Edited version of private advice

Authorisation Number: 1052262608373

Date of advice: 25 June 2024

Ruling

Subject: Employee share scheme

Question 1

Will the irretrievable cash contributions by Company A to the Trustee to fund the acquisition of, or subscription for, Company A Shares by the Trust for the purpose of the Plan 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 contributions by Company A to the Trustee, following exercise of Rights, to fund the acquisition of Company A Shares by the Trust for specific employees, be treated as a deemed dividend within the meaning of Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 3

Will CGT event E5 happen at the time when the Participants become absolutely entitled to Company A Shares held by the Trustee under the Plan?

Answer

Yes.

Question 4

If CGT event E5 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E5 happening be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Company A Shares at a price that is the same as, or less than, the cost base of the Company A Shares in the hands of the Trustee?

Answer

Yes.

Question 5

Will CGT event E7 happen in respect of the Company A Shares held by the Trustee?

Answer

No - the specified scheme does not include any facts that gives rise to CGT event E7 happening.

Question 6

If CGT event E7 does happen, will a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Company A Shares at a price that is the same as, or less than, the cost base of the Company A Shares in the hands of the Trustee?

Answer

Not applicable.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Background

Company A is an unlisted Australian private company. Company A is seeking to implement an employee share plan (Plan).

The Plan is part of Company A's remuneration strategy and aims to ensure the long-term creation of value in Company A by:

•         Rewarding eligible participants (Participants) with options granted by Company A (Awards). Each Award represents a right to be issued a special class of share in the capital of Company A (Shares), subject to the terms of the Plan and the terms and conditions on which they are invited to participate in the Plan (Invitation).

•         Assisting with the retention of key talent personnel.

A Trust has been established in accordance with the terms of the Trust Deed to facilitate the implementation of the Plan.

Awards

The Plan will operate under the rules stated in the Plan.

Employee Share Trust

The Trust will be established to facilitate opportunities to align the interests of employees with the future growth and profitability of Company A and to administer the current and any future employee incentive plans by Company A for the benefit of Participants of the Plan.

The Trust will be used to facilitate the acquisition of Shares acquired by Participants. The Trust will have the additional role of acquiring other Shares following vesting/exercise of the Awards.

The trustee of the Trust will be an independent third party (Trustee).

The Trust will operate as outlined in the Trust Deed.

Timing of contributions

Company A will not provide cash contributions to the Trust prior to the grant of Awards. More typically, Company A will wait until receipt of the exercise notice from Participants before providing the Trust with the cash necessary to acquire Shares to satisfy the acquisition / subscription of shares related to those Awards. Accordingly, the contribution is made in respect of a particular Company A employee.

Use of the Trust to facilitate the Plan

It is intended that the Trust will be used to hold Shares for employees of Company A pursuant to the Plan.

In summary, some of the commercial benefits of using the Trust include:

•         Provides capital management assistance and flexibility for Company A.

•         Gives effect to disposal restrictions on the Shares allowing key shareholders to keep control over Company A ownership by preventing the disposal of shares to third parties.

•         Greater flexibility for Company A to accommodate the long-term incentive arrangements both now and into the future for different employee and executive groups as Company A continues to expand operations and therefore employee numbers.

•         Providing an external vehicle through which Shares in Company A can be acquired and possibly held on behalf of the relevant Participant. This assists Company A to satisfy corporate law requirements relating to a company dealing in their own shares.

•         Enables the implementation of the Plan in line with the Group's policies on employee share plans.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 section 109C

Income Tax Assessment Act 1936 subsection 109C(1)

Income Tax Assessment Act 1936 subsection 109C(2)

Income Tax Assessment Act 1936 section 109ZB

Income Tax Assessment Act 1936 subsection 109ZB(3)

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Subdivision 83A-B

Income Tax Assessment Act 1997 Subdivision 83A-C

Income Tax Assessment Act 1997 section 83A-10

Income Tax Assessment Act 1997 subsection 83A-10(1)

Income Tax Assessment Act 1997 subsection 83A-10(2)

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-75(1

Income Tax Assessment Act 1997 subsection 104-85(1)

Income Tax Assessment Act 1997 subsection 104-85(3)

Income Tax Assessment Act 1997 Division 128

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

Income Tax Assessment Act 1997 section 130-90

Income Tax Assessment Act 1997 subsection 130-90(1)

Income Tax Assessment Act 1997 subsection 130-90(2)

Income Tax Assessment Act 1997 subsection 960-100(2)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Summary

The irretrievable cash contributions by Company A to the Trustee to fund the acquisition of, or subscription for, Shares by the Trust for the purpose of the Plan will not be assessable income of the Trust under section 6-5 or 6-10 of the ITAA 1997.

Detailed reasoning

Section 95 of the ITAA 1936 defines the 'net income of the trust estate' as the total assessable income of the trust, calculated as if the trust were a taxpayer in respect of that income and a resident, less all allowable deductions.

Section 6-5 of the ITAA 1997 provides that assessable income includes income according to ordinary concepts, which is called ordinary income. Further, section 6-10 of the ITAA 1997 provides that assessable income also includes statutory income.

None of the provisions listed in section 10-5 of the ITAA 1997 are relevant in this situation and therefore the irretrievable contributions will be included in net income of the trust only if they are income according to ordinary concepts.

The contributions made by Company A are irretrievable and non-refundable to it in accordance with the Trust Deed. The funds provided by Company A to the Trustee are used in accordance with the Trust Deed and the Plan for the sole purpose of the employee share schemes. All contributions by Company A to acquire Shares constitute accretions to the corpus of the trust.

Therefore, the irretrievable cash contributions made by Company A to the Trustee of the Trust to fund the subscription for, or acquisition of Shares by the Trust in accordance with the Trust Deed of the Trust will not be assessable income of the Trust pursuant to sections 6-5 or 6-10 of the ITAA 1997.

This view is consistent with ATO Interpretative Decision ATO ID 2002/965 Trustee not assessable on employer contributions made to it under the employer's employee share scheme.

Question 2

Summary

The contributions by Company A to the Trustee, following the exercise of the Awards to fund the acquisition of Company A Shares by the Trust for specific employees will not be treated as a deemed dividend within the meaning of Division 7A of the ITAA 1936.

Detailed reasoning

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 subsection 960-100(2) of the ITAA 1997 and includes the trustee of a trust.

Contributions made by Company A to the Trustee would satisfy subsection 109C(1) of the ITAA 1936 if the Trustee holds Shares at the time the contribution is made, or the Trustee is an associate of a person who holds Shares, such as a beneficiary of the Trust. Subsection 109C(2) of the ITAA 1936 would then apply to treat the amount of the contributions to be a deemed dividend, subject to Company A's distributable surplus for the relevant income year.

Exception

Certain payments made by a private company to an entity are excluded from the operation of section 109C of the ITAA 1936.

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 section 136 of the FBTAA.

Paragraph 36 of Taxation Ruling TR 2018/07 Income tax: employer remuneration trusts, states that in considering benefits provided to employees or associates of employees in the context of the FBTAA (specifically, in the definition of a 'fringe benefit'), Edmonds J in FC of T v Indooroopilly Children Services (QLD) Pty Ltd [2007] FCAFC 16 [35] concluded that the reference to an employee is a reference to a particular employee.

The Trustee is an associate of any Company A employee who is a beneficiary of the Trust as defined in sections 109ZD and 318 of the ITAA 1936. Contributions are made by Company A to the Trustee once the Board resolves to provide a particular Participant a Share upon exercise of an Award. At the time of each contribution, the Board will provide the Trustee a notice listing Company A's employees, for whom the contribution is being made, i.e. the portion of the contribution and the applicable number of Shares to be acquired in respect of each employee. As the contribution would be made to the Trustee in respect of a particular Company A employee, it would satisfy section 109ZB of the ITAA 1936.

Therefore, the contributions made by Company A to the Trustee will not be deemed to be dividends under section 109C of the ITAA 1936, as its operation would be excluded under section 109ZB of the ITAA 1936.

Question 3

Summary

CGT event E5 will happen at the time when the Participants become absolutely entitled to Shares held by the Trustee under the Plan.

Detailed reasoning

Pursuant to section 102-20 of the ITAA 1997, an entity can make a capital gain or loss if, and only if, a CGT event happens.

Under subsection 104-75(1) of the ITAA 1997, CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 of the ITAA 1997 applies) as against the trustee. The time of the event is when the beneficiary becomes absolutely entitled to the asset (subsection 104-75(2)).

According to subsection 104-75(3) of the ITAA 1997, if CGT event E5 happens, the trustee may make a capital gain if the market value of the asset, at the time of the event, is more than its cost base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base.

In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 of the ITAA 1997 applies.

Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 explains the principles set out in the leading English trust law case of Saunders v. Vautier (1841) 49 ER 282 in relation to 'absolutely entitled' as follows:

... if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway.

Pursuant to the Trust Deed, a Participant is the beneficial owner of and absolutely entitled to their Allocated Shares. Allocated Shares is defined as a Trust share that is credited to the Trust share account of a Participant, which is a Company A Share held by the Trustee. Once credited, the Participant (i.e., the beneficiary) will become absolutely entitled to the allocated shares (i.e., a CGT asset of the Trust) as against the Trustee. Accordingly, pursuant to subsection 104-75(1) of the ITAA 1997, CGT event E5 will happen at this time.

Question 4

Summary

If CGT event E5 does happen, a capital gain or capital loss made by the Trustee as a result of CGT event E5 happening will be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Shares at a price that is the same as, or less than, the cost base of the Shares in the hands of the Trustee.

Detailed reasoning

Subsection 130-90(1) of the ITAA 1997 provides that any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, will be disregarded to the extent it results from a CGT event, if:

(a)  The CGT event is CGT event E5 or E7;

(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(2) of the ITAA 1997 provides that subsection (1A) or (1) does not apply if the beneficiary acquired the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time the CGT event happens.

Employee share trust

The term 'employee share trust' referred to in subsection 130-90(1) of the ITAA 1997 is defined in subsection 995-1 as having the meaning given by subsection 130-85(4).

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:

(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 ITAA 1997

The beneficial interest in a share received by a Participant when a share in Company A is provided to them under the terms of the Trust Deed and the Plan is an ESS interest within the meaning of subsection 83A-10(1) of the ITAA 1997.

Subsection 83A-10(2) of the ITAA 1997 defines an employee share scheme as being a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment.

The Plan is an ESS within the meaning of subsection 83A-10(2) of the ITAA 1997 because it is a scheme under which rights to acquire shares in Company A (being ESS interests) are provided to employees in relation to the employees' employment.

Company A has established the Trust to acquire shares in Company A and to allocate those Shares to employees in order to satisfy ESS interests acquired by those employees under the Plan. The beneficial interest in the Shares is itself provided under an employee share scheme because it is provided under the same scheme under which the rights are provided to employees in relation to their employment.

Paragraphs 130-85(4)(a) and (b) of the ITAA 1997 are therefore satisfied because:

•         the Trust acquires Shares in Company A; and

•         the Trust ensures that ESS interests (as defined in subsection 83A-10(1) of the ITAA 1997, being beneficial interests in the Shares of Company A), are provided under an ESS (as defined in subsection 83A-10(2) of the ITAA 1997) by allocating those Shares to the employees in accordance with the Trust Deed and the Plan;

Paragraph 130-85(4)(c) of the ITAA 1997

Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) of the ITAA 1997 will also require that the Trustee undertake incidental activities that are a function of managing the Trust.

Paragraph 130-85(4)(c) of the ITAA 1997 provides that a trustee can engage in activities that are merely incidental to those described in paragraphs 130-85(4)(a) and (b). The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13: Income tax: what is an employee share trust?

Paragraph 12 of TD 2019/13 lists examples of activities which are merely incidental for the purposes of paragraph 130-85(4)(c) of the ITAA 1997.

Paragraph 13 of TD 2019/13 lists examples of activities that are not merely incidental for the purposes of paragraph 130-85(4)(c) of the ITAA 1997.

Under the Trust Deed, the activities of the Trustee are limited to the sole purpose of exercising its powers and discharging its obligations under the Trust Deed and the relevant Plan (and for no other purpose). All other activities of the Trust are incidental to the Trustee undertaking these sole activities.

It is considered that in accordance with the terms of the Trust Deed, the Trustee is required to manage and administer the trust consistent with the definition of an "employee share trust" for the purpose of subsection 130-85(4) of the ITAA 1997.

Therefore paragraph 130-85(4)(c) of the ITAA 1997 will be satisfied as all other activities to be undertaken by the Trustee are merely incidental to managing the Plan.

Therefore, the Trust satisfies the definition of an employee share trust in subsection 130-85(4) of the ITAA 1997.

Paragraph 130-90(1)(a) of the ITAA 1997

Paragraph 130-90(1)(a) of the ITAA 1997 is satisfied if the CGT event is E5 or E7.

It was determined in question 3 that where a Participant becomes absolutely entitled to Company A's Shares as against the Trustee, CGT event E5 will occur pursuant to subsection 104-75(1) of the ITAA 1997.

Paragraph 130-90(1)(b) of the ITAA 1997

Paragraph 130-90(1)(b) of the ITAA 1997 is satisfied if the CGT event happens in relation to a share.

Subsection 995-1(1) of the ITAA 1997 defines a share to mean a share in the capital of a company. A share held by the Trustee of the Trust and to which a participant is entitled to upon the exercising of an Award is a share in the capital of Company A.

Accordingly, paragraph 130-90(1)(b) of the ITAA 1997 will be satisfied when CGT event E5 happens in relation to a share for the purposes of that paragraph.

Paragraph 130-90(1)(c) of the ITAA 1997

Paragraph 130-90(1)(c) of the ITAA 1997 is satisfied if the beneficiary had acquired a beneficial interest in the share by exercising a right.

Paragraph 130-90(1)(c) of the ITAA 1997 will be satisfied as a Participant will acquire a beneficial interest in a share in Company A by the exercising of an Award granted under the Plan.

Paragraph 130-90(1)(d) of the ITAA 1997

Paragraph 130-90(1)(d) of the ITAA 1997 is satisfied if the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C applied.

Subsection 83A-20(1) of the ITAA 1997 states that Subdivision 83A-B applies to an ESS interest if you acquire the interest under an employee share scheme at a discount.

The term 'employee share scheme' is defined in subsection 83A-10(2) of the ITAA 1997 as:

An employee share scheme is a *scheme under which *ESS interests in a company are provided to employees, or *associates of employees, (including past or prospective employees) of:

(a) the company;....

in relation to the employees' employment.

For the purposes of subsection 83A-10(2) of the ITAA 1997, subsection 995(1) defines the term 'scheme' as follows:

(a) any *arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The Plan is an employee share scheme for the purposes of Division 83A of the ITAA 1997 as it is an arrangement under which an ESS interest (i.e. a beneficial interest in a right to acquire a beneficial interest in a Share of Company A), is provided to eligible employees in relation to their employment in Company A in accordance with the Trust Deed.

As the rights granted under the Plan will be acquired by the employees at a discount, they are ESS interests to which Subdivision 83A-B of the ITAA 1997 applies.

Accordingly, Subdivision 83A-B of the ITAA 1997 will apply to the Awards acquired under the Plan as pursuant to subsection 83A-20(1) of the ITAA 1997, the ESS interest will be acquired under an employee share scheme at a discount (assuming the interest has appreciated over time).

It should be noted however that whether a Participant is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B) or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), will depend on which of the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. Under either circumstance paragraph 130-90(1)(d) will be satisfied.

As such, a capital gain or capital loss that arises for the Trustee of the Trust established pursuant to the Trust Deed at the time when CGT Event E5 happens in relation to the Shares held by the Trustee will be disregarded under section 130-90 of the ITAA 1997, if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee.

Question 5

Summary

CGT event E7 does not happen in respect of the Shares held by the Trustee, because the specified scheme does not include any facts that give rise to CGT event E7 happening.

Detailed reasoning

Under subsection 104-85(1) of the ITAA 1997, CGT event E7 happens if the trustee of a trust (except a unit trust or a trust to which Division 128 applies) disposes of a CGT asset of the trust to a beneficiary in satisfaction of the beneficiary's interest, or part of it, in the trust capital. The timing of the event is when the disposal occurs (subsection 104-85(2)).

According to subsection 104-85(3), if CGT event E7 happens, the trustee may make a capital gain if the market value of the asset, at the time of the disposal, is more than its cost base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base.

However, in relation to the scheme as set out in the 'Relevant facts and circumstances' section above, CGT event E7 does not occur. This is because the scheme does not include any facts that gives rise to CGT event E7 happening.

Question 6

Summary

This question is not applicable, because CGT event E7 does not happen under the specified scheme.

Detailed reasoning

As per the answer in Question 5 above, CGT event E7 does not arise. Therefore, it is not necessary to consider whether a capital gain or capital loss made by the Trustee as a result of CGT event E7 happening be disregarded under section 130-90 of the ITAA 1997 if the Participants acquire the Shares at a price that is the same as, or less than, the cost base of the Shares in the hands of the Trustee.