Edited version of private advice

Authorisation Number: 1052200214213

Date of advice: 13 December 2023

Ruling

Subject: Employee share scheme and genuine disposal

Question

Will the deferred taxing point happen to the options (or employee share scheme interests) in the 20XX - 20XX income year?

Answer

Yes

This ruling applies for the following period:

30 June 20XX

The scheme commenced on:

30 June 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.

The Employee is currently employed by an Australian company, a subsidiary of a company (Parent) in Country X.

In recognition of the Employee's valuable contributions and to align their interests with the Employer's long-term performance, the Parent company has granted stock options to the Employee.

The stock options were specifically issued by the Employer's holding company, and outlined in the terms of the Employment and Stock Agreement.

The Employer's Incentive Plan and Stock Option Agreement were provided to the Employee before the grant of stock options was accepted by the Employee.

The Option Acceptance Agreement was signed by the Employee as a condition of acceptance of the grant of stock options.

The granting of stock options serves as an incentive for the Employee to continue their dedicated service to the organisation and support the mutual objective of promoting the overall prosperity.

Stock options typically have a vesting period, which is the time period over which an employee becomes able to exercise their options. Vesting usually occurs over a period of several years, incentivising the employee to stay with the company.

In stock options arrangements, a cliff period refers to a specific time frame during which an employee must wait before any vesting occurs.

The purpose of implementing a cliff period is often to incentivise employee loyalty and commitment to the company. It encourages employees to remain with the organisation for a certain period before they can fully benefit from their stock options. The idea is that it aligns the employee's interests with the long-term success of the company.

Once the options have vested, the employee can choose to exercise their options by purchasing the company's stock at the exercise price.

The Employer is not registered on any stock exchange.

The only option the employee has, once the option has been exercised, is to hold onto the purchased shares but not sell them on the open market unless the company arranges a secondary sale.

The employer's restrictions are written in the company's bylaws.

Among the terms and conditions governing the stock options, exists a provision on the restriction for transferring of shares.

Restriction on transfer

No holder of Restricted Shares may transfer, sell, assign, pledge, enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of, or otherwise in any manner dispose of or encumber, whether voluntarily or by operation of law, or by gift or otherwise ('transfer'), Restricted Shares or any right or interest therein without the prior written consent of the Corporation, upon duly authorised action by the Board of Directors in its sole discretion, and such holder otherwise complying with the requirements of this Article.

The restriction contained in section XXX 'Restriction on Transfer' shall not apply to the following transactions (each, a 'Permitted Transfer'):

(i) any transfer during the Restricted Stockholder's lifetime by gift or pursuant to XX domestic relations orders to the Restricted Stockholder's immediate family or a trust for the benefit of Restricted Stockholder or Restricted Stockholder's immediate family, where "immediate family" as used herein shall mean spouse, Spousal Equivalent, lineal descendant or antecedent, parent, sibling, stepchild, stepparent, mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law (and for avoidance of doubt shall include adoptive relationships), and where a person is deemed to be a "Spousal Equivalent" provided the following circumstances are true: (a) irrespective of whether or not the relevant person and the Spousal Equivalent are the same sex, they are the sole Spousal Equivalent of the other for the last twelve (12) months, (b) they intend to remain so indefinitely, (c) neither are married to anyone else, (d) both are at least 18 years of age and mentally competent to consent to contract, (e) they are not related by blood to a degree of closeness that which would prohibit legal marriage in the state in which they legally reside, (f) they are jointly responsible for each other's common welfare and financial obligations, and (g) they reside together in the same residence for the last twelve (12) months and intend to do so indefinitely;

(ii) any transfer or deemed transfer effected pursuant to the Restricted Stockholder's will or the laws of intestate succession;

(iii) any transfer by an entity Restricted Stockholder to an Affiliate (as defined below) of such Restricted Stockholder, where, for purposes of this Article, (a) an "Affiliate" of an entity Restricted Stockholder shall include any individual, firm, corporation, partnership, association, limited liability company, trust or other entity who, directly or indirectly, controls, is controlled by or is under common control with such entity Restricted Stockholder or such entity Restricted Stockholder's principal, including, without limitation, any general partner, managing member, managing partner, officer or director of such entity Restricted Stockholder, such entity Restricted Stockholder's principal or any venture capital fund now or hereafter existing that is controlled by one or more general partners or managing members of, or shares the same management company with, such entity Restricted Stockholder or such entity Restricted Stockholder's principal, and (b) the terms "controlling," "controlled by," or "under common control with" shall mean the possession, directly or indirectly, of (x) the power to direct or cause the direction of the management and policies of an entity Restricted Stockholder, whether through the ownership of voting securities, by contract, or otherwise, or (y) the power to elect or appoint at least 50% of the directors, managers, general partners, or persons exercising similar authority with respect to such entity Restricted Stockholder;

(iv) a corporate Restricted Stockholder's transfer of all of its shares to a single transferee pursuant to and in accordance with the terms of any bona fide merger, consolidation, reclassification of shares or capital reorganization of the corporate Restricted Stockholder, or pursuant to a bona fide sale of all or substantially all of the stock or assets of a corporate Restricted Stockholder, provided in each case that such transfer is not essentially simply a transfer of the Restricted Shares without substantial additional assets other than cash or cash equivalents being transferred;

(v) any repurchase or redemption of Restricted Shares by the corporation: (a) at or below cost, upon the occurrence of certain events, such as the termination of employment or services; or (b) at any price pursuant to the corporation's exercise of a right of first refusal to repurchase such Restricted Shares (including the purchase of such Restricted Shares by the corporation's assignee); and/or

(vi) any transfer or deemed transfer approved by a majority of the disinterested members of the Board, even though the disinterested directors are less than a quorum; provided, however, that notwithstanding the foregoing, if a transfer or deemed transfer is approved pursuant to this clause

(vi) and the Restricted Shares of the transferring Restricted Stockholder are subject to co-sale rights (the "Co-Sale Rights"), the persons and/or entities entitled to the Co-Sale Rights shall be permitted to exercise their respective Co-Sale Rights in conjunction with such approved transfer or deemed transfer without any additional approval of the Board.

Provided, however that each transferee, assignee, or other recipient of any interest in the Restricted Shares shall, as a condition to the transfer, agree to be bound by all of the restrictions set forth in these bylaws.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 section 83A-120

Reasons for decision

Question

Will the deferred taxing point happen to the options (or employee share scheme interests) in the 20XX - 20XX income year?

Summary

The deferred taxing point will be when the options are exercised.

Detailed reasoning

The focus of the genuine disposal restriction condition is on the Employee's ability to divest themself of ownership of any shares that they acquire by exercising the options.

While section XXX imposes restrictions on transfers of shares by the Employee, these restrictions do not apply to 'permitted transfers' as defined in section XXX.

Consequently, the Employee will be allowed to make permitted transfers of the shares they acquire by exercising the options from the day they become the owner of those shares. This means that the Employee will be able to dispose of those shares from that date.

Therefore, the shares acquired by exercising the options will not be subject to genuine disposal restrictions and the deferred taxing point for those options will occur on the date they are exercised.

The employee share scheme (ESS) provisions are contained in Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997).

In summary, the ESS provisions recognise the dual nature of grants of shares or rights to acquire shares (collectively ESS interests) as both a component of an employee's remuneration package and also as an ongoing investment. To this end, the ESS provisions provide a mechanism for recognising an appropriate value for remuneration purposes and an adjustment to the purchase price for investment purposes to reflect the amount treated as remuneration.

The ESS achieve this outcome by:

•                     determining when a taxpayer needs to include any discount received in relation to a share or right to acquire the share in their assessable income

•                     calculating the amount of this discount using the market value of the share or right to acquire the share at this date ignoring any selling restrictions or forfeiture conditions, and

•                     using this date and the market value of the share or right as the acquisition date and amount paid for it for all other income tax purposes.

Deferred taxing point

Subdivision 83A-C of the ITAA 1997 provides that when certain conditions are satisfied, the discount in relation to an ESS interest is not included in the employee's assessable income in the income year they acquire the ESS, but will be included when the deferred taxing point (DTP) occurs under section 83A-120 of the ITAA 1997.

The DTP for ESS interest granted under a tax-deferred scheme are outlined at subsection 83A-120(2) which states that the DTP for rights to acquire shares is the earliest of the following:

•                     when there is no real risk that you will forfeit or lose the ESS interest other than by disposing of it, and there are no restrictions on you disposing of the ESS interest (subsection 83A-120(4))

•                     when your employment in respect of which you acquired the interest ends (subsection 83A-120(5))

•                     the end of the 15-year period starting when you acquired the ESS interest (subsection 83A-120(6)), or

•                     when you have exercised the right and there is no risk that you will forfeit or lose the resulting beneficial interest in the share (other than by disposing of it) (subsection 83A-120(7)).

Genuine selling restrictions

The explanatory memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 states the following in relation to genuine selling restrictions for shares and rights to acquire shares:

1.192 Genuine restrictions preventing disposal could include a condition of the scheme that contractually prevents disposal of shares. If disposing of an ESS interest would be a criminal offence, for example under a law regulating insider trading, then the employee would also be considered genuinely restricted from disposing of the share.

1.193 A company's internal share trading policy is only considered to be a restriction preventing disposal for the purposes of deferring the taxing point if the penalty for breaking the policy constitutes an effective sanction. This means that if there is no legal prohibition on the disposal of the ESS interest, there must be serious and enforced consequences for breaching the policy.

1.194 A restriction that otherwise meets the conditions for a genuine restriction, but is able to be lifted in cases of severe financial hardship, is nonetheless considered to be a genuine restriction.

1.195 Restrictions preventing disposal are considered to be lifted once an opportunity arises in which a taxpayer can realise the share.

1.196 In the case of a trading window, or restrictions that may lift and then re-engage, if the employee does not avail themself of the opportunity to dispose of the share and the window subsequently closes, there is no further delay in the taxing point. The taxing point would still be at the commencement of the first trading window.

1.197 The restriction and conditions covered by the deferred taxing points are only those that existed when the employee acquired the ESS interest. Conditions and restrictions that have been added subsequent to acquisition are ignored for the purposes for determining the deferred taxing point.

...

1.200 The taxing point is the point at which the taxpayer can take some action to realise the benefit. It does not matter whether or not they chose to do so.

Genuine selling restrictions is provided in Taxation Determination TD 2022/4 Income tax: when are you genuinely restricted from immediately disposing of an interest provided under an employee share scheme? In paragraphs 8 to 11:

8. The terms 'genuinely', 'immediately' and 'disposing' are undefined and take their ordinary meaning, having regard to their statutory context.

The meaning of 'genuinely'

9. Relevantly, the ordinary meaning of 'genuine' is '... being truly such; real; authentic: genuine regret; genuine worth. ... properly so called ...'.

10. The Courts have considered something to be genuine when it is '... put forward in good faith [and] more than a mere assertion', '... bona fide... and not spurious, hypothetical, illusory or misconceived' and with '... an existence that is objectively demonstrable independently of the exigencies [which] evoked it'.

11. To be genuine, a scheme's disposal restrictions must be sufficiently identifiable (real and objectively demonstrable), certain and legally enforceable (not spurious or hypothetical). There must be serious and enforced consequences when a breach of a scheme's disposal restriction occurs.¹³ Conversely, a disposal restriction is not genuine if it is open to manipulation such that it does not in a real, practical sense limit the disposal.

Application to your situation

The question for this private ruling is will the restrictions on disposing of a share after exercising a right be considered a 'genuine' disposal.

There is no restriction on the Employee transferring the shares, after exercising the option, as defined in section XXX of the Bylaws, 'permitted transfers', therefore this is not considered to be a genuine disposal restriction. The taxing point is at the time the options are exercised, that is in the 20XX income year.