Edited version of private advice

Authorisation Number: 1052233752097

Date of advice: 8 April 2024

Ruling

Subject: Employee share trust

Issues

Question 1

Will contributions paid by the Employer to Trust pursuant to the employee share trust deed constitute an income tax deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. However, pursuant to the Single Entity Rule, the deduction is allowable to the Head Company.

Question 2

When will contributions paid by the Employer to the Trust pursuant to the Trust Deed be deductible?

Answer

If employees acquire their ESS interests after the Employer pays contributions under the scheme, section 83A-210 of the ITAA 1997 will operate to make that contribution deductible in the income year in which employees acquire their interests.

If employees acquire their ESS interests at or before that time, section 8-1 of the ITAA 1997 will apply to make the contribution deductible in the income year in which the contribution was made.

Question 3

Will the contributions paid by the Employer to the Trust constitute a 'fringe benefit' as defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

No

Question 4

Will contributions paid by the Employer to the Trust constitute an obligation under the

Superannuation Guarantee (Administration) Act 1992 (SGAA 1992)?

Answer

No

Trustee issues

Question 1

Will amounts contributed by the Employer to the Trust for the benefit of employees constitute assessable income of the Trust for the purposes of section 6-5 of the ITAA 1997?

Answer

No

Question 2

Will amounts contributed to the Trustee by participant employees for the acquisition of additional Units constitute assessable income of the Trust under section 6-5 of the ITAA 1997?

Answer

No

Question 3

Will contributions by the Employer to the Trustee to fund the acquisition of the Employer shares and/or the expenses of operating the Trust be treated as a deemed dividend within the meaning of Division 7A of ITAA 1936?

Answer

No

Employee issues

Question 1

What amount will be assessable income to the Employee (even if they participate indirectly through an associate) in the event they are entitled to an Employee Redemption Amount?

Answer

The amount to be included in their assessable income depends on whether they acquired Units for no consideration or paid market value.

For Units acquired for no consideration, Division 83A of the ITAA 1997 applies and the employee will include the Employee Redemption Amount less any cost base in their assessable income.

For Units acquired at market value, Division 83A of the ITAA 1997 does not apply and the employee will include any capital gain or loss calculated under the capital gains tax (CGT) provisions.

Question 2

Will the Employee be assessed on contributions the Employee makes to acquire additional Units in the Trust?

Answer

No

Question 3

Will the Employee be assessed on the value of units issued by the Trustee to the Employee (or to their associate) where the Employer is not liable for fringe benefits tax?

Answer

Yes

Question 4

If the Employee is liable to income tax on the market value provided in relation to the issue of Units, will the market value be limited to the Employee Redemption Amount (as defined in the Trust Deed)?

Answer

Yes, where the Employee Redemption Amount reflects market value at the deferred taxing point.

Question 5

When the Employee acquires Units in the Trust, and assuming the ESS deferred taxing point isn't the 15th anniversary of the date of acquisition under subsection 83A-115(6) of the ITAA 1997, and that the 30-day rule in subsection 83A-115(3) doesn't apply, and that an exit event hasn't occurred, will the ESS deferred taxing point be when the employee ceases employment?

Answer

Yes

Question 6

Will the Employee be liable for capital gains tax on any capital gain made on redemption of Units?

Answer

No, unless the redemption happens after the deferred taxing point or the employee paid market value for the Units.

Question 7

Where the Employee has paid market value for the acquisition of additional Units, will the Employee be liable for capital gains tax on any capital gain made upon the redemption of Units?

Answer

Yes

Question 8

Will the broad availability requirement in subsection 83A-105(2) of the ITAA 1997 be met if, although all employees are entitled to acquire ESS interests under the scheme, an invitation to participate will be based on employee performance such that at least 75% of the permanent employees of the employer who have completed at least 3 years of service (whether continuous or non-continuous) with the employer and who are Australian residents may not actually participate in the scheme?

Answer

Yes. Under the Plan, employees will meet the broad availability requirement, provided that the scheme is available to least 75% of the permanent employees of the employer who have completed at least 3 years of service (whether continuous or non-continuous) with the employer and who are Australian residents.However, if an employee performance requirement has the effect that the Employer does not invite at least 75% of the Australian resident permanent employees of the Employer who have completed at least three years of service to participate in the Plan, it will not meet the broad availability condition.

Scheme issue

Question 1

Will the general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme described?

Answer

No

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

The Employer is an Australian- incorporated company.

The Employer is part of the Tax Consolidated Group (Group). The Company is the head entity (Head Company) of the Group. (The reference to Employer also refers to the Group where relevant). The Group provides X services in X industry.

The Employer's employee trust, known as the Trust, has been established by the Employer in collaboration with its employees. The Trust is to be governed in accordance with the proposed Deed of Settlement to establish the Trust provided with the application (Trust Deed).

The Employer intends to implement the Trust to attract, retain, motivate and reward employees for performance by conferring beneficial interests in ordinary shares of the Employer upon its employees, which are funded by improved profitability performance.

The Trust Employee Manual provided with the application (Manual) explains the arrangement to employees.

The employee share plan is governed by the Trust Deed (the Plan).

The persons invited to participate in the Trust are all existing employees of the Employer and new employees that have achieved at least 24 months of continuous employment. Employees in managerial positions are naturally excluded from any decision by the Board as to their remuneration or from any decision as to their participation in the Trust or an issue of ESS interests under the Trust.

The Employer will invite eligible employees to participate in the Plan by owning Units. The Units in the Trust Fund are intended to confer a beneficial interest in shares in the Company (Shares) to eligible employees that participate in the Plan .

The Employer, and invited employees who participate and meet qualifying criteria, will be able to make contributions to the Trust. The Employer must pay contributions to the Trust to allow it to acquire shares in the Company. All employer contributions, when made, will be attributable to identified employees. The Trustee of the Trust will acquire Shares from existing Shares or an allotment of new Shares issued.

The Employer will invite all existing eligible employees to participate in the Trust on an annual basis.

From time to time, additional employees may be nominated by the Employer to participate in

the Trust, including new employees who have achieved at least 24 months of continuous employment with the Employer.

In relation to eligible employees:

•        the Employer will make an offer to a group of employees for them to participate in the Trust.

Trust;

•        this group of employees will consist of at least 75% of the Employer's permanent employees who have completed at least 3 years of service (whether continuous or non-continuous) and who are Australian residents; and

•        the outcome of the process is that 75% of those permanent employees may not end up participating in the Trust and acquire Units, but an offer would have been made to them anyway.

The invitation will include the terms and conditions upon which the Units will be issued. Following receipt of an invitation, an eligible employee who wishes to participate in the Plan will return the completed application form. Upon acceptance of the application by the Employer, eligible employees become Participants in the Plan. The Employer will then instruct the Trustee to allocate a specific number of Units to the Participant and to designate one fully paid ordinary share in the Company (Share) to each Unit (Allocated Share). The Trustee shall ensure such designation is recorded in the books and records of the Trust.

An invitation to an employee will:

•        entitle the employee (or an associate nominee) to acquire units in the Trust (Units) and become a Unit Holder in the Trust;

•        mean that the employee (or their associate) becomes subject to conditions which would disentitle or forfeit their rights and interest in the Units (a Disqualifying Event). Redemption of a Unit is further subject to Disqualifying Discounts, which is to apply by reference to the length of time that the employee has been employed with the Employer;

•        mean that the employee (or their associate) becomes subject to restrictions on their ability to sell, transfer or otherwise dispose of their Units (i.e. genuine restriction); and

•        require the Employer to pay a contribution to enable the Trustee to acquire ordinary shares in the Employer (so as to support the issue of new Units to eligible employees).

Only employees (or their associates) may acquire Units.

Immediately after the Participant acquires the Unit, they do not hold a beneficial interest in more than 10% of the Shares in the Employer and are not in a position to cast or control the casting of more than 10% of the maximum number of votes that might be cast at a general meeting of the Employer (having regard to section 83A-45 of the ITAA 1997).

The market value of the Company will be determined by an independent valuer each financial year. From this valuation the underlying share price will be determined. The net asset backing of Units will reflect the share price, the number of shares in the Employer held by the Trustee for the Trust and the number of Units on issue.

Units will be issued for an issue price which reflects the market value of those Units. The

market value of Units will be directly equivalent to the market value of the underlying ordinary shares in the Company on a 1-to-1 ratio.

The Employee Units provided to the Participants are substantially the same rights in respect of the Shares which are allocated to the Units as if the Participants were the legal owners of the Shares. Subject to the provisions of the Trust Deed, a Unitentitles the Participants to:

•        receive the income deriving from the Allocated Shares including dividends declared in respect of the Shares;

•        to the extent that voting rights are attached to the Shares, direct the Trustee on how it should be exercised;

•        receive the Employee Redemption Amount (described below) on redemption.

The income of the Trust will be distributed to each Unit Holder (i.e. Participant) on an annual basis, based on the cash dividends from ordinary shares allocated to Units held by the Unit Holder. Unit Holders will be entitled to receive any dividends paid on Allocated Shares referable to their Units. These dividends may be franked and any franking credits will 'flow-through' to the Unit Holder.

Under the terms of the Trust Deed, no income or capital of the Trust may be distributed to the Employer and the Employer is excluded from any benefit under the Trust.

Units may only be redeemed under the terms of the Trust Deed.

Upon redemption of Units, the relevant Unit Holder will be entitled to receive an Employee Redemption Amount, being the cash value of the sale of the Allocated Shares (i.e. those

shares that are 'allocated' to the Units remaining after applying Disqualification Discount, if applicable), net of the costs of sale. Where the redemption trigger is the 15^th anniversary of the issue date of the relevant Units the Unit Holder may direct the Trustee to transfer the Allocated Shares referrable to the remaining Units to the Unit Holder or continue to hold the remaining Units on behalf of the Unit Holder. However, where the employee is a bad leaver or subsequently becomes a 'Bad Leaver' their entitlement under the Units is forfeited.

A Bad Leaver means:

•        A Participant that ceases to be employed by or otherwise providing services to the Employer or an Associated Company due to Termination or Termination for Cause or as otherwise designated as a Bad Leaver in the reasonable opinion of the Board;

•        A former Employee who, within a period of 12 months from the cessation of such employment or provision of services to the Employer or Associated Company:

o        commences employment with, or otherwise providing services, to a competitor of the Employer or Associated Company AND solicits employees, clients, or subcontractors from the Employer or Associated Company;

o        commits fraud;

o        is charged with or convicted of a serious criminal offence (in the reasonable opinion of the Board); or

o        otherwise brings the Employer or Associated Company into disrepute (within the reasonable opinion of the Board or the Board of Directors of the relevant Associated Company).

•        A Participant who is in breach of the anti-compete clause in their employment contract.

If a Disqualifying Event occurs, the relevant Units will be forfeited.

A Disqualifying Event includes:

•        the employee becomes bankrupt;

•        the employee transferring or assigning or attempting to transfer or assign a Unit or creating or attempting to create any equitable, contingent, future or partial interest or other security interest in a Unit;

•        the employee becomes of unsound mind or where his estate is liable to be dealt with under any law relating to mental health;

•        the employee's employment is Terminated for Cause; or

•        such other events as may be nominated by the Employer.

The Units are also subject to the Disqualification Discount. An employee must hold the

Units for a designated time before they fully vest. If the designated time is not reached, then a Disqualification Discount applies.

This discount will necessarily reduce the amount of Units (and therefore the underlying

Allocated Shares) which are available to be redeemed and sold by the Trustee on behalf of

the exiting employee. This is set out as follows:

The entitlement percentage is the percentage of Units of a Participant which they are entitled to redeem in the event of a redemption, when the individual units have been held for the time frame specified.

The Trust Deed include both a restriction on sale or transfer of Units such that an employee is only able to transfer, deal with or redeem their Units until the earlier of:

•        cessation of employment;

•        sale (or listing) of the Employer; and

•        15 years (the maximum deferral period) from the acquisition of the Units.

The Trust Deed also provides that if an employee attempts to deal with, transfer or redeem their Units at any time before the abovementioned events, then the Units are forfeited.

Both the Employer, and one or more invited employees (who satisfy the qualifying criteria)

will be able to make contributions to the Trust.

Participants may acquire additional Units at market value. Employees who are also members of the Trust will be allowed to use their bonus to purchase additional Units in the Trust.

The Trust does not involve any salary sacrifice arrangement other than salary sacrifice arrangements that comply with subsection 83A-105(4) of the ITAA 1997.

The Trust does not involve the Trustee making loans to employees (whether interest bearing or interest free and whether of a limited recourse nature or not).

The Trust may also involve the employee subscribing for Units in the Trust at market value, paid in full by the employee at the time of subscription.

Individual A is an employee who will participate in the Plan (Employee).

The Trust has a special purpose corporate trustee (Trustee) which has been established to be trustee of and manage the affairs of the Trust.

The Trustee has restricted investment powers set out in the Trust Deed as follows:

•        the investment powers of the Trustee are limited to obtaining shares, or rights to acquire shares, in the Company; and

•        distributions of income or capital to employees or associates of employees under the terms and conditions of the Trust Deed.

The start-up rules in section 83A-33 of the ITAA 1997 do not apply.

The relevant ESS interests will have a market value greater than nil, whether determined by the general concept of market value, or the regulations under Division 83A of the Income Tax Assessment Regulations 1997.

Assumptions

The 30-day disposal rule will not apply.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 6-25

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 subdivision 83A-A

Income Tax Assessment Act 1997 subdivision 83A-B

Income Tax Assessment Act 1997 subdivision 83A-C

Income Tax Assessment Act 1997 section

Income Tax Assessment Act 1997 section 1

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 section 109ZB

Income Tax Assessment Act 1936 section 177D

Fringe Benefits Tax Assessment Act 1986 section 136

Superannuation Guarantee (Administration) Act 1992 section 11

Reasons for decision

Employer issues

Question 1

Will contributions paid by the Employer to the Trust pursuant to the Trust Deed constitute an income tax deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

Employer contributions paid to the Trust will be deductible under section 8-1 of the ITAA 1997. They meet the positive limbs of section 8-1 of the ITAA 1997 because they are incurred as part of a business carried on for the purpose of earning assessable income. They are not excluded by any of the negative limbs.

Detailed reasoning

Under section 8-1 of the ITAA 1997, an employer is entitled to a deduction for losses or outgoings to the extent that it is either incurred in gaining or producing the employer's assessable income or is necessarily incurred in carrying on a business for the purposes of gaining or producing the employer's assessable income.

However, a deduction is not allowed under section 8-1 of the ITAA 1997 to the extent that the contribution is an outgoing of capital, or of a capital nature, is an outgoing of a private or domestic nature, is incurred in the gaining or producing exempt income or non-assessable non-exempt income or is prevented from being deductible under a specific provision of the ITAA 1997 or the ITAA 1936.

TR 2018/7 sets out the Commissioner's view on how the taxation laws apply to an employee remuneration trust arrangement that operates outside the employee share scheme rules in Subdivision 83A-B or Subdivision 83A-C of the ITAA 1997. Notwithstanding, the principles are equally relevant to employee share plan trust arrangements.

Paragraph 9 of TR 2018/7 provides that a contribution is deductible to the employer under section 8-1 where all the following applies:

•        it is an irrevocable payment of cash, made at a time when the employer carries on a business for the purposes of gaining or producing assessable income;

•        it is made because the employer reasonably expects their business to benefit from their contribution via a gaining or producing assessable income; and

•        it is intended to be permanently and entirely dissipated in remunerating employees of that business within a relatively short period of the contribution being made (other than employees who are wholly engaged in affairs of capital of the business).

Has the outgoing attributable to the contribution been incurred?

To qualify for a deduction under section 8-1 of the ITAA 1997, a loss or outgoing must be incurred.

The term 'incurred' is not defined in the legislation, however, broadly a taxpayer incurs an outgoing at the time the taxpayer owes a present money debt that they cannot escape (see Taxation Ruling TR 97/7). Otherwise, a loss or outgoing is incurred when a taxpayer is definitively committed to the outgoing (see Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492; Coles Myer Finance Pty Ltd v. Federal Commissioner of Taxation 93 ATC 4214).

A contribution made to the trustee of a trust is incurred only when the ownership of that contribution passes from an employer to the Trustee and there is no circumstance in which the employer can retrieve that contribution (see Pridecraft Pty Ltd v Federal Commissioner of Taxation [2004] FCAFC 339; Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCAFC 339).

Accordingly, it must be established in this case that the contributions paid to the trustee of the Trust are irretrievable and not refundable, otherwise they will not be a permanent outgoing incurred for the purposes of section 8-1 of the ITAA 1997.

Has the outgoing attributable to the contribution been incurred in gaining or producing assessable income, or necessarily incurred in carrying on a relevant business?

In addition to being incurred, for a contribution to an employee share plan trust to be deductible it must have either been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business of gaining or producing assessable income.

Any contribution made to the Trust is not incurred by the Employer in gaining or producing any assessable income. Accordingly, to be deductible any contribution made by the Employer to the Trust, must be necessarily incurred by the Employer in carrying on its business.

In order to satisfy this requirement, there must be a relevant connection between the outgoing and the business. An expense will have a relevant connection to the business when it is 'desirable or appropriate in the pursuit of the business ends of the business' (see Ronpibon Tin NL and Tongkah Compound NL v. Federal Commission of Taxation (1949) 78 CLR 47; Magna Alloys & Research Pty Ltd v. Federal Commission of Taxation (1980) FCA 150).

Paragraph 10 of TR 2018/7 provides that the following considerations are relevant to establishing a sufficient connection between a contribution and the benefit to the employer's business:

•        the nature and timing of the benefits to be delivered by the employer and the employees;

•        employee awareness of the scheme; and

•        whether the scheme and the contribution address (or has the capacity to address) the business-related need or function.

In the context of this matter, the objectives of the arrangement are to attract, retain, motivate and reward employees for performance.

Single entity rule

Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax assessment Act 1997 sets out the Commissioner's view on the what the single entity rule (SER) in section 701-1 of the ITAA 1997 is and how it applies to members of a consolidated group. Relevantly, it explains that:

3. Section 701-1 of the ITAA 1997 is a key provision of the consolidation regime. It is the means by which the members of a consolidated group are treated as a single entity (being the head company) for income tax purposes.

...

Consequences of the SER

7. For income tax purposes the SER deems subsidiary members to be parts of the head company rather than separate entities during the period that they are members of the consolidated group.

8. As a consequence, the SER has the effect that:

(a) the actions and transactions of a subsidiary member are treated as having been undertaken by the head company;

(b) the assets a subsidiary member of the group owns are taken to be owned by the head company (with the exception of intra-group assets) while the subsidiary remains a member of the consolidated group;

(c) assets where the rights and obligations are between members of a consolidated group (intra-group assets) are not recognised for income tax purposes during the period they are held within the group whether or not the asset, as a matter of law, was created before or during the period of consolidation (see also paragraph 11 and paragraphs 26-28); and

(d) dealings that are solely between members of the same consolidated group (intra-group dealings) will not result in ordinary or statutory income or a deduction to the group's head company.

...

19. The scope of the core purposes is expressed in the opening statement in the Guide to the consolidation regime at section 700-1. It states '[t]his Part allows certain groups of entities to be treated as single entities for income tax purposes.' [emphasis added].

20. The EM at paragraph 2.22 supports this scope:

Some examples of the effect of absorption of the subsidiaries into the head company (for the purposes of working out its income tax liability or losses) are that during consolidation:

•        the taxable income of the taxpayer under section 4-15 of the ITAA 1997 refers to that of the head company. This calculation is made on the basis that income and deductions are assessed or allowable under the ITAA 1997 to the head company only;

...

Application in these circumstances

The Employer has established the Trust for the purposes of rewarding participating employees where certain conditions are satisfied.

The contributions made to the Trust are considered irrevocable and irretrievable to the Employer and that will incur an outgoing for the purposes of section 8-1 of the ITAA 1997 at the time it makes such contributions to the Trustee of the Trust.

The Employer expects that the Trust will result in an improvement to recruitment, retention and motivation of employees. Employees are made aware of the scheme via the Manual and offers to acquire units.

Accordingly, the contributions made by the Employer to the Trust have a sufficient connection with the Employer's business and will satisfy the nexus of being necessarily incurred in carrying on that business for the purposes of gaining or producing assessable income. Pursuant to the SER, the deductions are allowable to the Head Company.

Question 2

When will contributions paid by the Employer to the Trust pursuant to the Trust Deed be deductible?

Summary

If employees acquire their ESS interests after the Employer pays contributions under the scheme, section 83A-210 of the ITAA 1997 will operate to make that contribution deductible in the income year in which employees acquire their interests.

If employees acquire their ESS interests at or before that time, section 8-1 of the ITAA 1997 will apply to make the contribution deductible in the income year in which the contribution was made.

Detailed reasoning

As discussed above, section 8-1 allows deductions when losses or outgoings are incurred.

Taxation Ruling TR 97/7 Income Tax: section 8-1 - meaning of 'incurred' - timing of deductions (TR 97/7) sets out the Commissioner's view about the meaning of incurred which explains that you incur an expense when you have a presently existing liability to pay a pecuniary sum equal to that expense, or when payment of the expense is made in the absence of such a presently existing liability.

TR 97/7 explains that:

•        The courts have been reluctant to attempt an exhaustive definition of a term such as 'incurred'. The following propositions do not purport to do this, they help to outline the scope of the definition. The following general rules, settled by case law, assist in most cases in defining whether and when a loss or outgoing has been incurred: a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below, it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum;

•        a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;

•        a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation (based on probabilities);

•        whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;

•        in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid.

However, section 83A-210 of the ITAA 1997 deals with the timing of deductions and may apply to align the deduction with when the individual acquires their ESS interest. It states that if:

•        you provide another entity with money or property for the purpose of enabling an individual to acquire (directly or indirectly) an ESS interest under an ESS scheme, and

•        that time occurs before the time the ultimate beneficiary acquires the ESS interest,

•        then for the purpose of determining the year in which you can deduct an amount in respect of providing that money or property, you are taken to have provided it at the acquisition time.

ATO web-guidance 'Share trusts' accessed at https:www.ato.gov.au on 6 March 2024 explains that the deduction would generally be available in the income year the money was paid to the share trust. However, the ESS rules defer the timing of the deduction until an employee acquires the ESS interest.

ATO Interpretative Decision ATO ID 2010/103 Income Tax: employee share scheme: timing of deduction for money provided to the trustee of an employee share trust confirms that section 83A-210 of the ITAA 1997 may apply where the trust purchases 'excess' shares to hold in reserve to meet obligations to issue shares to employees in the next year.

Application in these circumstances

If employees acquire their ESS interests after the Employer pays contributions under the Plan, then section 83A-210 of the ITAA 1997 will operate to make that payment deductible in the income year at the acquisition time. However, if employees acquire their ESS interests at or before the contribution, section 8-1 of the ITAA 1997 would apply to make that payment deductible in the income year in which payment was made.

Question 3

Will the contributions paid by the Employer to the Trust constitute a 'fringe benefit' as defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Summary

The contributions the Employer makes to the Trustee of the Trust, to fund the Trust in accordance with the Trust Deed with respect to the Plan and the provision of Units to employees will not constitute a fringe benefit under subsection 136(1) of the FBTAA.

Detailed reasoning

Section 136 of the FBTAA defines fringe benefits to exclude benefits constituted by the acquisition of:

•        an ESS interest under an employee share scheme to which Subdivisions 83A-B or 83A-C of the ITAA 1997 apply, or

•        money or property by an employee share trust (within the meaning of the ITAA 1997).

'Employee share trust' in that Act broadly means a trust whose sole activities are giving ESS interests to employees. 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:

•        obtaining shares or rights in a company, and

•        ensuring that ESS interests in the company (that are beneficial interests in those shares or rights) are provided under the scheme to employees or their associates, or

•        other activities that are merely incidental to those ends.

Application in these circumstances

The Employer contributions are excluded as fringe benefits. The contributions provide the Trust with funds to acquire shares in the Employer. The Trust Deed requires the Trustee to allocate those shares to Units, and it will issue those Units to employees. Broadly, the Trust Deed prohibits the Trustee from using trust funds for other purposes. It is noted that the Trustee will administer the Trust in accordance with the Trust Deed. Therefore, the Trust qualifies as an employee share trust. Consequently, contributions paid by the Employer would be excluded as fringe benefits under the FBTAA.

Question 4

Will contributions paid by the Employer to the Trust constitute an obligation under the Superannuation Guarantee (Administration) Act 1992 (SGAA 1992)?

Summary

Benefits constituted by the acquisition of an ESS interest under an employee share trust would not be salary or wages for SGAA 1992 purposes.

Detailed reasoning

Broadly, the SGAA 1992 imposes a super guarantee charge where employers do not pay the minimum super guarantee by the due date.

Section 16 imposes a superannuation guarantee charge on a shortfall for a quarter.

Individual employee shortfalls are calculated by multiplying the total salary or wages paid by an employer to the employee for the quarter, multiplied by the charge percentage (section 19 of the SGAA 1992).

Section 11 of the SGAA 1992 provides that salary or wages excludes fringe benefits.

However, section 23 of the SGAA 1992 reduces the charge percentage by contributions made by an employer.

The contribution is worked out by dividing the contribution by ordinary time earnings.

Section 6 of the SGAA 1992 defines ordinary time earnings to mean earnings in respect of ordinary hours of work (other than lump sums for leave), and also earning consisting of over-award payments, shift-loading, or commission.

Superannuation Guarantee Ruling SGR 2009/2 Superannuation guarantee: meaning of the terms 'ordinary time earnings' and 'salary or wages' explains thatbenefits covered by the ESS rules will not be treated as salary or wages.

Fringe benefits and other non-cash benefits

58. Fringe benefits as defined in the Fringe Benefits Tax Assessment Act 1986 (FBTAA) are excluded under subsection 11(3) of the SGAA. Additionally, the Commissioner takes the view that other 'benefits', within the meaning of the FBTAA, given by employers to employees that are neither fringe benefits nor salary or wages within the meaning of that Act are not salary or wages for SGAA purposes. For example:

•                     contributions made by an employer to a complying superannuation fund for the benefit of an employee (including those required to be made by the superannuation guarantee legislation itself); and

•                     the acquisition of a share, or of a right to acquire a share, under an employee share scheme (within the meaning of Division 13A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936)), are not salary or wages for SGAA purposes.

Application in these circumstances

Consequently, the ESS interests are excluded for the purposes of the SGAA 1992. As shares and rights to acquire shares under an ESS are excluded, it follows that benefits constituted by the acquisition of an ESS interest under an employee share trust would not be salary or wages for SGAA 1992 purposes either.

Trustee issues

Question 1

Will amounts contributed by the Employer to the Trust for the benefit of employees constitute assessable income of the Trust for the purposes of section 6-5 of the ITAA 1997?

Question 2

Will amounts contributed to the Trustee by participant employees for the acquisition of additional Units constitute assessable income of the Trust under section 6-5 of the ITAA 1998?

Summary

The Employer and Employee contributions to the Trustee for the purposes of the scheme constitute capital receipts to the Trustee and are not assessable income under section 6-5 or 6-10 of the ITAA 1997.

Detailed reasoning

Section 95 of the ITAA 1936 defines net income in relation to a trust as follows:

Net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions...

Assessable income includes both ordinary income and statutory income according to sections 6-5 and 6-10 of the ITAA 1997. Ordinary income is income according to ordinary concepts. Statutory income is income that is not ordinary income but is included in assessable income because of a specific provision of the ITAA 1997 or ITAA 1936.

Ordinary income

Section 6-5 of the ITAA 1997 provides that a taxpayer's assessable income includes income according to ordinary concepts.

The expression 'income according to ordinary concepts' is not a defined term. However, case law has identified factors which may be relevant in determining whether a receipt is properly characterised as income according to ordinary concepts. For example, in GP International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124, the High Court of Australia found that:

To determine whether a receipt is of an income or of a capital character, various factors may be relevant. Sometimes, the character of receipt will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

As a general rule, amounts received as a result of carrying on a business should represent ordinary income. However, receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business.

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 confirms that the trustee of the employee share scheme trust will not be assessed under sections 6-5 or 6-10 of the ITAA 1997 on contributions made to it by an employer for the purpose of and under the employer's employee share scheme.

Statutory income

Section 10-5 of the ITAA 1997 provides a list of provisions of assessable income for the purposes of section 6-10 of the ITAA 1997.

Application in these circumstances

The contributions made by the Employer to the Trustee of the Trust are irretrievable and non-refundable to Employer in accordance with the Trust Deed as they do not have any beneficial interest in the trust assets: the contributions received from the Employer can only be used to fund the acquisition of shares and operate the Trust in accordance with the terms of the Trust Deed. Therefore, the irretrievable contributions received by the Trustee of the Trust are capital in nature for the purposes of section 6-5 of the ITAA 1997.

None of the provisions relating to statutory income apply to contributions made by employers to an employee remuneration trust (or similar transactions).

The funds provided to the Trustee of the Trust in accordance with the Trust Deed and for the sole purpose funding the acquisition of Employer shares for the purposes of operating the Plan constitute capital receipts to the Trustee and are not assessable income under section 6-5 or 6-10 of the ITAA 1997.

Employee contributions will not be assessable income of the Trustee under section 6-5 of the ITAA 1997 for the same reasons.

Question 3

Will contributions by the Employer to the Trustee to fund the acquisition of the Employer shares and/or the expenses of operating the Trust be treated as a deemed dividend within the meaning of Division 7A of ITAA 1936?

Summary

Contributions made by the Employer 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) of the ITAA 1936.

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

Relevantly, 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 section 960-100 of the ITAA 1997 and includes the trustee of a trust.

The contributions made by the Employer to the Trustee would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Employer shares at the time the contribution is made. Section 109C of the ITAA 1936 would apply to treat the amount of the contributions to be a deemed dividend, subject to Employer's distributable surplus for the relevant income year, unless an exception applies.

Exception

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. In considering benefits provided to employees or associates of employees in the context of that Act (specifically, in the definition of a 'fringe benefit'), Commissioner of Taxation v Indooroopilly Children Services (Qld) Pty Ltd concluded that the reference to an employee is a reference to a particular employee.

Application in these circumstances

The Trustee is an associate of any of the Employer's employee who is a beneficiary of the Trust. Contributions are made by the Employer to the Trustee once it is resolved to provide a particular Participant with a Unit to which a Share is to be allocated. As the contribution would be made to the Trustee in respect of a particular employee, subsection 109ZB(3) of the ITAA 1936 will be satisfied.

Therefore, the contributions made by the Employer to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936, as its operation would be excluded under subsection 109ZB(3) of the ITAA 1936.

Employee issues

Question 1

What amount will be assessable income to the Employee (even if they participate indirectly through an associate) in the event they are entitled to an Employee Redemption Amount?

Summary

For employees who acquired their Units for no consideration under the Plan, any amount included in the employee's assessable income upon receiving an Employee Redemption Amount will be limited to the amount included under Subdivision 83A-C of the ITAA 1997, unless that redemption happens after the deferred taxing point. For completeness, employees who dispose of their interests after the deferred taxing point may need to include any capital gain from subsequent CGT events in their assessable income.

Employees who purchase their Units at market value will also need to include in their assessable income any capital gain from any CGT event happening on receiving their Employee Redemption Amount.

Detailed reasoning

This arrangement will be treated as an employee share scheme under Division 83A of the ITAA 1997 and employees will receive beneficial interests in rights.

Section 6-5 of the ITAA 1997 includes ordinary income in assessable income.

Section 6-10 of the ITAA 1997 includes statutory income in assessable income.

Section 6-25 of the ITAA 1997 provides that where the amount is both ordinary income and covered by a specific provision, the specific provision will prevail, unless a contrary intention' appears.

Section 10-5 of the ITAA 1997 sets out the list of provisions about statutory income, which may vary or replace amounts which would otherwise be ordinary income. The item for employee share schemes lists Subdivisions 83A-B and 83A-C of the ITAA 1997.

In broad terms, the ESS rules include the value of a discount under an ESS scheme in your assessable income. If Subdivision 83A-B of the ITAA 1997 applies, the discount is included in your assessable income immediately. However, if deferred taxation under Subdivision 83A-C of the ITAA 1997 applies, you include an amount in your assessable income at the deferred taxing point.

ESS interests are defined in two ways. Subsection 83A-10(1) of the ITAA 1997 provides that an interest (in a company) is:

•        a beneficial interest in a share in the company, or

•        a beneficial interest in a right to acquire beneficial interests in a share in the company.

Subsection 83A-10(2) of the ITAA 1997 provides that employee share schemes are schemes under which ESS interests in a company are provided to employees or associates, in relation to the employee's employment.

The ESS rules apply to treat ESS interests held through trusts as being held by beneficiaries. Section 83A-320 of the ITAA 1997 provides that 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.

Application in these circumstances

In this case section 83A-320 of the ITAA 1997 will treat Shares held through the Trust as being held directly by the participating employees. Once the Trustee acquires Shares, the Shares will be allocated to Units, and the Units will be issued to employees in accordance with the Plan. Each Unit will correspond to a particular number of Shares, such that Division 83A of the ITAA 1997 will apply to treat employee unitholders as having beneficial interests in the Shares allocated to their Units.

For completeness, the Plan will also be an employee share scheme. The Units are issued to employees in respect of employment because only employees are invited to subscribe for Units, under a scheme which purports to be set up for employees' benefit. Since beneficial interests in shares attach to those Units, the Trustee will be also providing ESS interests to employees under the Plan.

As the Employee has not paid consideration for the Units and the value of the units are equal to the value of the underlying shares the Employee is taken to have acquired the ESS interests at a discount. The Units in the Trust and therefore the ESS interests are provided to the Employee as an incentive by their employer and as such are acquired by the Employee in relation to their employment. Therefore, Division 83A of the ITAA 1997 will apply to the acquisition of units by the Employee.

However, where the Employee acquires additional Units in the Trust and pays market value consideration for such Units neither of the operative Subdivisions of Division 83A will apply to the acquisition of such Units. Although the interests acquired meet the definition of ESS interests in section 83A-10 of the ITAA 1997 and such interests are arguably acquired in relation to employment, Division 83A will only apply where such interests are acquired at a discount (refer to the discussion below).

The taxing point is deferred if employees meet conditions in Subdivision 83A-C of the ITAA 1997 - otherwise, the discount is taxed upfront under Subdivision 83A-B.

Subdivision 83A-B of the ITAA 1997 applies by default where Subdivision 83A-C does not apply. Subdivision 83A-B applies where you acquire an interest under an ESS at a discount: subsection 83A-20(1). Subsection 83A-105(1) provides that Subdivision 83A-C applies, and not Subdivision 83A-B, where the conditions for that subsection are met.

Broadly, Subdivision 83A-C of the ITAA 1997 provides deferred tax treatment to ESS interests where the employee is prevented from disposing of those interests, and other conditions are met. These conditions are set by section 83A-105. For ESS interests that are beneficial interests in shares, the taxing point happens at the earliest time when the employee is not prevented from disposing of them, or after 15 years. While some conditions are common to all interests, some different conditions apply depending on whether the ESS interests are classified as rights or shares.

Where Subdivision 83A-C of the ITAA 1997 applies, section 83A-110 includes the ESS interest's market value, worked out at the deferred taxing point (reduced by any cost base) in the employee's assessable income.

With respect to forfeited interests, section 83A-310 of the ITAA 1997 may apply (which means that Division 83A does apply). Broadly, the employee must forfeit the interest or lose a right (without disposing or exercising it). Further, that forfeiture or loss can't be a result of:

•        the employee's choice (except a choice to leave employment or to let a right lapse or be cancelled), or

•        a scheme condition that protects the employee against a fall in the ESS interest's market value.

The Employer's scheme meets the common conditions in Subdivision 83A-C of the ITAA 1997.

For deferred tax treatment under Subdivision 83A-C of the ITAA 1997, there are four conditions common to both rights and shares.

•        Subdivision 83A-B of the ITAA 1997 would (apart from section 83A-105) apply to the scheme: paragraph 83A-105(1)(a).

•        After applying section 83A-315 of the ITAA 1997, there is still a discount given in relation to the interest: paragraph 83A-105(1)(aa). Section 83A-315 allows for regulations to determine the market value of ESS interests; the only ESS regulations are in Division 83A of the Income Tax Assessment Regulations 1997, which apply to unlisted rights that must be exercised within 15-years.

•        Section 83A-33 of the ITAA 1997, relating to start-ups, does not reduce the amount to be included in your assessable income: paragraph 83A-105(1)(ab).

•        Subsections 83A-45(1), (2), (3), and (6) of the ITAA 1997 apply to the interest: paragraph 83A-105(1)(b).

Section 83A-315 of the ITAA 1997 deals with market value. Section 83A-315 provides that whenever Division 83A requires you to use market value, you should instead use the amount specified in regulations. The only relevant regulations are in Division 83A of the Income Tax Assessment Regulations 1997. Regulation 83A-315.01 provides that where unlisted rights must be exercised within 15 years, you can choose market value, or amounts determined by regulations 83A-315.02 through to 83A-315.09.

Application in these circumstances

Under this Plan, Units issued without consideration will meet the common conditions. The Units are issued for no consideration, so employees will have received the ESS interest (being a beneficial interest in the shares) at a discount. The ESS interests will have a market value greater than nil.

Any Units purchased at market value will not meet the common conditions: employees will have purchased them at market value, so they will not have received them at a discount.

The start-up rules will not apply.

Only current employees of the Employer (a subsidiary of the Company) will be allocated Units under the Plan, so the condition in subsection 83A-45(1) of the ITAA 1997 is met.

Subsection 83A-45(2) of the ITAA 1997 applies as only beneficial interests in ordinary shares of the Company will be acquired under the Plan.

Subsection 83A-45(3) of the ITAA 1997 applies because on these facts the integrity rule does not apply. The integrity rule applies when the taxpayer is employed by an investment company and another company. As stated in paragraph 2.32 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1995 (which explained the prior employee share scheme provisions in Division 13A of the ITAA 1936, and in particular former section 139DF), for the purposes of this integrity rule a holding company that holds shares in operating subsidiaries that are not investment companies will not be considered an investment company itself. The predominant business of the Group is not investment. The Company is the head company in the consolidated group. The employees are employed by the Employer, a subsidiary of the Company and a member of the consolidated group and are not employed by the Company.

Subsection 83A-45(6) of the ITAA 1997 applies because a participant under the scheme described in this ruling will not, immediately after the acquisition of the Units, directly or indirectly hold or control a legal or beneficial interest in 10% or more of the shares in the Company (including the voting rights that relate to those shares) having regard to the terms of subsection 83A-45.

The Employer scheme meets the conditions applying to beneficial interests in shares: it meets the real risk of forfeiture requirement and the broad availability requirement.

ESS interests that are beneficial interests in shares need to meet two conditions for the deferred tax treatment to apply. These are set by paragraph 83A-105(1)(c) of the ITAA 1997.

First, when you acquire the ESS interest, at least 75% of Australian resident permanent employees who have completed at least 3 years' service must be entitled to acquire ESS interests under the scheme or another ESS providing ESS interests in the employer or holding company: subsection 83A-105(2) of the ITAA 1997.

Second, either:

•        when you acquire the ESS interest, there's a real risk that you will forfeit it or lose it under the scheme conditions (other than by disposing of it): subsection 83A-105(3)(a) or

•        broadly, the ESS interest is provided under a salary sacrifice arrangement: subsection 83A-105(4).

In relation to the requirement of a real risk of forfeiture, ATO Interpretative Decision ATO ID 2010/61 Income Tax: Employee share scheme: real risk of forfeiture - minimum term of employment and good leaver provisions and ATO web-guidance 'ESS - Real risk of forfeiture' accessed at https://www.ato.gov.au on 6 March 2024 explain that ESS interests will be forfeited if the employee does not complete a minimum term of employment. It is accepted that there is a real risk of forfeiture where the minimum term of employment is:

•        at least 12 months, or

•        at least 6 months where the maximum deferral is no more than 3 years.

Application in these circumstances

A participant in the scheme will meet the first condition. Each year, the Employer will make an offer to a group of employees inviting them to subscribe for Units. That group will consist of at least 75% of the Employer's permanent employees who are Australian residents and have completed at least 3 years' service. Whilst it is possible that some of those employees might elect not to participate in the Plan, they were eligible to have done so. When each employee acquires their interests, at least 75% of Australian resident permanent employees with at least 3 years' service will have been entitled to acquire ESS interests under the scheme.

Employees under the scheme are at real risk of forfeiture when they acquire their ESS interests under the Plan. The Plan rules mean that employees will effectively forfeit their units if they do not complete one year of employment after their units are issued. The Trust Deed provides that Units will not qualify for redemption on leaving employment where the employee has held the Units for less than one year. When the Units have been held for one year the entitlement percentage will be 25% increasing to 100% when held for 4 years. The Commissioner accepts a nil entitlement amounts to forfeiture, because their ESS interests have no economic value when realised. As such the real risk of forfeiture condition is met.

The conditions in subsection 83A-105(1) of the ITAA 1997 are met, so Subdivision 83A-C applies.

It follows that section 83A-110 of the ITAA 1997 operates to include the market value of the interest in the Employee's assessable income at the ESS deferred taxing point, reduced by the interest's cost base.

For completeness, Division 83A of the ITAA 1997 would not include amounts in an employee's assessable income if they forfeit their interests under the Plan in circumstances covered by section 83A-310.

Conclusion

Employees who do not forfeit their interests will include the market value of their interests in assessable income for units issued at a discount and may have capital gains in some circumstances.

The deferred tax treatment applies to Units acquired for no consideration (refer to the discussion above).

For those Units, Subdivision 83A-C of the ITAA 1997 will apply in the following manner.

Section 83A-110 of the ITAA 1997 will apply to include the market value of the employee's interests in their assessable income in the income year of the ESS deferred taxing point, less any cost base.

Employees receiving ESS interests will apply Division 83-A of the ITAA 1997 at the deferred taxing point (assuming section 83A-310 does not apply). If amounts from the same transaction could also be assessed under other provisions (whether ordinary income or statutory income), section 6-25 of the ITAA 1997 will apply to prevent that double taxation of that amount.

Employees will not be subject to CGT if they are taxed under Division 83A (refer to the discussion above) at the ESS deferred taxing point, but they may be subject to CGT if they dispose of their ESS interest after that point (refer to the discussion above).

Employees may also have capital gains where they purchase Units at market value. In that case, the ESS rules in Subdivision 83A of the ITAA 1997 will not apply because employees have not acquired ESS interests at a discount (refer to the discussion above).

Question 2

Will the Employee be assessed on contributions the Employee makes to acquire additional Units in the Trust?

Summary

The acquisition is neither ordinary nor statutory income and the consideration provided is an outgoing.

Detailed reasoning

When the Employee acquires additional units at market value they are providing arms-length market value consideration for the acquisition of an asset, namely the Unit. The acquisition is neither ordinary nor statutory income and the consideration provided is an outgoing - which is not assessable.

Question 3

Will the Employee be assessed on the value of units issued by the Trustee to the Employee (or to their associate) where the Employer is not liable for fringe benefits tax?

Summary

The Employee will be assessed on the value of units issued by the Trustee to the Employee (or to their associate) where the Employer is not liable for fringe benefits tax - but only to the extent that the unit value is taxed at the ESS deferred taxing point under the ESS provisions or reflected in a capital gain on a later disposal.

Detailed reasoning

As discussed above, Units acquired for no consideration would be taxed under Subdivision 83A-C of the ITAA 1997, which applies to include the market value of the Units at the ESS deferred taxing point in the employee's assessable income. For Units subject to Subdivision 83A-C, employees may have capital gains if they later dispose of their interests after that ESS deferred taxing point.

Units acquired for no consideration will not be assessable to employees under other provisions. Even if the value of those units were assessable as ordinary income under 6-5 or statutory income), section 6-25 of the ITAA 1997 will operate to prevent that about being taxed more than once.

Division 83A of the ITAA 1997 will not apply to any additional Units acquired by employees at market value and these Units would be subject to the normal CGT rules.

Units purchased at market value will not be assessed to employees. The employee is paying full market value for their units and the only thing they are receiving or gaining from the transaction is the unit they are buying.

Question 4

If the Employee is liable to income tax on the market value provided in relation to the issue of Units, will the market value be limited to the Employee Redemption Amount (as defined in the Trust Deed)?

Summary

Where the Employee is liable to income tax on the market value provided in relation to the issue of Units, the market value be limited to the Employee Redemption Amount where the Employee Redemption Amount reflects market value of the ESS interest at the ESS deferred taxing point.

Detailed reasoning

As discussed above, Units acquired for no consideration would qualify for deferred tax treatment under Subdivision 83A-C of the ITAA 1997.This means that employees will include the market value of their ESS interests (determined at the ESS deferred taxing point) in their assessable income, less cost base.

The general rules governing cost base are set out in section 110-25 of the ITAA 1997. Broadly, the cost base of a CGT asset consists of five elements (subsection 110-25(1) of the ITAA 1997). Relevantly, the first element is the total of:

•        the money you paid, or are required to pay, in respect of acquiring it; and

•        the market value of any other property you gave, or are required to give, in respect of acquiring the asset.

There are a number of modifications to the general rules about cost base. The market value substitution rule in subsection 112-20(1) of the ITAA 1997 modifies the general rule by replacing the first element of the cost base and reduced cost base of a CGT asset acquired from another entity with its market value (at the time of acquisition) where:

•        You did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

o        CGT event D1 happening; or

o        Another entity doing something that did not constitute a CGT event happening; or

•        Some or all of the expenditure you incurred to acquire it cannot be valued; or

•        You did not deal at arm's length with the other entity in connection with the acquisition.

However, the market value substitution rule does not apply to the extent it relates to the acquisition of an ESS interest to which Subdivision 83A-C of the ITAA 1997 applies (subsection 130-80(4) of the ITAA 1997.

In those circumstances where the holder of Units remaining after the application of the disqualification discounts redeems their Units under the Deed, and receives the Employee Redemption Amount, this amount will reflect the cash value of the Allocated Shares (referrable to the Units that are being redeemed) when they are sold, net of any selling costs.

'Market value' in this context means the price that fully informed buyers and sellers would reach, if bargaining at arm's length (refer to e.g. ATO web-guidance Market valuation for taxation purposes' accessed at www.ato.gov.au on 6 March 2024).

Application in these circumstances

Whether the Employee Redemption Amount reflects market value will depend on whether the buyer and seller are bargaining at arm's length under normal market conditions, and whether any selling costs reduce the employee redemption amount below that amount.

For completeness, cost base is likely to be 'nil' for Units acquired for no consideration.

As the market value substitution rule will not apply, the cost base of the Units would be limited to amounts (if any) with respect to the other elements of the cost base.

Units acquired for market value may produce a capital gain or loss on redemption (refer to the discussion above).

Question 5

When the Employee acquires Units in the Trust, and assuming the ESS deferred taxing point isn't the 15th anniversary of the date of acquisition under subsection 83A-115(6) of the ITAA 1997, and that the 30-day rule in subsection 83A-115(3) doesn't apply, and that an exit event hasn't occurred, will the ESS deferred taxing point be when the employee ceases employment?

Summary

The deferred taxing point will be when employees leave employment, assuming that happens before 15 years after acquisition, and that they leave before any exit event.

The Plan qualifies for deferred tax treatment under Subdivision 83A-C of the ITAA 1997. The relevant taxing point will be the earliest time when employees are not at risk of forfeiture and are no longer genuinely restricted from disposing of their ESS interests under the scheme. In this case, that will be when employees leave employment because they cannot dispose of their ESS interests until that point, assuming that employees do not remain employed for 15 years, an exit event does not happen, and they do not dispose of their interests within 30 days of what would otherwise be the deferred taxing point.

Detailed reasoning

Different rules apply to determining the taxing point for beneficial interests in shares, and beneficial interests in rights.

There are rules for determining the deferred taxing point where Subdivision 83A-C of the ITAA 1997 applies.

Section 83A-115 of the ITAA 1997 applies to shares, while section 83A-120 applies to rights.

In both cases, the deferred taxing point is modified to be the date of the disposal of the ESS interest (or the shares acquired on exercising the rights), if that happens within 30 days of that deferred taxing point: see subsections 83A-115(3) and 83A-120(3).

It is assumed that the 30-day disposal rule will not apply.

There are two possible deferred taxing points for shares. Subsection 83A-115(2) of the ITAA 1997 provides that the deferred taxing point is the earliest of the times mentioned in subsections (4) to (6) subsection (5), about ceasing employment, was repealed effective 1 July 2022.

Subsection (4) indicates that the first taxing point is the earliest time when:

•        there's no real risk that you will forfeit or lose the interest under the ESS conditions, other than by disposing it, and

•        when the scheme no longer restricted you immediately disposing of the ESS interest.

Subsection (6) sets out that the second taxing point is the end of the 15-year period starting when you acquired the interest.

Application in these circumstances

The effect of the rules under the Plan is that employees can't dispose of their Units or redeem their Units until they leave employment, an exit event occurs or the 15^th anniversary of the acquisition of the Units has happened. The employees are genuinely restricted from disposing of the Units until they redeem their Units on the occurrence of one of these events in accordance with the terms of the Plan.

In this question we have been asked to assume that the ESS deferred taxing point is not the end of the 15-year period starting when the participant acquired the ESS interest, the 30 day rule does not apply and an exit event has not occurred.

Therefore, the relevant taxing point under the Plan will be when employees leave employment, if that happens after one year. Upon ceasing employment, the employee may redeem their remaining Units after the disqualification discounts are applied and direct the Trustee to sell the shares allocated to those Units whereby they will become entitled to receive the Employee Redemption Amount.

As discussed above, employees will be at risk of forfeiture for 1 year after they acquire their Units, unless an Exit Event happens.

For completeness, an employee leaving employment before the 1-year period may have no deferred taxing point. Under section 83A-310 of the ITAA 1997, Division 83A is taken never to have happened in relation to an ESS interest if the employee forfeits the interest or loses it, unless the forfeiture or loss happens through a choice not to exercise a right or to allow it to lapse. Employees who leave during the 1-year period would usually forfeit their beneficial interest in shares, (unless an Exit Event happened). In that case, section 83A-310 would apply of the ITAA 1936 (which means that Subdivision 83A has no application).

Question 6

Will the Employee be liable for capital gains tax on any capital gain made on redemption of Units?

Summary

The Employee is not liable for capital gains tax on any capital gain made on the redemption of Units unless the redemption of Units occurs after the deferred taxing point for the ESS interest.

Detailed reasoning

Subdivision 130-D of the ITAA 1997 operates to recognise that Division 83A contains the primary rules for taxing gains on ESS interests acquired under employee share schemes and that capital gains and capital losses on such interests should usually be disregarded during the period in which Division 83A applies to them.

In particular section 130-80 of the ITAA 1997 operates to disregard any capital gain or capital loss to the extent it results from a CGT event (other than where the capital gain or loss results from CGT events E4, G1 or K8) if the CGT event happens in relation to an ESS interest you acquire under an employee share scheme and: if Subdivision 83A-C applies to the interest, the time of the acquisition is the time when the CGT event happens; or the CGT event happens on or before the ESS deferred taxing point for the interest.

As Subdivision 83A-C applies to the acquisition of Units the effect of subsection 130-80 of the ITAA 1997 is to disregard the capital gain or capital loss from CGT events that happen from the time of acquisition up until the deferred taxing point.

Once a deferred taxing point arises in respect of the unit section 83A-125 of the ITAA 1997 operates inter alia to reset the cost base of the unit at its market value unless the deferred taxing point occurs at the time the unit is disposed of.

Question 7

Where the Employee has paid market value for the acquisition of additional Units, will the Employee be liable for capital gains tax on any capital gain made upon the redemption of Units?

Summary

The acquisition of the Units (and underlying shares) will constitute an acquisition of a CGT asset to which Part 3-1 and Part 3-3 of the ITAA 1997 will apply.

Detailed reasoning

As discussed above, section 130-80 of the ITAA 1997 only operates to disregard capital gains and capital losses where either Subdivision 83A-B or Subdivision 83A-C applies to the ESS interest.

Where a unit is acquired for market value (i.e. not at a discount) neither Subdivision 83A-B or 83A-C of the ITAA 1997 will apply.

Consequently, the acquisition of the Units (and underlying shares) will constitute an acquisition of a CGT asset to which section 109-5 of the ITAA 1997 and the remainder of Part 3-1 and Part 3-3 will apply.

Question 8

Will the broad availability requirement in subsection 83A-105(2) of the ITAA 1997 be met if, although all employees are entitled to acquire ESS interests under the scheme, an invitation to participate will be based on employee performance such that at least 75% of the permanent employees of the employer who have completed at least 3 years of service (whether continuous or non-continuous) with the employer and who are Australian residents may not actually participate in the scheme?

Summary

Whether the broad availability requirement in subsection 83A-105(2) of the ITAA 1997 is met depends on whether, at that time, more than 75% of Australian resident permanent employees with at least 3 years' service are, or have been, entitled to acquire ESS interests under the scheme.

Under the Plan, employees will meet the broad availability requirement, provided that the scheme is available to least 75% of the permanent employees of the employer who have completed at least 3 years of service (whether continuous or non-continuous) with the employer and who are Australian residents.

If an employee performance requirement has the effect that the Employer does not invite at least 75% of the Australian resident permanent employees of the Employer who have completed at least three years of service to participate in the Plan, it will not meet the broad availability condition.

Detailed reasoning

The broad availability requirement is a condition for deferred tax treatment for ESS interests that are shares under Subdivision 83A-C of the ITAA 1997.

Subsection 83A-105(2) of the ITAA 1997 requires that when you acquire your ESS interest at least 75% of your employer's Australian resident permanent employees who have completed at least 3 years of service are, or had been, entitled to acquire ESS interests under the scheme or under another scheme.

The broad availability requirement is only relevant to ESS interests which are beneficial interests in shares: paragraph 83A-105(1)(c) of the ITAA 1997. The Explanatory Memorandum (EM) to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009, explained the test as follows:

Schemes must be broadly available (in respect of shares)

1.165 The employer must offer a scheme or schemes that are available to at least 75 per cent of the Australian resident permanent employees of the company with three or more years service (whether continuous or non-continuous). This means over all the schemes that the employer offers, more than 75 per cent of Australian resident permanent employees with three or more years service must be able to access shares under at least one of those schemes. [Schedule 1, item 1, subsection 83A-105(2)]

1.166 Consistent with the current law, this requirement does not apply to schemes that offer only rights to acquire a share, rather than shares.

1.167 While this requirement is to encourage schemes to be available as widely as possible, the scheme or group of schemes offered by an employer are only required to be offered to permanent employees with at least three years service, and only to 75 per cent of those employees, because it may be difficult in practice to offer the scheme to all employees including, for example, to casual employees.

1.168 The scheme is only required to be offered to 75 per cent of Australian resident permanent employees to ensure employers with a significant percentage of foreign employees can offer employee share schemes to their Australian employees without undue complexity.

Application in these circumstances

The scheme will meet the broad availability requirement, provided that the scheme is available to at least 75% of the permanent employees of the employer who have completed at least 3 years of service (whether continuous or non-continuous) with the employer and who are Australian residents.

If an employee performance requirement has the effect that the Employer does not invite at least 75% of the Australian resident permanent employees of the company who have completed at least three years of service to participate in the Plan, it will not meet the broad availability condition.

Scheme issues

Question 1

Will the general anti-avoidance provisions under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme described?

Summary

The Commissioner will not make a determination that Part IVA of the ITAA 1936 applies to deny in part or full, any tax benefit derived by the Employer, Trustee or Employee with respect to the Plan.

The dominant purpose of the scheme is to provide remuneration to employees in a form that promotes the Employer's business objectives, rather than to obtain a tax benefit.

Detailed reasoning

Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules (PS LA 2005/24) deals with the application of the general anti-avoidance rules, including Part IVA of the ITAA 1936. Before the Commissioner can exercise the discretion in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met. These are:

•        there must be a scheme within the meaning of section 177A of the ITAA 1936;

•        a tax benefit (as defined in subsection 177C(1) of the ITAA 1936) arises that was obtained or would be obtained in connection with the scheme but for Part IVA of the ITAA 1936; and

•        having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies.

The Scheme

A scheme is defined in subsection 177A(1) of the ITAA 1936 which states:

a.    any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

b.    any scheme, plan, proposal, action, course of action or course of conduct.

It is considered that this definition is sufficiently wide to cover the proposed employee arrangement under the Plan, which consists of the creation of the Trust, including the Trust Deed.

Tax Benefit

'Tax benefit' is defined in subsection 177C(1) of which the relevant paragraph is:

Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

...

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out...

Dominant purpose

Pursuant to subsection 177D(1), paragraphs 177D(2)(a) to (h) of the ITAA 1936 set out the following factors that must be considered in deciding whether a scheme was entered into for the purpose of obtaining a tax benefit:

a. the manner in which the scheme was entered into or carried out;

b. the form and substance of the scheme;

c. the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

d. the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

e. any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

f. any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

g. any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

h. the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Subsection 177A(5) of the ITAA 1936 requires the purpose to be the dominant purpose. Therefore, in considering whether Part IVA applies or not, the necessary comparison to be made in relation to the factors listed in subsection 177D(2) is between the scheme as proposed and the relevant counterfactual.

a) The manner of the scheme

The Employer contends that the presence of the Trust provides transparency for the employees with respect to their participation in the scheme.

It is accepted that the Trust provides benefits to the operation of the scheme having regard to the fiduciary obligations of a trustee.

(b) The form and substance of the scheme

The substance of the scheme is the provision of remuneration in the form of Units to eligible employees who participate in the Plan. The scheme includes the provision of funds to the Trust and the holding and/or investment of those funds by the Trustee in Shares to be allocated to Units (providing beneficial interests in Shares) to employees of the Employer, all being interrelated components of the scheme.

Whilst the inclusion of the Trust in the scheme may confer a tax benefit (e.g. facilitating deductions for the Employer), it cannot be concluded that it is the only benefit provided as outlined above.

(c) The timing of the scheme

The scheme has not been established at a time to provide a substantial year-end deduction to the Employer, but by recurring contributions (following the initial contribution). There is nothing in these facts to suggest a dominant purpose of seeking to obtain a tax benefit in relation to the scheme.

(d) The result of the scheme

The result of the scheme is to provide the Employer with allowable deductions for the contributions it makes to the Trust. However, it is noted that the contributions are irretrievable and reflect a genuine non-capital outgoing on the part of Employer to achieve a business outcome. It is accepted that a deduction is allowable in these circumstances.

(e) Any change in the financial position of the company

As noted above, the Employer makes irretrievable contributions to the Trust and those contributions constitute a real expense with the result that the Employer's financial position is changed to that extent. While it may be arguable that the quantum of the deductions is higher with the Trust as part of the scheme than would be the case in other alternatives to the scheme, there is nothing artificial, contrived or notional about the Employer's expenditure.

(f) Any change in the financial position of other entities or persons

The contributions by the Employer to the Trust will form part of the corpus of the Trust and must be dealt with by the Trustee in accordance with the terms of the Trust Deed i.e. for investment in Shares to be allocated to Units provided to Participants in the Plans. The Employer is not a beneficiary of the Trust and its contributions cannot be returned to it in any form.

The financial position of Participants in the Plans will change as a result of participating in the scheme. However, this will be the case regardless of the manner in which the Units are funded/paid.

Therefore, the contributions made by the Employer amount to a real change to the financial position of the Trustee. The financial position of Participants in the schemes will also undergo a real change. There is nothing artificial, contrived or notional about these changes.

(g) Any other consequence

Not relevant to this scheme.

(h) The nature of any connection between the Employer and any other persons

The relationship between the Employer and the Participants in the scheme is one of employer/employee. The Trustee is independent of the Employer and is under a fiduciary obligation to act in the interests of the employees who participate in the scheme and in particular, in this case, the Plan. There is nothing to suggest that the parties are not acting at arm's length to one another. Accordingly, there is nothing in relation to this factor to indicate a dominant purpose of obtaining a tax benefit.

Conclusion

On balance, it is considered that the Plan would not be implemented for the dominant purpose of obtaining a tax benefit.

Consequently, the Commissioner will not make a determination that Part IVA of the ITAA 1936 applies to deny in part or in full any tax benefit with respect to the Plan.