Edited version of private advice

Authorisation Number: 1052188902749

Date of advice: 17 November 2023

Ruling

Subject: Employee share schemes

Question 1

Will the irretrievable cash contributions by Company A and its Australian subsidiaries (the Group) to Company C (Trustee) as trustee for the Company A Employee Share Trust (the Trust) to fund the acquisition of, or subscription for, shares in Company A (Company A Shares) by the Trust 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 Group to the Trustee, following exercise of Share Rights to fund the acquisition of Company A Shares by the Trust for specific employees which fall under the definition of 'employee' in section 136 of the Fringe Benefits Tax Assessment Act 1986, be treated as a deemed dividend within the meaning of Division 7A of ITAA 1936?

Answer

No.

Question 3a

Will CGT event E5 in section 104-75 of the ITAA 1997 happen at the time when an employee becomes absolutely entitled to Company A Shares held by the Trustee of the Trust?

Answer

Yes.

Question 3b

If CGT event E5 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E5 happening be disregarded under section 130-90 of the ITAA 1997 if the employees acquire the Company A Shares for the same or less than the cost base of the Company A Shares in the hands of the Trustee?

Answer

Yes.

Question 4a

Will CGT event E7 in section 104-85 of the ITAA 1997 happen in respect of Company A Shares held by the Trustee of the Trust?

Answer

No.

Question4b

If CGT event E7 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the ITAA 1997 if the employees acquire the Company A Shares for the same or less than the cost base of the Company A Shares in the hands of the Trustee?

Answer

Not necessary to rule.

This ruling applies for the following periods:

Year ending 31 December 2023

Year ending 31 December 2024

Year ending 31 December 2025

Year ending 31 December 2026

Year ending 31 December 2027

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

This private ruling is based on the facts stated in the description of the scheme that is set out below, including the following documents, or relevant parts of them, which are to be read with the description

•         The Employee Share Trust Deed (Trust Deed) as provided to the Commissioner.

•         The Plan Rules provided to the Commissioner consisting of:

­   The Omnibus Plan

­   The Non-Employee Omnibus Plan

•         The template invitation letters provided to the Commissioner.

If your circumstances are different from these facts, this private ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background

Company A is an unlisted Australian company. Company A should be considered a private company on the basis it is an unlisted company and is not a public company pursuant to section 103A of the Income Tax Assessment Act 1936 (ITAA 1936).

It has lodged a notification to the ATO forming a tax consolidated group with its wholly-owned Australian subsidiaries. All references to the Group are to the tax consolidated group.

The Group's business performance is influenced by the quality and performance of its employees. Company B is a subsidiary entity and is the sole employer in the Group. The Group will implement an employee share scheme as part of its remuneration strategy and its aim to ensure the long-term creation of value in the Group. The scheme will reward eligible participants with the ability to acquire ordinary shares in Company A (Company A Shares) through the exercise of options (Share Rights) which allows the participants to partake in business growth. The scheme will also assist with the retention of key talent personnel.

The employee share scheme will consist of the Company A Employee Omnibus Incentive Plan (Employee Plan) and Company A Limited Non-Employee Omnibus Incentive Plan (Non-Employee Plan) (together the Plansor Plan). The Non-Employee Plan relates to non-executive directors who may participate in the scheme.

Further details in relation to the Plans are set out below.

Share Rights and Company A Shares

The Plans operate as follows in relation to the Share Rights granted under the Plans:

• Eligible employees are granted awards. These awards are Share Rights which provide options to acquire Company A Shares. Only ordinary shares will be issued by Company A in respect of the Share Rights.
• It is at the absolute discretion of the Board to extend an invitation to grant Share Rights to eligible employees and Non-Executive Directors (Participants).
• Invitations sent to the Participants outline:

­   the number of options for which that Participant may apply;

­   the grant date;

­   the grant fee (if any) for each Share Right or how such fee is to be calculated:

­   any vesting conditions;

­   any exercise conditions;

­   the exercise price;

­   any restrictions on the manner of deliver of the Company A Shares following exercise of the Share Rights;

­   whether the Share Rights must be equity settled or may, at the discretion of the Board, be equity settled or cash settled (see clause XX of Schedule X of each of the Plans); and

­   any other supplementary terms and conditions considered relevant by the Board.

• A Participant may not sell, assign, transfer or otherwise deal with their Share Rights, unless the Board so approves in their absolute discretion or the relevant dealing is effected by force of law on death or legal incapacity to the Participant's legal personal representative (see clause XX of Schedule X of each of the Plans).
• Participants will not be entitled to voting rights or rights to receive dividends until the options are exercised and the Participant holds Company A Shares (see clause XX of Schedule X of each of the Plans).
• Options may be exercised when all applicable vesting conditions and any applicable exercise conditions have been satisfied, by delivery of an exercise notice and the payment of any exercise price applicable (see clause XX of Schedule X of each of the Plans).
• As soon as practicable after the valid exercise of a Share Right, Company A must issue, allocate or cause to be transferred to that Participant the number of Company A Shares to which the Participant is entitled (Equity Settled). Where permitted in the relevant invitation and subject to Board approval, the Group may pay a cash amount to the Participant equal to the value of the Company A Shares which would have otherwise been granted to the Participant if the options had been Equity Settled (Cash Settled) (see clause XX of Schedule X of each of the Plans).
• Where a Participant ceases employment then (see clauses XX and XX of Schedule X of each of the Plans):

­   the Participant may retain any vested and unexercised options, unless the Board exercises its absolute discretion by written notice to cancel those vested options for their market value; and

­   all unvested options will be forfeited on a date determined by the Board, unless the Board provides express written consent that some or all of the Participant's unvested options may be retained. Where the Board determines that the Participant may retain unvested options, those options will be held subject to the same terms and conditions that the Participant held those options prior to ceasing employment or other such terms and conditions as the Board sees fit.

• Options which have not yet been exercised must be forfeited immediately on the date the Board determines that any applicable vesting condition or exercise condition has not been, or cannot be, met by the relevant date (see clause XX of Schedule X of each of the Plans).
• Where a Participant acts fraudulently or dishonestly, or wilfully breaches his or her obligations, the Board may deal with or take any actions, in relation to options or Company A Shares resulting from the exercise of options so as to ensure no unfair benefit is obtained by the Participant.
• Company A Shares acquired by Participants as a result of exercising their options may be subject to a disposal restriction, where the Participant must not dispose of their Company A Shares unless the disposal is in accordance with the Plans, the relevant invitation, the shareholders agreement, company constitution and any securities trading policy or otherwise authorised by the Board.
• The Plans allow Company A to use an employee share trust to facilitate the allocation of Company A Shares to a Participant (i.e. the Trustee to subscribe for and/or acquire shares to be held on behalf of the Participants under the Plans and to hold any Company A Shares under the Plans on such terms and conditions as provided by the Board in its absolute discretion) (see clause XX of each of the Plans).
• All Company A Shares issued under the Plans will rank pari passu in all respects with the shares of the same class from the date of issue (see clause XX of Schedule X of each of the Plans).

The Plans also detail the rules regarding R Shares and L Shares (terms defined in the Plans). These are not covered by this ruling.

Company A Employee Share Trust

The Company A Employee Share Trust (the Trust) will be established as a sole purpose trust for the purpose of holding Company A Shares for the satisfaction of Share Rights under the rules of the Plans (refer to point X in the X section of the Trust Deed). The Board (as defined in the Plans) may do all things necessary for the establishment, administration, operation, and funding of an employee share trust and may, in its absolute discretion, require that a Participant's Company A Shares are held in the employee share trust.

For completeness, the Trust will not be involved in the process of satisfying any Cash Settled Share Rights under the Plans or any future equity plans. The Trust will only be used to acquire Company A Shares for the purpose of satisfying Equity Settled Share Rights. Any Cash Settled Share Rights will be settled outside the Trust directly by the Group.

The Trust provides the Group with greater flexibility to accommodate the incentive arrangements of the Group both now and into the future as the group continues to expand its operations. The Trust provides capital management assistance and flexibility for the Group, in that the Trust can use the contributions made by the Group either to acquire Company A Shares on market, or alternatively to subscribe for new Company A Shares.

Additionally, it provides an arm's length vehicle through which Company A Shares can be acquired and held on behalf of employees. In effect, this aspect allows Company A to satisfy corporations law requirements relating to companies dealing in their own shares. The Trust also gives effect to disposal restrictions on the Company A Shares allowing key shareholders to keep control over Company A ownership by preventing the disposal of shares to third parties.

Company C (Trustee), an independent third party, is the Trustee of the Trust, and will operate the Trust in accordance with Company A Employee Share Trust Deed (Trust Deed).

Broadly, the Trust will operate as follows:

• The Group must provide the Trustee with the funds required for the purchase of Company A Shares in accordance with the Plans (refer to clause XX of the Trust Deed).
• All funds provided by the Group are considered accretions to the corpus of the Trust and are not repayable (refer to subclause XX of the Trust Deed).
• The Trustee is not permitted to carry out activities which are not matters connected to or for the purposes of an employee share scheme plan as defined in section 83A-10 of the ITAA 1997 (refer to subclause XX of the Trust Deed).
• Company A and the Trustee agree that 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 (refer to clause XX of the Trust Deed).
• The funds provided by the Group are used by the Trustee to acquire Company A Shares either on-market or via a subscription for new Company A Shares based on written instructions from Company A (refer to clause XX of the Trust Deed).
• Where the Plans stipulate that the Company A Shares are to be held by the Trustee on behalf of Participants, the Trustee will hold the Company A Shares as shares in respect of a Participant (i.e. on an allocated basis) (refer to clause XX of the Trust Deed).
• Where the Plans provide that the Company A Shares may be held by the Trustee on behalf of Participants or employees, the Trustee will hold the Company A Shares as unallocated shares for Participants generally (refer to clause XX of the Trust Deed).
• After a disposal restriction period lapses, the Trustee must transfer the relevant number of shares into the name of the relevant employee or any third party as directed by the relevant employee (i.e. legal title) upon a withdrawal notice being submitted to the Trustee (refer to clauses XX and XX of the Trust Deed).
• The Trustee can sell shares on behalf of a Participant where permitted to do so by the Participant (refer to clause XX of the Trust Deed).
• The Group will incur/has incurred the majority of the Trust's administration costs which include:

­   Employee plan record keeping;

­   Production and dispatch of holding statements to Participants;

­   Costs incurred in the acquisition of Company A Shares from other shareholders, such as brokerage costs and the allocation of such shares to Participants;

­   Other trustee expenses such as the annual audit of financial statements and preparation of the annual income tax return for the Trust;

­   Legal and tax fees associated with obtaining advice in relation to the Trust Deed, including reviewing and amending the Trust Deed from time to time;

­   Implementation costs, including the services provided by the Group's accounting, tax and legal advisors.

Contributions to the Trust

The Group will not typically provide cash contributions to the Trust prior to the exercise of Share Rights under the Plans by Participants. More typically, the Group will wait until the Share Rights vest where subject to automatic exercise or receipt of the exercise notice from Participants before providing the Trust with the cash necessary to acquire Company A Shares to satisfy the acquisition / subscription of shares related to those Share Rights, as noted above in order to specify the particular employee that the contribution is made in respect of a particular Group employee.

Relevant legislative provisions

Section 6-5 of the ITAA 1997

Section 6-10 of the ITAA 1997

Section 10-5 of the ITAA 1997

Section 960-100(2) of the ITAA 1997

Subsection 130-90 of the ITAA 1997

Subdivision 83A-B of the ITAA 1997

Subdivision 83A-C of the ITAA 1997

Subsection 130-85(4) of the ITAA 1997

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

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

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

Subsection 104-75(1) of the ITAA 1997

Subsection 95(1) of the ITAA 1936

Division 7A of the ITAA 1936

Section 109C of the ITAA 1936

Subsection 109C(1) of the ITAA 1936

Subsection 109C(2) of the ITAA 1936

Section 109ZB of the ITAA 1936

Subsection 109ZB(3) of the ITAA 1936

Section 109ZD of the ITAA 1936

Section 318 of the ITAA 1936

Does Part IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for Company C as trustee for the Company A Employee Share Trust.

Legislative references in the following are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997), unless otherwise indicated.

Issue

Employee share schemes

Question 1

The total assessable income of a trust estate is calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1) of the Income Tax Assessment Act 1936 (ITAA 1936)).

The assessable income of a taxpayer includes income under ordinary concepts (section 6-5) or statutory income (section 6-10).

None of the provisions listed in section 10-5 (list of provisions about assessable income that is not ordinary income) are relevant in the present circumstances. The irretrievable cash contributions made by the Group to the Trustee of the Trust will therefore not be included in the assessable income of the Trustee under section 6-10.

The contributions made by the Group are irretrievable and non-refundable to it in accordance with the Trust Deed (refer to clauses XX, XX and XX of the Trust Deed). The funds provided to the Trustee are used in accordance with the Trust Deed and the Plan for the sole purpose of the employee share schemes (see point X in the background section of the Trust Deed). Therefore, the contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10 (ATO Interpretative Decision ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme).

Question 2

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 Company A Shares when contributions are made by the Group. Consequently, the contributions would not be deemed to be a dividend under section 109C of the ITAA 1936.

However, contributions made by the Group to the Trustee would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Company 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 the Group'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 Fringe Benefits Tax Assessment Act 1986 (FBTAA). Specifically, what is meant by 'an employee' for the purpose of this provision takes on the meaning it is given in section 136 of 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 Group employee who is a beneficiary of the Trust as defined in sections 109ZD and 318 of the ITAA 1936. Contributions are made by the Group to the Trustee once the Board resolves to provide a particular Participant a Company A Share. At the time of each contribution, the Board will provide the Trustee a notice listing the Group's employees, for whom the contribution is being made, i.e. the portion of the contribution and the applicable number of Company A Shares to be acquired in respect of each employee. As the contribution would be made to the Trustee in respect of a particular Group employee it would satisfy section 109ZB of the ITAA 1936.

Therefore, the contributions made by the Group to the Trustee for specific employees which fall under the definition of "employee" in section 136 of the FBTAA will not be deemed dividends under section 109C of the ITAA 1936, as its operation would be excluded under section 109ZB.

Question 3a

Under subsection 104-75(1), CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against the trustee.

A beneficiary becomes absolutely entitled to a CGT asset of a trust if they can call for the asset (for which they have a vested and indefeasible interest in) to be transferred to them or at their direction. The shares held on trust for the purposes of the Plan are CGT assets of the Trust as defined in subsection 108-5(1).

Once any applicable relevant conditions/restrictions have been met (if any), the Trustee must transfer the relevant shares to the Participant and the Company will register the Participant as the holder of those shares.

CGT event E5 will happen at that time as the Participant thereby becomes absolutely entitled to those shares.

Question 3b

Any capital gain or capital loss that the Trustee makes, if CGT event E5 happens, is disregarded if section 130-90 applies. To qualify for this exemption, the Trust must be an 'employee share trust' (EST).

Employee Share Trust

To determine whether the Trust is an 'employee share trust' for the purposes of subsection 130-85(4) an analysis of what the Trustee actually does and its powers and duties that are prescribed in the Trust Deed is required. However, as indicated in the facts the Trustee will exercise its powers and obligations as set out in the Trust Deed. Therefore, it meets the definition of 130-85(4) as:

• the Trust acquires shares in a company, namely Company A
• the sole purpose being the acquisition, holding, and ongoing administration of holding Company A Shares under the Plans for the benefit of the Participants (see the Trust Deed).
• the Trustee is not permitted to carry out activities that are not connected to or for the purpose of the Plans established by the Group (see the Trust Deed)
• the Commissioner accepts that the other activities undertaken by the Trustee will be merely incidental to this purpose 130-85(4)(c)
• the Trust ensures that ESS interests as defined in subsection 83A-10(1) are provided under an employee share scheme (as defined in subsection 83A-10(2)) by allocating those shares to the employees in accordance with the Trust Deed and the Plans
• the Trust Deed indicates that Company A and the Trustee agree the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purpose of subsection 130-85(4).

Additionally, the other criteria for the exemption in section 130-90 to apply are met because:

• at the time the Participant becomes absolutely entitled to the Company A Shares as against the Trustee, CGT event E5 happens (paragraph 130-90(1)(a))
• CGT event E5 happens in relation to Company A Shares (paragraph 130-90(1)(b))
• the Participant acquires the Company A Share by exercising a Share Right granted under the Plan (paragraph 130-90(1)(c)); and
• the Participant acquired the Share Rights under the Plan for nil consideration (i.e. at a discount) and therefore Subdivision 83A-B will apply to those Share Rights (unless Subdivision 83A-C applies instead) (paragraph 130-90(1)(d)).

As all the conditions in section 130-90 are satisfied, any capital gain or capital loss that arises for the Trust at the time when CGT event E5 happens will be disregarded if the Company A Shares are acquired by the employee for the same or less than the cost base of the shares in the hands of the Trust.

Question 4a

Under section 104-85, 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, in relation to the scheme as set out in the Relevant facts and circumstances section above, CGT event E7 does not occur.

Question 4b

As per the answer in Question 4 above, CGT event E7 does not happen. Therefore, it is not necessary to consider whether a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening would be disregarded under section 130-90.