Edited version of private advice

Authorisation Number: 1052183616111

Date of advice: 27 October 2023

Ruling

Subject: Employee share scheme

Question 1

Will the irretrievable cash contributions by the Head Entity to the Trustee to fund the acquisition of, or subscription for, the Head Entity's shares by the Trust for the purpose of the Plan be assessable income of the Trust under section 6-5 or 6-10 of the ITAA 1997?

Answer

No.

Question 2

Will contributions by the Head Entity to the Trustee, following exercise of Awards or acceptance of Plan Shares, to fund the acquisition of Head Entity's shares by the Trust for specific employees, be treated as a deemed dividend within the meaning of Division 7Aof ITAA 1936?

Answer

No.

Question 3

Will a capital gain or capital loss that arises for the Trustee at the time when either CGT Event E5 or E7 happens in relation to the Head Entity's Shares held by the Trustee 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.

This ruling applies for the following periods:

Year ending 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

The scheme commenced on:

1 October 2022

Relevant facts and circumstances

The Head Entity is an unlisted Australian company and parent company of an income tax consolidated group.

The Head Entity is seeking to implement an employee share scheme through an Employee Share Trust with a third-party unrelated trustee.

The ESS satisfies the requirements in subdivision 83A-B and 83A-C of the ITAA 1997.

The Head Entity will provide irretrievable cash contributions to fund the acquisitions of shares in itself by the Employee Share Trust for the purposes of the ESS

The Head Entity may incur ongoing expenses, including costs to manage tax affairs, on behalf of the EST and ESS.

On termination of the EST, any residual Trust Assets must be paid to another EST established and maintained for the benefit of the Head Entity's Employees, or a charity with a deductible gift recipient status. The Trustee must not pay any remaining assets (Surplus Assets) to any Group Company.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 95

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 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 subsection 995-1(1)

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 section 109ZB

Income Tax Assessment Act 1936 section 109ZD

Does IVA apply to this private ruling?

Yes.

Reasons for decision

Question 1

Summary

The irretrievable cash contributions made by the Group to fund the acquisition of Head Entity's 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

ATO Interpretative Decision ATO ID 2002/965 Trustee not assessable on employer contributions made to it under the employer's employee share scheme provides the Commissioners view on the whether the funds provided to the Trustee for the purpose of and under an employee share scheme are assessable.

Where the funds are provided to the Trustee are used in accordance with the Trust Deed and Plan Rules for the sole purpose of and under the employee share scheme, the contributions will constitute capital receipts to the Trustee, and will therefore not be assessable under sections 6-5 or 6-10 of the ITAA 1997.

Question 2

Summary

Contributions made by the Head Entity 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 the Head Entity. Consequently the contributions would not be deemed to be a dividend under section 109C of the ITAA 1936.

However, the contributions made by the Head Entity to the Trustee would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds the Head Entity's 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 the Head Entity'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.

Subsection 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 2018/7 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 Head Entity employee who is a beneficiary of the Trust as defined in sections 109ZD and 318 of the ITAA 1936. Contributions are made by the Head Entity 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 the Head Entity'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 Head Entity employee they would satisfy section 109ZB of the ITAA 1936.

Therefore, the contributions made by the Head Entity 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 3

Summary

A capital gain or capital loss that arises for the Trustee at the time when the Participants become absolutely entitled to the Head Entity's 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

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, 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).

Paragraphs 130-85(4)(a) and (b) of the ITAA 1997

The beneficial interest in a share received by a Participant when a share in the Head Entity is provided to them under the terms of the draft Trust Deed and the Plan is an ESS interest within the meaning ofsubsection 83A-10(1) of the ITAA 1997.

Subsection 83A-10(2) of the ITAA 1997 defines an employee share scheme as being 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 ESS within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which rights to acquire Shares in the Taxpayer (being ESS interests) are provided to employees in relation to the employees' employment.

The Taxpayer has established the Trust to acquire shares in the Taxpayer and to allocate those Shares to employees in order to satisfy ESS interests acquired by those employees under the Plan. The beneficial interest in the Taxpayer's share is itself provided under an employee share scheme because it is provided under the same scheme under which the rights are provided to employees in relation to their employment.

Paragraphs 130-85(4)(a) and (b) of the ITAA 1997 are therefore satisfied because:

•         the Trust acquires Shares in the Taxpayer; and

•         the Trust ensures that ESS interests (as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in the Shares of the Taxpayer), are provided under an ESS (as defined in subsection 83A-10(2) of the ITAA 1997) by allocating those Shares to the employees in accordance with the draft Trust Deed and the Plan;

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

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.

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,

•         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.

Clause 4.8 of the Trust Deed requires the Trust to be managed and administered in a way that it satisfies the definition of employee share trust under subsection 130-85(4) of the ITAA 1997.

It is considered that this clause requires the trustee to manage and administer the trust consistent with the definition of an "employee share trust" for the purpose of subsection 130-85(4) of the ITAA 1997. Under the Trust Deed, it is intended that the activities of the Trustee are limited to the sole purpose of exercising its powers and discharging its obligations under the Trust Deed and the relevant Plan Rules (and for no other purpose). It is intended that all other activities of the Trust are incidental to the Trustee undertaking these sole activities.

Therefore paragraph 130-85(4)(c) of the ITAA 1997 will be satisfied as all other activities to be undertaken by the Trustee are merely incidental to managing the Plan.

Therefore, the Trust satisfies the definition of an employee share trust in subsection 130-85(4) of the ITAA 1997.

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 the Head Entity's 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-Dof 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 the Head Entity's 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 the Head Entity's 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 the Head Entity's 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 Head Entity's 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 the Head Entity's 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 the Head Entity. 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 the Head Entity 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 the Head Entity), is provided to eligible employees in relation to their employment in the Head Entity 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 the Head Entity will pay the Trustee funds to acquire the Head Entity's shares for the Plan. That when the Trust acquires the Head Entity's 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 (acquisition price) paid by the Trust to acquire those Shares will also be 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.