Edited version of private advice

Authorisation Number: 1052253341538

Date of advice: 24 May 2024

Ruling

Subject: Deductions - employment expenses

Question 1

Will the irretrievable cash contributions by the Company X tax consolidated group (Company X Group) to the trustee to fund the acquisition of, or subscription for, ordinary shares in Company X (Shares) by the Trust be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will a capital gain or capital loss that arises for the Trustee at the time when CGT Event E5 happens in relation to Shares held by the Trustee be disregarded under section 130-90 of the ITAA 1997, if the participants acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee?

Answer

Yes.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below including the following documents, or relevant parts of them, which are to be read with the description:

1. Company X Invitation to Participate in the FY 20XX Plan 1 Offer (Plan 1 Grant Letter), and
2. Company X Invitation to Participate in the FY 20XX Plan 2 Offer (Plan 2 Grant Letter).

Overview

1.    Company X is an Australian public company within a particular industry).

2.       Company X is an Australian resident for income tax purposes and is the head entity of a consolidated group (Group).

3.       Company X's group has subsidiary members which are employer entities in respect to Company X's Australian based employees.

Plans

4.    As part of the overall remuneration strategy, in addition to fixed remuneration, Company X offers certain employees and executives, payments of shares upon the satisfaction of certain performance conditions. This is implemented through the following share plans (collectively the "Plans"):

1. Plan 1; and
2. Plan 2.

5.    The Plans also allow access to Participants who are or who become non-residents. Contributions to the Trust may be made to acquire Shares in relation to awards granted to non-resident Participants. The consideration of contributions made with respect to non-resident Participants (and any associated Australian tax implication for Company X) is outside the scope of this ruling.

6.    Company X and a number of wholly owned subsidiaries of the Company X TCG are employers of individuals that participate in the Plans (Employer Entities).

Plan 1

7.    Plan 1 was adopted by Company X's board of directors (Board) on a certain date. The terms and conditions of Plan 1 are set out in the Plan 1 Rules.

8.    The terms on which Participants are invited to participate in Plan 1 are set out in the Plan 1 Grant Letter.

9.    Broadly under Plan 1, the Board may issue an invitation to Employees to participate in a grant of, or grant to Employees a number of awards (for nil consideration), being the right to acquire a fully paid ordinary share in Company X (Share) and will only vest once the board determines that any relevant conditions have been satisfied.

Plan 2

10.  Plan 2 was approved by the Board on a particular date. The terms and conditions of Plan 2 are set out in the Plan 2 Rules. The Plan 2 Rules were approved by the Board on another date.

11.  The terms on which Participants are invited to participate in Plan 2 are set out in the Plan 2 Grant Letter.

12.  The key terms of the Plan 2 Rules are the same as the Plan 1 Rules although an award may also be an option or other instrument providing a right to acquire a share.

Company X Employee Share Trust

13.  Company X established the Trust on a specific date under the terms of a trust deed.

14.  The trustee of the Trust (Trustee) is an external trustee acting in an independent capacity on behalf of the beneficiaries of the Trust.

15.  The Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the ITAA 1997.

Contributions to the Trust

16.  Company X does not and will not pay cash contributions to the Trust prior to the issue of Rights under the Plan to Participants.

17.  Company X where possible, will wait until the Rights vest before providing the Trust with cash necessary to acquire Shares to satisfy the acquisition or subscription of Shares related to those Rights. In relation to Restricted Shares Company X will wait until the grant of relevant Shares to make relevant contributions to the Trust.

18.  Where it makes commercial sense to do so, Company X may make cash contributions to the Trust prior to the Rights vesting, and where relevant, prior to Rights being exercised by the Participants or in the event that Restricted Shares are granted to Participants. In this case, Company X will contribute to the Trust enough funding to enable purchase of Shares in advance of when Rights are likely due to vest or are exercised by Participants or in the case of Restricted Shares, prior to the grant.

19.  Contributions to the Trust may be made by Company X on behalf of Australian tax residents and non-Australian tax residents. This ruling only relates to contributions made in relation to Australian tax residents or non-Australian tax residents who are working in Australia.

Associated costs

20.  Company X will incur various on-going costs associated with the services provided by the Trustee of the Trust in respect of the on-going administration and management

21.  Company X will incur on-going administration costs associated with the company's accounting and legal advisors in relation to the Plan.

Company X will incur various costs in relation to the establishment of the Trust.

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 102-20

Income Tax Assessment Act 1997 section 104-75

Income Tax Assessment Act 1997 section 130-90

Income Tax Assessment Act 1997 subsection 130-85(4)

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 section 104-85

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Summary

No, the irretrievable cash contributions will not be assessable income of the Trust under sections 6-5 or 6-10.

Detailed reasoning

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 Income Tax Assessment Act 1936 (ITAA 1936).

As Chief Justice Jordan noted in Scott v Commissioner of Taxation (1935) 35 SR (NSW) 215 (Scott):

.. what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of receipts.[1]

Ordinary income

Section 6-5 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 certain factors which may assist in determining whether a receipt is properly characterised as income according to ordinary concepts.

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.

In GP International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124; (1990) 64 ALJR 392; (1990) 93 ALR 193; (1990) 21 ATR 1; 90 ATC 4413; [1990] HCA 25 (Pipecoaters), 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.

The contributions made by Company X or any other member of the Company X TCG to the Trust forms part of the corpus of the Trust that will be applied for the sole purpose of acquiring, or subscribing for, shares for the benefit of the Participants under the Plans. The cash contributions received by the Trustee are therefore of a capital character.

It is irrelevant that, from Company X's perspective, the cash contribution may be deductible under section 8-1 of the ITAA 1997 because whether a receipt is income or capital depends on its objective character in the hands of the recipient, rather than the payer. This is made clear in Pipecoaters, where the High Court held that:

...although the amount expended on the construction of the plant was a capital expenditure, it does not follow that the taxpayer's receipt of the establishment costs was a receipt of capital.[2]

From the Trustee's perspective, the irretrievable cash contributions made by Company X are capital in nature and therefore not assessable to the Trust under section 6-5 of the ITAA 1997.

Statutory income

Section 10-5 provides a list of provisions of assessable income for section 6-10 purposes. None of the provisions apply to a cash contribution made by an employer to a trust established under an employee share scheme (ESS).

Therefore, the irretrievable cash contributions made by Company X or any other member of the Company X TCG to the Trustee of the Trust to fund the acquisition of, or subscription to, Company X shares are also not assessable income of the Trust pursuant to section 6-10 of the ITAA 1997.[3]

Question 2

Summary

Yes, any capital gain or capital loss that arises for the Trust, when participants of the Plans become absolutely entitled to the shares, is disregarded under section 130-90, if the participants acquire the shares for the same or less than the cost base of the shares in the hands of the Trust.

Detailed reasoning

Subsection 102-5(1) states that your assessable income includes your net capital gain (if any) for the income year. You make a capital gain or capital loss if and only if a CGT event happens (section 102-20).

CGT event E5 happens when participants become absolutely entitled to the Shares

CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust as against a trustee (subsection 104-75(1)). The time of the event is when the beneficiary becomes absolutely entitled to the asset (subsection 104-75(2)).

Subsection 130-85(2) treats a beneficiary as absolutely entitled to the relevant share from the time of acquisition of the ESS interest until they no longer have the ESS interest in the share. Subsection 130-85(2) only applies if the following requirements under subsection 130-85(1) are satisfied:

(a)  the beneficiary acquires an ESS interest under an employee share scheme

(b)  Subdivision 83-B or 83-C applies to the ESS interest, and

(c)   the ESS interest is, or arises because of, an interest the beneficiary holds in an employee share trust.

Participants acquire ESS interests under the Plans which are employee share schemes

An 'employee share scheme' is defined in subsection 83A-10(2) as a scheme under which 'ESS interests' in a company are provided to employees of the company, or a subsidiary of the company, in relation to the employees' employment.

Subsection 83A-10(1) defines an 'ESS interest', in a company, as a beneficial interest in a share in the company or a right to acquire a beneficial interest in a share in the company.

Paragraph 130-85(1)(a) is satisfied because:

• the participants of the Plans are beneficiaries of the Trust which was established for the purpose of administering the Plans
• the Plan is a scheme under which participants are granted Rights in relation to their employment that provides them with the right to acquire shares in the Company.

Subdivision 83A-B or 83A-C applies to the Shares and Rights

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

As Shares and Rights are provided to participants of the Plans for no consideration, they are acquired by those participants at a discount and Subdivision 83A-B would apply to those ESS interests (unless the conditions in subsection 83A-105(1) are satisfied, in which case Subdivision 83A-C would apply instead).

An ordinary share in Company X held by the Trustee and to which an employee becomes entitled to upon the exercise of a right is a share in Company X. Accordingly, paragraph 130-85(1)(b) is satisfied.

The Shares and Rights arose because of an interest the participants hold in an employee share trust

As outlined earlier, the participants of the Plans are beneficiaries of the Trust as they have an interest in the Shares that are held in the trust.

Subsection 995-1(1) defines 'employee share trust' as having the meaning given by subsection 130-85(4).

Subsection 130-85(4) defines an 'employee share trust', for an employee share scheme, as a trust whose sole activities are:

(a)  obtaining shares or rights in a company; and

(b)  ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of:

(i)     the company; or

(ii)    a subsidiary of the company; and

(c)   other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b).

Paragraphs 130-85(4)(a) and (b) of the definition of an employee share trust are satisfied because the Trustee:

•      acquires Shares in the Company, and

•      ensures those Shares (which are 'ESS interests' under subsection 83A-10(1)) are provided under the Plans (which are 'employee share schemes' as defined in subsection 83A-10(2)) to participants (who are employees of Company X) by allocating those Shares to the participants in accordance with the Trust Deed and the rules of the respective plans.

Taxation Determination TD 2019/13 Income tax: what is an 'employee share trust'? sets out the Commissioner's view on the type of activities that are and are not considered merely incidental for the purposes of paragraph 130-85(4)(c).

Whether a trust is an 'employee share trust' for the purposes of subsection 130-85(4) requires an analysis of what the trustee actually does, not only the powers and duties that are prescribed in the trust's deed.

The Trust Deed provides that:

The Company and the Trustee agree that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of 130-85(4) of the ITAA 1997.

In addition, the Deed limits the scope of activities which can be undertaken by the Trustee. Based on the information above, the functions of the Trustee will be limited to those activities mentioned in paragraphs 130-85 (4)(a) and 130-85 (4) (b) of the ITAA 1997 or will be merely incidental activities as described in 130-85(4)(c).

Accordingly, the Commissioner considers the Trust to be an 'employee share trust' for the purposes of subsection 130-85(4) and paragraph 130-85(1)(c) is satisfied.

As all the conditions in subsection 130-85(1) are satisfied, the participants are taken to be absolutely entitled to the Shares held by the Trustee from the time they were granted Rights under the Plans pursuant to subsection 130-85(2), and CGT event E5 will happen at that time.

Capital gain or capital loss to be disregarded under section 130-90

However, subject to subsection 130-90(2), any capital gain or capital loss made by an employee share trust, to the extent that it results from CGT event E5, is disregarded if either subsection 130-90(1A) or subsection 130-90(1) applies.

Subsection 130-90(1A) applies to Restricted Shares

Subsection 130-90(1A) states that any capital gain or capital loss made by an employee share trust to the extent that it results from CGT event E5 is disregarded if:

(a)  immediately before the event happens, an ESS interest is a CGT asset of the trust

(b)  CGT event E5 happens because a beneficiary of the trust becomes absolutely entitled to the ESS interest as against the trustee; and

(c)   Subdivision 83A-B or 83A-C applies to the ESS interest.

Subsection 130-90(1A) applies to the Restricted Shares under the Plans because:

• the Shares (which are 'ESS interests' under subsection 83A-10(1)) are CGT assets of the Trust (shares are CGT assets pursuant to subsection 100-25(2))
• CGT event E5 happens to those Shares as Plan participants become absolutely entitled to them when they are allocated those Shares by the Trustee, and
• as explained earlier, Subdivision 83A-B or 83A-C would apply to those Shares as they are acquired by Plan participants at a discount.

Subsection 130-90(1) applies to Rights granted under the Plans

Subsection 130-90(1) states that in relation to Shares held for future acquisition under employee share schemes any capital gain or loss will be disregarded, to the extent it results from a CGT event if:

(a)  the CGT event is CGT event E5

(b)  the CGT event happens in relation to a share

(c)   the beneficiary had acquired a beneficial interest in the share by exercising a right; and

(d)  the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C applied.

Subsection 130-90(1) applies to the Rights granted under the Plans because:

• CGT event E5 happens when the Rights are granted to Plan participants
• CGT event E5 happens in relation to shares in the Company
• Plan participants acquire a beneficial interest in those Shares when they exercise their Rights, and
• as explained earlier, Subdivision 83A-B or 83A-C would apply to those Rights as they are acquired by Plan participants at a discount.

Conclusion

As the requirements under subsection 130-90(1A) and subsection 130-90(1) are met in relation to the Shares held by the Trust for the Plans respectively, any capital gain or capital loss made by the Trust as a result of CGT event E5 happening will be disregarded (provided that the participants do not acquire the Shares for more than their cost base in the hands of the Trust at the time the CGT event happens).

[1] Scott at 220.

[2] Pipecoaters at 4420.

[3] This view is consistent with ATO ID 2002/965 Income Tax - Trustee not assessable on employer contributions made to it under the employer's employee share scheme, whichfound that: 'The funds provided to the Trustee are used in accordance with the Trust Deed and Plan Rules for the sole purpose of and under the employeeshare scheme. The contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10 of the ITAA 1997'.