Edited version of private advice

Authorisation Number: 1052209246419

Date of advice: 9 January 2024

Ruling

Subject: ESS - 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 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

A company (Coy A) is an Australian registered company and Australian resident for tax purposes.

Coy A established an employee share option plan (ESOP) as part of its employee incentive program, governed by the ESOP Rules.

Coy A has granted options over ordinary shares in Coy A to its employees under the ESOP.

Each option had an exercise price greater than or equal to the market value of an ordinary share in Coy A when the options were acquired.

Options were last granted during the 20XX income year.

The primary conditions for the start-up concession under section 83A-33 of the Income Tax Assessment Act 1997 (ITAA 1997) are satisfied as:

•         Coy A was an Australian resident at the time the options were acquired

•         no equity interests in Coy A (or any subsidiary of the company, holding company of the company or subsidiary of a holding company of the company) are or have been listed for quotation in the official list of an approved stock exchange

•         Coy A was incorporated within XX years of the end of the most recent income year before options were acquired (no subsidiary of the company, holding company of the company or subsidiary of a holding company of the company were incorporated more than 10 years prior to the end of the most recent income year before options were acquired)

•         Coy A had an aggregate group turnover of less than $XX million in the most recent income year before the income year in which options were acquired; and

•         the amount that must be paid to exercise the options is greater than or equal to the market value of an ordinary share in Coy A when the options were acquired.

The further conditions for the start-up concession under section 83A-45 of the ITAA 1997 are satisfied as:

•         options under the ESOP were only issued to employees of Coy A

•         all options under the ESOP relate to ordinary shares in Coy A

•         the integrity rule about share trading and investment companies is not applicable

•         the ESOP provides rules regarding the disposal of the options and the minimum holding period

•         no employee has been issued with options individually that is equivalent to 10% or more shareholding and voting power.

During the income year ending 20XX, a takeover of Coy A occurred (the takeover).

Option holders were offered a payment in exchange for the cancellation of all unvested and/or vested unexercised options they held under the ESOP, subject to completion of the takeover.

All current employee option holders accepted the offer.

Until early 20XX, Coy A's priority was to sufficiently build its business and raise further equity from either new or existing shareholders until the business was financially self-sustaining.

Coy A did not seek takeover and implemented various strategies to demonstrate potential to become a viable business.

The point where takeover became the only option other than windup was a Board meeting early in 20XX. At that meeting it was confirmed by one of the directors that Coy A faced capital and funding challenges rather than business performance therefore the likely outcome was for a particular entity to take management of Coy A.

It was expected that a potential offer would need to include a large degree of debt relief which would allow Coy A to continue as a going concern.

Coy B subsequently purchased the shares in Coy A for an agreed amount.

The market value of Coy A's shares at the time of cancellation of the options (had option holders been able to exercise their options at this time) was nominal.

The total amount paid to option holders for cancelling their options was $X.

The ESOP cancellation payment amount offered to each unit holder was based on the number of options held.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 subsection 83A-33(1)

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

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

Income Tax Assessment Act 1997 subparagraphs 83A-45(5)(a)(i) and (ii)

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 further 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; and

(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.

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.

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.

Consideration of Coy A's circumstances

From incorporation, Coy A has granted options to employees under its ESOP.

Coy A's ESOP specifically prevents disposal of options by current employees during the minimum holding period years except under a particular scheme.

Options were last granted under the ESOP during the 20XX income year and at that time there was no indication that a 100% sale of the company would occur.

Takeover became the only option other than windup of the company in early 20XX. Prior to that time, Coy A's intention was to raise additional share capital to support building the business and demonstrate potential to become a viable business.

All membership interests were disposed of as part of a 100% takeover of Coy A on the completion date in the 20XX income year. The takeover resulted in the holders of the company options disposing of all of their ESS interests within 3 years of acquiring them.

There is no evidence to suggest that options were allocated after it became clear that a takeover was imminent, and no evidence to suggest that the operators of the ESOP did not intend for every option holder under the ESOP to be restricted from disposing of their options for the minimum holding period.

Accordingly, the Commissioner is satisfied that the requirements of subparagraphs 83A-45(5)(a)(i) and (ii) are met and will allow the minimum holding period to end at the earlier date of when the options were disposed of under the takeover arrangement.