Edited version of private advice

Authorisation Number: 1052295020376

Date of advice: 23 August 2024

Ruling

Subject: Capital gains tax

Question 1

Will the irretrievable cash contributions by Company X or any member of the Company X income tax consolidated group (Company X TCG), to the trustee of the Company X Trust (Trustee) to fund the acquisition of Company X shares by the Company X Employee Share Trust (Trust) for the purposes of the Plans be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No

Question 2

Will a capital gain or capital loss that arises for the Trustee at the time when the employees become absolutely entitled to Company X shares (capital gains tax (CGT) event E5) 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?

Answer 2

Yes

This ruling applies for the followingperiods:

Income tax years ended 30 June 20XX to 30 June 20XX

The scheme commenced on:

In a particular income year

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:

•                Company X Invitation to Participate in Plan 1 Offer (Plan 1 Offer Letter), and

•                Company X Invitation to Participate in Plan 2 Offer (Plan 2 Offer Letter), and

•                Company X Invitation to Participate in Plan 3 Offer (Plan 3 Offer Letter)

Company X

1.     Company X is an Australian incorporated company involved in a particular industry.

2.     Company X is the head entity of the Company X income tax consolidated group (Company X TCG) consisting of itself and its wholly owned Australian subsidiaries.

3.     Company X operations are purely Australian based. It does not have overseas business operations or staff outside of Australia.

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

a.              Plan 1

b.              Plan 2; and

c.              Plan 3.

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.     Awards will be granted for nil consideration under the Plans.

7.     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

8.     Plan 1 was adopted by Company X's Annual General Meeting on a certain date. The terms and conditions of Plan 1 are set out in the Plan 1 Rules.

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

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

Plan 2

11.  Plan 2 was approved by Company X's Annual General Meeting on a particular date. The terms and conditions of Plan 2 are set out in the Plan 2 Rules.

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

13.  Broadly under Plan 2, the Board may issue an invitation to Employees granting 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 3

14.  The terms on which Participants are invited to participate in Plan 3 are set out in the Plan 3 Offer Letter.

15.  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.

16.  Broadly under Plan 3, the Board may issue an invitation to Employees granting to Employees a number of awards (for nil consideration), being the right to acquire a fully paid ordinary share in Company X (Share) (or to receive a Cash Equivalent Value, at the discretion of Company X) and will only vest once the board determines that any relevant conditions have been satisfied.

Company X employee share trust (Trust)

17.  The Trust was established for the sole purpose of subscribing for, acquiring, holding and transferring shares for the benefit of Participants under the Plans.

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

19.  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.

20.  Under the Trust Deed, the Trust broadly operates as follows:

a.              Company X or a member of the Company X TCG will provide the Trustee with the funds required for the purchase of or subscription for shares in accordance with the Plans and all funds provided to the Trustee will constitute accretions to the corpus of the Trust and will not be repayable by the Trustee.

b.              Company X or a member of the Company X TCG is likely to contribute funds, by way of capital contribution to the Trust when written notice ("Dealing Notice") is provided by the Board to the Trustee.

c.              These funds will be used by the Trustee to acquire the shares in Company X either by on-market purchase or via a subscription for new shares in Company X based on the Dealing Notice provided by Company X.

d.              Allocated Shares acquired by the Trustee must be allocated to the relevant Participants and held on their behalf as soon as reasonably practicable where required to do so, or permitted, by the relevant Plan Rules. Each Participant will be the beneficial owner of and absolutely entitled to their Allocated Shares.

e.              Unallocated Shares must be held by the Trustee on behalf of Participants and employees generally. The Trustee must deal with each Unallocated Share in the manner set out in a Dealing Notice from the Board.

f.               If the Unallocated Share is a Forfeited Share, the Trustee must dispose of that particular Unallocated Share provided that such disposal is in accordance with the Trust Deed.

g.              If the Trustee is an associate of Company X, the Trustee may only exercise, at its own discretion, the voting rights in relation to Unallocated Shares where the Trustee determines that to do so is consistent with the Trustee's fiduciary duties and that voting in those circumstances is 'merely incidental' to obtaining, holding and providing Shares in Company X to the Participants.

h.              If the Trustee is not an associate of Company X, the Trustee must not exercise voting rights in relation to Unallocated Shares.

i.               At any time after expiry of the Restriction Period (if any), the Trustee must transfer the relevant number of shares into the name of the relevant Participant or any third party nominated by the Participant (i.e. legal title) upon a Withdrawal Notice being lodged with and approved by the Board.

j.               The Trustee can sell Allocated shares on behalf of a Participant where permitted to do so by the Participant, less any taxes and costs incurred by the Trustee to sell these shares, with the Participant receiving the balance of the proceeds.

k.              The Trustee is not entitled to receive from the Trust Assets or any Participant any fees, charges, commission or other remuneration for operating or administering the Trust. However, Company X must pay or reimburse to the Trustee from Company X' own resources any such fees, charges, commission or other remuneration incurred by the Trustee, as Company X and the Trustee agree from time to time.

l.               In the event that the Trust is terminated, the Trustee must not pay any of the Surplus Assets to any Group Company. Group Company is defined as Company X and each of its subsidiaries.

Associated costs

21.  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 of the Trust.

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

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

24.  Company X will also incur costs in managing its own tax affairs in relation to the Employee Share Scheme.

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

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

Detailed reasoning

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)).

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 83A-B or 83A-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 an employee share scheme

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 either a share in the company or a right to acquire a beneficial interest in a share in the company.

As Participants are granted awards under the Plans in relation to their employment, which provide them with the right to acquire shares in Company X, they are taken to have acquired ESS interests under an employee share scheme and paragraph 130-85(1)(a) is satisfied.

Subdivision 83A-B or 83A-C applies to the Awards

As Participants acquire Awards under the Plans for nil consideration (i.e., at a discount), Subdivision 83A-B will apply to those Rights (unless Subdivision 83A-C applies instead) and paragraph 130-85(1)(b) is satisfied.

The Awards or Options arose because of an interest the Participants hold in an employee share trust

The awards granted to Participants under the Plans provide the Participants with an interest in the shares held in the Trust.

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

(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 Trust acquires shares in Company X, and

•       the Trust ensures that awards (which are ESS interests) are provided to Participants under an employee share scheme by allocating shares to them in accordance with the governing documents of the scheme.

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 the 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 deed.

The Commissioner considers the Trust to be an employee share trust based on the terms of the Trust deed 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 the awards under the Plans pursuant to subsection 130-85(2), and CGT event E5 will happen at that time.

If CGT event E5 happens, any capital gain or capital loss that the Trustee makes, is disregarded if section 130-90 applies. Section 130-90 provides as follows:

(1A) Disregard any capital gain or capital loss made by an employee share trust to the extent that it results from a CGT event, if:

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

(b)           either of the following subparagraphs applies:

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

(ii)            the event is CGT event E7, and the event happens because the trustee disposes of the ESS interest to a beneficiary of the trust; and

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

(1) Disregard any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, to the extent that it results from a CGT event, if:

(a) the CGT event is CGT event E5 or E7; and

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

(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 (about employee share schemes) applied.

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

The exemption in section 130-90 will apply because:

•                the Trust is an employee share trust as defined in subsection 130-85(4)

•                at the time the Participant becomes absolutely entitled to the shares as against the Trustee, CGT event E5 happens

•                CGT event E5 happens in relation to shares

•                the Participant acquires the share by exercising a Right granted under the Plan and

•                the Participant acquired the Rights under the Plan for nil consideration (i.e., at a discount) and therefore Subdivision 83A-B will apply to those Awards or Options (unless Subdivision 83A-C applies instead).

As all the conditions in section 130-90 are satisfied, any capital gain or capital loss that arises for the Trust at the time when CGT event E5 happens will be disregarded if the shares are acquired by the employee for the same or less than the cost base of the shares in the hands of the Trust.

[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 employee share scheme. The contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10 of the ITAA 1997'.