Edited version of private advice

Authorisation Number: 1052234384702

Date of advice: 21 March 2024

Ruling

Subject: Employee share scheme taxing point

Question

Is any amount of the employee share scheme (ESS) discount, related to the grant of Performance Rights 1 and Performance Rights 2, included in your assessable income in the 20XX income year?

Answer

No.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 August 20XX

Relevant facts and circumstances

You are an Australian resident for tax purposes.

You were employed by the Company from late 20XX to August 20XX.

Performance Rights 1 - salary sacrifice

In XXX you received a letter from the Company inviting you to accept a temporary change in your remuneration structure. This was due to the Company facing financial difficulty.

You were advised that there would be a 10% reduction in your annual base salary, for 12 months, starting from XXXX.

You accepted the invitation from the Company on XXXX.

To compensate you for the reduction in your salary, Performance Rights were to be issued to you on a quarterly basis, in lieu of your forgone salary. The details of your revised remuneration were outlined, as follows, in a letter you provided to us, from the Company to you dated XXXX:

Attached to that letter was 'Annexure A', which outlined the Performance Rights Conditions. At paragraph (n) of the conditions, it provides:

(l) subdivision 83A-C of the Income Tax Assessment Act 1997, which enables tax deferral on Performance Rights, will apply (subject to the conditions in that Act) to the Performance Rights granted to you.

The Performance Rights were offered and issued to you subject to the terms of the Company Plan (the Plan). The exercise of these Performance Rights would result in the issuance to you (or your nominee) of ordinary shares in the Company.

These Performance Rights 1 did not have any vesting conditions and vested immediately upon them being issued to you.

Performance Rights 1 were issued to you in lieu of the salary forgone. You did provide that whilst most of the Performance Rights 1 issued to you were based on the fixed 10% salary reduction amount, one tranche of Performance Rights 1 was set at a notional value.

The Performance Rights 1 were issued to you for nil cash consideration.

Following the granting and vesting of the Performance Rights you were required to exercise them by completing a form before they were to be converted to fully paid ordinary shares of the Company.

Despite the letter from the Company outlining that the Performance Rights were to be issued starting from XXX, you did not start receiving the Performance rights until XXXX.

The following Performance Rights 1 were granted to you under this salary sacrifice scheme:

The Performance Rights were issued in the name of your family trust (the Trust), as your listed nominee. You exercised Performance Rights 1 on XXXX.

Performance Rights 2 - short term incentive cash bonus

In XXXX you were entitled to a short-term incentive cash bonus (Cash Bonus).

In a letter dated XXXX from the Company to you, you were invited to apply for Performance Rights in lieu of the Cash Bonus (Performance Rights 2). This was again due to the financial difficulties being faced by the Company.

The Performance Rights 2 were subject to the terms and conditions outlined in that letter, which included at paragraph (n):

(n) subdivision 83A-C of the Income Tax Assessment Act 1997, which enables tax deferral on Performance Rights, will apply (subject to the conditions in that Act) to the Performance Rights granted to you under this Offer.

These were not subject to any vesting conditions and vested immediately upon grant.

On XXXX, you were granted XXX Performance Rights 2 at this time, in lieu of the Cash Bonus.

You exercised these Performance Rights on XXXX.

The Company merged with Company B on XXXX. This merger constituted the occurrence of a "change of control" for the purposes of the Plan. This meant that all vesting conditions attached to the Performance Rights were deemed from this date to automatically be waived.

From XXXX, as a result of the merger, all Performance Rights were automatically exercised, and the Company Shares were to be issued by XXXX.

You provided an Employee Share Scheme statement for year ending XXXX, which was issued to you by the Company. Performance Rights 1 and Performance Rights 2 are outlined in that statement as follows:

(* these ESS interests are Performance Rights 2)

This statement has listed the Performance Rights 1 and Performance Rights 2 were issued to you under a tax deferral scheme. It provides that the discount on the ESS interests is assessable in the XXX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Division 83A-120

Reasons for decision

The ESS provisions are contained in Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997). These provisions recognise the dual nature of ESS interests as both remuneration and investments. To this end, The ESS provisions provide a mechanism for recognising an appropriate value for remuneration purposes and an adjustment to the purchase price for investment purposes to reflect the amount treated as remuneration.

The ESS provisions recognise this outcome by determining:

•         When a taxpayer needs to include any discount received in relation to ESS interests in their assessable income, and

•         The amount of the ESS discount.

Schemes where you are taxed on the discount in the year you acquired the interest are known as 'taxed-upfront schemes. ESS interests acquired under a tax-deferred ESS will be assessed for tax purposes in the year in which the deferred taxing point occurs. In accordance with subsection 83A-110(1) of the ITAA 1997, the amount assessed will be the market value of the ESS interests at the deferred taxing point, reduced by the cost base of the ESS interests.

For an ESS interest that is a right to acquire a share that is granted on or after 1 July 2015, the deferred taxing point will be the earliest of the times provided in subsections 83A-120(4) to (7) of the ITAA 1997, summarised as follows:

•         The first possible taxing point is when there is no real risk of forfeiting the right and the scheme no longer genuinely restricts disposal of the right (subsection 83A-120(4) of the ITAA 1997)

•         The second possible taxing point is when the employment ends in respect of which the right was acquired (subsection 83A-120(5) of the ITAA 1997)

•         The third possible taxing point is fifteen years from the grant date (when you acquired the ESS interest) (subsection 83A-120(6) of the ITAA 1997)

•         The fourth possible taxing point is, exercise the right, and the resulting share is not at a real risk of forfeiture or subject to genuine selling restrictions (subsection 83A-120(7) of the ITAA 1997)

Operation of subsection 83A-120(3) of the ITAA 1997 can change the deferred taxing point if an ESS interest (or the share acquired on exercise of the right) is sold within 30 days of the deferred taxing point. The deferred taxing point will instead be the date of that disposal. That is, the deferred taxing point is moved to the sale date if this occurs within 30 days of the date identified by the provision. This is called the 30-day rule.

Genuine selling restrictions

The fourth possible taxing point under subsection 83A-120(7) of the ITAA 1997 will be the first time that a participant can deal with the resulting share acquired from exercising the right, that is, where there is no real risk of forfeiture and all genuine disposal restrictions ended.

The term 'genuine selling restriction' is not defined for the purposes of Division 83A of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (2009 Budget Measures No. 2) Act 2009 states the following in relation to genuine selling restrictions for shares and rights to acquire shares:

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

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

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

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

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

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

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

Taxation Determination TD 2022/4 Income tax: when are you genuinely restricted from immediately disposing of an interest provided under an employee share scheme? (TD 2022/4). TD 2022/4 sets out the principles for working out when a scheme's disposal restrictions were 'genuine disposal restrictions' and, if they were, when you are no longer genuinely restricted by the scheme for the purposes of determining the ESS deferred taxing point.

Paragraph 28, 29 and 30 of TD 2022/4 are particularly relevant and provide:A scheme's genuine disposal restrictions may operate for either a fixed or variable period of time. The period of time may be determined by reference to:

•        Performance or vesting conditions

•        Internal share trading policies

•        Insider trading prohibitions in the Corporations Act 2001 (paragraph 28)

A scheme's genuine disposal restrictions will no longer restrict you on the first date on which you have an opportunity to dispose of your ESS interest. This will be the first time you can take some action to deal with or realise your ESS interest (for example, by way of sale, transfer or gift) (paragraph 29).

Further,

It does not matter whether you in fact take action or whether the lifting of trading restrictions only occurs temporarily (for example, during a short-term trading window after which restrictions are reimposed). The scheme will no longer restrict you at the commencement of the first trading window, or the first trading day after the restrictions are lifted, even if they are lifted only temporarily (paragraph 30).

Application to your situation

The Company has reported that the deferred taxing point happened in the XXXX income year, as outlined in the Employee Share Scheme statement for that year.

Based on our analysis, we are satisfied that the vesting date of both Performance Rights 1 and Performance Rights 2 was on the respective granting dates for each of the tranches of these Performance Rights. This is because all the Performance Rights vested immediately at the time they were granted and were not subject to any selling restrictions. All these vesting dates fell within the XXXX income year and as such, the discounts on these ESS interests are assessable in the XXXX income year.

Under section 83A-110, the amount to be included as assessable income, is the market value of the ESS interest reduced by the cost base of the ESS interest.