Edited version of private advice

Authorisation Number: 1052196279206

Date of advice: 5 December 2023

Ruling

Subject: Employee share trust

Question 1

Is the Trust an Employee Share Trust for the purposes of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

For the purposes of the reporting obligations under section 392-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953), do the ESS interests issued under the plan qualify for a tax deferral under division 83A-C of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 2019

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 company is an Australian proprietary company.

The company was incorporated in 19XX by the founders, who were the initial shareholders of the company.

The company previously had various classes of share on issue. In 20XX, a special resolution of shareholders approved the selective buy-back of the shares for $X each.

The company has a number of permanent full time and part time employees and several casual employees

The Trust

To incentivize and motivate its employees, the company has been working towards becoming a 100% employee-owned company.

In 2012, the company established the Trust to offer its employees employee share scheme interests.

The company intended that the Trust would purchase the Shares held by the founders and for beneficial interests in those shares to be offered to eligible employees under the terms of the trust.

The Trust commenced purchasing shares form the founders in 20XX and also began offering interests in the Trust to employees.

The Trust is a unit Trust which is designed to provide employee share scheme interests to attract, retain and motivate employees.

Clause Y of the Trust Deed sets out the Trustees power to raise money, borrow, give security and give guarantees.

Clause X of the Trust Deed sets out restrictions in exercising the trustee's powers.

Current unit holders

The Trust now has a number of Employee Unit Holders and a number of Employee Units on issue. The Trust also has X Employee Units on issue which were issued for $X each when the Trust was established.

The Employee Units were issued to the Employee Unit Holders for nil consideration, with each offer being subject to the same terms and conditions (except as to the number of Units offered).

Although dividends have been issued in the past, no dividends have been issued since the Trust commenced purchasing shares from the founders in 20XX.

There is a limit of the maximum number of Units that an Employee can acquire in the Trust.

Shareholders deed

In 20XX, the company, the founders and the trustee entered into a Shareholders Deed (Deed) regarding the operation of the company and interests in it.

The company is considering winding-up the Trust so that in future it can adopt a simpler structure for offering ESS interests to its employees.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 subsection 83A-20(1)

Income Tax Assessment Act 1997 section 83A-30

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 subsection 83A-45(1)

Income Tax Assessment Act 1997 subsection 83A-45(2)

Income Tax Assessment Act 1997 subsection 83A-45(3)

Income Tax Assessment Act 1997 subsection 83A-45(6)

Income Tax Assessment Act 1997 subsection 83A-105(1)

Income Tax Assessment Act 1997 subsection 83A-105(3)

Income Tax Assessment Act 1997 subsection 83A-105(6)

Income Tax Assessment Act 1997 section 83A-120

Income Tax Assessment Act 1997 subsection 83A-315(1)

Income Tax Assessment Act 1997 section 83A-330

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

Taxation Administration Act 1953 Schedule 1 section 392-5

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

Question 1

Is the Trust an Employee Share Trust for the purposes of the ITAA 1997?

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

(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).

Taxation Determination TD 2019/13 Income tax: what is an 'employee share trust'? states the following:

6.When testing whether a trustee of a trust (in that particular capacity) meets the requirements of subsection 130-85(4), it is necessary to examine the actual activities that the trustee has undertaken. Whilst the relevant trust documents may include powers and/or duties that are broad reaching, the mere existence of those powers or duties in the trust documents does not, of itself, mean that the trustee has breached the requirements to be an employee share trust.

7. Where the trust administers multiple ESS arrangements, it is the trustee's activities in relation to the whole of the trust that are examined.

8. To qualify as an employee share trust, a trustee's activities must be limited to those described in paragraphs 130-85(4)(a), (b) and (c).

Application to your circumstances

In this case we consider the restrictions provided by clause X cover the trustee power in clause Y. Therefore, we accept that in this case the Trust meets the sole activities test and can be considered an employee share trust for the purposes of the ITAA 1997.

Question 2

For the purposes of the reporting obligations under section 392-5 of Schedule 1 to the TAA 1953, do the ESS interests issued under the plan qualify for a tax deferral under division 83A-C of the ITAA 1997?

Summary

In this case we consider the ESS issued under the plan qualify for a tax deferral under division 83A-C of the ITAA 1997.

Detailed reasoning

Paragraph 392-5(1)(b) of Schedule 1 to the TAA 1953 provides that:

(1)          An entity (the provider) must give a statement to the Commissioner and to an individual for a financial year if:

...

(b)          all of the following subparagraphs apply:

(i)            the provider has provided ESS interests to the individual (whether during the year or during an earlier year);

(ii)           Subdivision 83A-C of the Income Tax Assessment Act 1997 (about employee share schemes) applies to the interests;

(iii)         the ESS deferred taxing point for the interests occurs during the year.

Each of the requirements of paragraph 392-5(1)(b) of Schedule 1 to the TAA 1953 are considered below.

Subparagraph 392-5(1)(b)(i) - the provider has provided ESS interests to the individual

Subsection 83A-10(1) of the ITAA 1997 provides that an ESS interest is a beneficial interest in either a share in a company or a right to acquire a share in a company.

An Employee Unit is an ESS interest as it is a beneficial interest in a company share. Therefore, subparagraph 392-5(1)(b)(i) of Schedule 1 to the TAA 1953 will be satisfied.

Subsection 392-5(1)(b)(ii) - Subdivision 83A-C of the ITAA 1997 applies to the ESS interests

Subsection 83A-105(1) of the ITAA 1997 sets out the requirements that must be satisfied for Subdivision 83A-C of the ITAA 1997 to apply to an ESS interest:

(1)          This Subdivision applies, and Subdivision 83A-B does not apply, to an ESS interest in a company if:

(a)          Subdivision 83A-B would, apart from this section, apply to the interest (see section 83A-20); and

(aa)       after applying section 83A-315, there is still a discount given in relation to the interest; and

(ab)       section 83A-33 (about start ups) does not reduce the amount to be included in your assessable income in relation to the interest; and

(b)          subsections 83A-45(1), (2), (3) and (6) apply to the interest; and

(c)          if the interest is a beneficial interest in a share:

(i)            subsection (2) of this section applies to the interest; and

(ii)           subsection (3) or (4) applies to the interest; and

(d)          if the interest is a beneficial interest in a right to acquire a beneficial interest in a share--subsection (3) or (6) applies to the interest.

Each of the requirements of subsection 83A-105(1) of the ITAA 1997 is considered below.

Paragraph 83A-105(1)(a) - Subdivision 83A-B of the ITAA 1997 would, apart from section 83A-105 of the ITAA 1997, apply

Subsection 83A-20(1) of the ITAA 1997 provides that Subdivision 83A-B of the ITAA 1997 applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

Subsection 83A-10(2) of the ITAA 1997 explains that an employee share scheme is a scheme under which ESS interests in a company are provided to employees of the company or subsidiaries of the company in relation to their employment.

In this case, Employee Units will constitute an ESS interest as they constitute a beneficial interest in a share in the company and all persons who hold Employee Units fall within the definition of employees of the company.

Paragraph 83A-105(1)(aa) - after applying section 83A-315 of the ITAA 1997, there is still a discount given in relation to the interest

Section 83A-30 of the ITAA 1997 provides that an ESS interest is taken to have been acquired by the employee for its market value (rather than its discounted value) to be calculated within the ordinary meaning of the term 'market value'.

'Market value' is defined in subsection 995-1(1) of the ITAA 1997 as having a meaning affected by Subdivision 960-S of the ITAA 1997. The provisions in sections 960-405 to 960-415 of the ITAA 1997 do not affect the meaning of market value in these circumstances.

The Employee Units are issued for no consideration and accordingly are taken to have been provided at a discount.

Paragraph 83A-105(1)(ab) - section 83A-33 of the ITAA 1997 (about start ups) does not reduce the amount to be included in your assessable income in relation to the interest

Section 83A-33 of the ITAA 1997 reduces amounts included in assessable income for start up companies. Subsections 83A-33(2) to (6) of the ITAA 1997 set out all of the circumstances that must apply for section 83A-33 of the ITAA 1997 to be applicable:

1.            The company (and its corporate group) must not have any interests listed on an approved stock exchange in the income year prior to the ESS interest being offered.

2.            The company (and its connected entities) must have been incorporated for less than 10 years.

3.            The company that grants the ESS interests must have an aggregated turnover of less than $50 million in the income year prior to the year the interests are granted.

4.            The employing company (which can be a subsidiary of the company granting the ESS interests are being offered) must be an Australian resident taxpayer.

5.            For start-ups to be eligible for the start-up concession, ESS interests that are beneficial interests in a share must be acquired at a discount of no more than 15% of its market value when it is acquired. In relation to ESS interests that are a beneficial interest in a right to a share, the amount that must be paid to exercise the right is greater than or equal to the market value of an ordinary share in the company when it is acquired.

In this case the start-up provision does not apply as the company has been incorporated for more than 10 years. Therefore, paragraph 83A-105(1)(ab) of the ITAA 1997 has no application as the company is not a start-up company.

Paragraph 83A-105(1)(b) - subsection 83A-45(1), (2), (3) and (6) of the ITAA 1997 apply to the interest

Subsection 83A-45(1) of the ITAA 1997 applies to ESS interests in a company if the participant is employed by the company when they acquire the interest.

In this case Employee Units will only be issued to employees of the company and therefore this requirement will be satisfied.

Subsection 83A-45(2) of the ITAA 1997 applies to an ESS interest acquired under an employee share scheme if, when the interests are acquired, all the ESS interests available for acquisition under the scheme relate to ordinary shares.

The shares in the company that are held by the Trust are ordinary shares and therefore we consider subsection 83A-45(3) of the ITAA 1997 is satisfied.

Subsection 83-45(3) of the ITAA 1997 applies to an ESS interest in a company unless the predominant business of the company is the acquisition, sale or holding of shares, securities or other investments, and you are an employee of the company as well as another company that is a subsidiary of the first company, a holding company of the first company or a subsidiary of a holding company of the first company.

The predominant business of the company is not the acquisition, sale or holding of shares, securities or other investments. Further, the participants are not employed by any subsidiary of the company, holding company of the issuing company or subsidiary of a holding company of the company. Therefore, the requirements under subsection 83A-45(3) of the ITAA 1997 are satisfied.

Subsection 83A-45(6) of the ITAA 1997 applies to an ESS interest in a company if, immediately after acquiring the interest, the participant does not hold a beneficial interest in more than 10% of the shares of the company, and they are not in a position to cast more than 10% of the maximum number of votes that may be cast at a general meeting of the company.

No participant in the scheme will hold a beneficial interest in more than 10% of the shares in the company, or be in a position to cast, or control the casting of, more than 10% of the maximum number of votes that may be cast at a general meeting of the company. Therefore, the requirement under subsection 83A-45(6) of the ITAA 1997 is satisfied.

As subsections 83A-45(1), (2), (3) and (6) of the ITAA 1997 all apply to the Employee Units paragraph 83A-105(1)(b) of the ITAA 1997 is satisfied.

Subparagraph 83A-105(1)(c) - if the interest is a beneficial interest in a share

Subparagraph 83A-105(1)(c) - if the interest is a beneficial interest in a share:

(i)            subsection (2) of this section applies to the interest, and

(ii)           subsection (3) or (4) applies to the interest.

The ESS rules apply to treat ESS interests held through trusts as being held by beneficiaries. Section 83A-320 says if you hold an interest in a trust whose assets include shares, and the interest corresponds to a particular number of the shares, then Division 83A treats them as holding a beneficial interest in the number of shares allocated to their interests.

Therefore, section 83A-320 will treat shares held through the Trust as being held directly by the participating Employees and Division 83A will apply to treat Employee Unit Holders as having beneficial interests in the shares allocated to their Units.

As the Employee Units under the plan are a beneficial interest in a share, paragraph 83A-105(1)(c) of the ITAA 1997 applies and paragraph 83A-105(1)(d) of the ITAA 1997 does not apply.

Subparagraph 83A-105(1)(c)(i) - if the interest is a beneficial interest in a share, subsection 83A-105(2) of the ITAA 1997 applies to the interest

Subsection 83A-105(2) of the ITAA 1997 requires that 75% of permanent employees of the company (who are Australian residents) with at least 3 years of service (whether continuous or not) are, or have been, entitled to acquire ESS interests under the scheme, or ESS interests in the employer company or its holding company (if any) under another scheme.

Based on the information provided, the Commissioner accepts the condition in subsection 83A-105(2) is met.

Subparagraph 83A-105(1)(c)(ii) - if the interest is a beneficial interest in a share, subsection 83A-105(3) or 83A-105(4) of the ITAA 1997 applies to the interest

Subsection 83A-105(3) of the ITAA 1997 applies if there is a real risk of forfeiture of the acquired ESS interests. If the ESS interest is a beneficial interest in a share, paragraph 83-105(3(a) applies if there is a real risk that, under the conditions of the scheme, the employee will forfeit or lose the ESS interest (other than by disposing of it).

The Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill (EM) states at paragraph 1.42:

An ESS interest is at real risk of forfeiture if a reasonable person would consider that there is a real risk that the employee would lose or forfeit the interest or never receive it ...

The EM states at paragraph 1.569:

The 'real risk of forfeiture' test does not require employers to provide schemes in which their employee share scheme benefits are at a significant or substantial risk of being lost. However, 'real' is regarded as something more than a mere possibility. Something is not a real risk if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility.

Further, ATO Interpretative Decision ATO ID 2010/61 Income Tax: Employee share scheme: real risk of forfeiture - minimum term of employment and good leaver provisions states that 'in considering whether a condition in a scheme imposes a real risk of forfeiture, regard should be had to whether a reasonable person would consider that there is a genuine connection between the forfeiture condition and aligning the interests of the employee and employer. If the risk of forfeiture is over a very short period of time to gain access to a relatively long period of deferral, the risk will not be considered real.'

Real risks of forfeiture in a scheme may include conditions where retention of the ESS interests is subject to:

•                     performance hurdles, or

•                     minimum term of employment.

An ESS may provide (at the time of grant) for ESS interests to be forfeited if the employee doesn't complete a minimum term of employment.

We accept that there will be a real risk of forfeiture where the minimum term of employment is at least six months and the maximum deferral is no more than three years; or where the minimum term of employment is at least 12 months.

Based on the terms of the Trust Deed, the conditions under the plan for the Employees Units include a minimum of 12 month employment, Employee's role and performance.

As the Employees Units are a beneficial interest in a share of the Employer, we accept 83A-105(3)(a) is satisfied. As each of the relevant requirements of section 83A-105(1) of the ITAA 1997 are satisfied, Subdivision 83A-C of the ITAA 1997 will apply.

Conclusion

In this case, for the purposes of the reporting obligations section 392-5 of Schedule 1 to the Taxation Administration Act 1953, we accept the ESS interests issued under the plan qualify for a tax deferral under division 83A-C of the ITAA 1997.