permitted to dispose of:

(a)  the scheme interest; or

(b)  a beneficial interest in a share acquired as a result of the scheme interest;

during the scheme interest's minimum holding period.

83A-45(5)

An ESS interest's minimum holding periodis the period starting when the interest is acquired under the employee share scheme and ending at the earlier of:

(a)  3 years later, or such earlier time as the Commissioner allows if the Commissioner is satisfied that:

(i)    the operators of the scheme intended for subsection (4) to apply to the interest during the 3 years after the acquisition of the interest; and

(ii)   at the earlier time that the Commissioner allows all membership interests in the relevant company were disposed of under a particular scheme

(b)  when the acquirer of the interest ceases being employed by the relevant employer.

The Explanatory Memorandum for the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 explains the introduction of the Commissioner's discretion in subsection 83A-45(5) as follows:

1.82 This Bill makes slight improvements to the existing minimum holding period condition by allowing the Commissioner to reduce the minimum holding period in situations in which all employees are effectively required to exercise and/or dispose of their ESS interests. For example, where there is an initial public offering of the company, or the company is subject to a full trade sale and employees have agreed to a 'tag along' clause in relation to holding of minority interests. The Commissioner in applying the discretion will need to have regard to whether, when employees acquired their interest, there was a genuine intention for the interests to be held for the minimum holding period.

As all the membership interests in the Company were acquired under the takeover, the only remaining consideration is whether the operators of the scheme intended for subsection (4) to apply to the interest during the 3 years after the acquisition of the interest.

The operators of the scheme would fail the test if they had either allowed a participant to dispose of their interest prior to the end of its minimum holding period or there was objective evidence that the scheme was not operated to prevent the participants from doing so.

Application to the Company's circumstances

Purchaser independently approached the Company with intent to acquire.

The founders of the Company held a strong preference for financing over acquisition and positioned themselves accordingly, giving preference to Investor's proposal.

Withdrawal of Investor's proposal necessitated a reassessment of the Company's direction.

Accordingly, the Company issued its final tranche of options. At that time there was no indication that a 100% sale would occur.

The Company shareholders (including the option holders) subsequently signed a share sale and purchase agreement with Purchaser (the agreement).

The agreement was completed on the Completion Date.

All vested and un-lapsed options were converted to ordinary shares just prior to completion and transferred to Purchaser under the transaction. This fell within 3 years of the grant of all options issued under the ESS.

As the Plan Rules specifically prevent disposals unless the arrangement met the requirements of section 83A-130, and there is no evidence that any such disposal has been allowed, the only remaining consideration is whether there was objective evidence that the scheme was not operated to prevent the participants from disposing of their interests before the end of the minimum holding period.

Objectively the Commissioner would not accept that that the scheme was operated to prevent the participants from disposing of their interests before the end of the minimum holding period where interests were allocated after the time that it became clear that a takeover was imminent.

As the evidence indicates that this is not the case, the Commissioner will exercise his discretion to allow the reduced minimum holding period to apply to all options.

The Company's final issue of unallocated options can be included as we accept that the focus was on securing an investor and after the potential investor's proposal was withdrawn, the decision was made to sell.