Edited version of private advice

Authorisation Number: 1052306652862

Date of advice: 17 September 2024

Ruling

Subject: Commissioner's discretion - minimum holding period

Question 1

Will the Commissioner exercise his discretion under paragraph 83A-45(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) to allow the minimum holding period for Options acquired under the Employee Option Plan (Option Plan) to end on the date of completion of the Sale and Purchase Agreement?

Answer

No.

Question 2

Pursuant to subsection 83A-33(1) of the ITAA 1997, can Option Holders under the Option Plan reduce the amount of the discount included in their assessable income under subsection 83A-25(1) of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 2024

Income year ending 30 June 2025

Relevant facts and circumstances

The Company is an Australian resident private company incorporated in 20XX and part of a group comprised of related corporate and trust entities (the Group).

The Group established the Option Plan under which select key employees of the Group, as determined by the Board, were invited by Offer Letter to apply for Options (either personally or through a Controlled Entity) which, when vested, provided for the right to subscribe for and be issued a specified number of ordinary shares in the Company and other corporate entities in the Group, and ordinary units in the trust entities in the Group; a stapled security for the purposes of section 83A-335 of the ITAA 1997.

Option Holders were granted Options under the Option Plan in the 2022 income year and were not required to pay for any Option they acquired under the Option Plan.

The Option Holder could exercise an Option after it had vested and before the expiry date for the Option, as stated in the Employee Option Plan Rules (Rules).

Clause 4(a) of the Rules states that, subject to clause 4(b) and 7, an Option Holder cannot apply for Group Securities until the Option vests on the 5^th anniversary after the date it is issued.

Clause 4(b) of the Rules states that if a Liquidity Event occurs each Option vests and each Option Holder may at that time exercise all Options held by them, even if the Option Holder has not held the Options for 5 years or more.

A Liquidity Event is defined in the Rules to mean a trade sale of 50% or more of the assets of or shares and units in the Group, measured by the value of those assets or shares and units as determined by the Board, or if there is an IPO.

Clause 7 of the Rules provides that each Option held by an Option Holder automatically expires:

•         upon the date the Participating Employee leaves the employ of the Group for any reason (unless it is due to their ill health or death and the Board in its absolute discretion determines otherwise);

•         if it is not exercised by the 10^th anniversary after the date it is issued; or

•         if there is a Liquidity Event and the Option Holder does not exercise the Option at the time of or before the Liquidity Event.

No compensation is payable to the Option Holder in respect of an expired Option.

The Exercise Price to be paid by the Option Holder to the Group for each Group Security was set out in the Offer Letter and was set at the market value of the Group Securities at the time the Options were issued. Pursuant to clause 5(d) of the Rules, where the Option is exercised at the time of a Liquidity Event other than an IPO, the Exercise Price will be paid to the Group from the proceeds generated from that Liquidity Event.

Under clause 14 of the Rules the Group could terminate the Option Plan at any time by written notice to each Participating Employee, as long as such termination did not affect any rights or restrictions attaching to Options that had been issued prior to the date of the termination.

Based on information provided by the Company:

•         subsections 83A-33(2) to (6) of the ITAA 1997; and

•         subsections 83A-45(1) to (3) and subsection 83A-45(6) of the ITAA 1997,

apply to the Options acquired under the Option Plan.

In the 20XX income year, the shareholders of the Company entered into a Sale and Purchase Agreement (SPA) which included the sale of the legal and beneficial interest in all of the issued shares and units in the Group entities to unrelated Buyers.

As a condition of the SPA, the Group entities in which Options were held under the Option Plan were required to enter into an Option Cancellation Deed with the Option Holders to ensure that there were no outstanding Options at the time of Completion of the SPA, and the Buyers were required to pay the Option Cancellation Amount.

A letter was sent by the Company to Option Holders shortly after entry into the SPA advising them that the Group's business was being sold by the existing shareholders and, as part of the sale, the Group proposes to:

•         cancel the Options held by the Option Holders; and

•         pay the Option Holders an amount commensurate to the purchase price they would have received had they exercised the Options and sold the shares allotted to them by the Buyers under the SPA (net of the Exercise Price payable had they exercised the Options, plus or minus their share of any payments for movements in the net working capital and net debt amounts of the Group as at Completion compared to estimated figures (a Completion Payment)).

By signing the letter, the Option Holders agreed with effect from Completion of the SPA that:

•         they will not be entitled to exercise any Option on and from the date of signing the letter;

•         the Options will be cancelled immediately before Completion of the SPA occurs;

•         they will no longer have any entitlements to any Options under the Option Plan; and

•         the Option Plan will be terminated.

The Completion Payment was based on the fair market value of the Option Holder's entitlements at the time of the sale.

When the Options were granted under the Option Plan there was no indication that a Liquidity Event would occur.

The cancellation of the Options in connection with the SPA happened within 3 years of the grant of all Options issued under the Option Plan.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 83A

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

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

Income Tax Assessment Act 1997 subsection 83A-25(1)

Income Tax Assessment Act 1997 section 83A-33

Income Tax Assessment Act 1997 subsection 83A-33(1)

Income Tax Assessment Act 1997 subsection 83A-33(2)

Income Tax Assessment Act 1997 subsection 83A-33(3)

Income Tax Assessment Act 1997 subsection 83A-33(4)

Income Tax Assessment Act 1997 subsection 83A-33(5)

Income Tax Assessment Act 1997 subsection 83A-33(6)

Income Tax Assessment Act 1997 section 83A-35

Income Tax Assessment Act 1997 section 83A-45

Income Tax Assessment Act 1997 subsection 83A-45(1)

Income Tax Assessment Act 1997 subsection 83A-45(2)

Income Tax Assessment Act 1997 subsection 83A-45(3)

Income Tax Assessment Act 1997 subsection 83A-45(4)

Income Tax Assessment Act 1997 subsection 83A-45(5)

Income Tax Assessment Act 1997 paragraph 83A-45(5)(a)

Income Tax Assessment Act 1997 subparagraph 83A-45(5)(a)(i)

Income Tax Assessment Act 1997 subparagraph 83A-45(5)(a)(ii)

Income Tax Assessment Act 1997 subsection 83A-45(6)

Income Tax Assessment Act 1997 section 83A-335

Reasons for decision

Questions 1 and 2

Summary

The Commissioner will not exercise his discretion under paragraph 83A-45(5)(a) to allow the minimum holding period for Options acquired under the Option Plan to end on the date of Completion of the SPA and, as a consequence, the Option Holders cannot reduce the amount of the discount included in their assessable income under subsection 83A-25(1).

Detailed reasoning

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, or associates of employees (including past or prospective employees) of the company (or subsidiaries of the company) in relation to the employee's employment.

An 'ESS interest' in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company, or a beneficial interest in a right to acquire a beneficial interest in a share in the company.

Relevantly, under section 83A-335, Division 83A applies in relation to a stapled security in the same way as it applies in relation to a share in a company if at least one of the interests that are stapled together to form the stapled security is a share in the company. Rights to acquire such stapled securities are treated as rights to acquire shares, and a company is taken to include (as part of the company) each stapled entity for the stapled security if at least one of the ownership interests that are stapled together to form the stapled security is a share in the company.

Subsection 83A-25(1) provides that your assessable income for an income year in which an ESS interest is acquired includes the discount given in relation to the interest. Sections 83A-33 (start ups) and 83A-35 (other cases) provide for a reduction of the amount of the discount included in your assessable income under subsection 83A-25(1), by the total of the amounts included in your assessable income under that subsection provided, among other things, the further conditions in section 83A-45 are satisfied.

One of the conditions in section 83A-45 is the minimum holding period condition under subsection 83A-45(4):

Minimum holding period

83A-45(4)

This subsection applies to an ESS interest you acquire under an employee share scheme if, at all times during the interest's minimum holding period, the scheme is operated so that every acquirer of an ESS interest (the scheme interest) under the scheme is not permitted to dispose of:

(a) the scheme interest; or

(b) a beneficial interest in a share acquired as a result of the scheme interest;

during the scheme interest's minimum holding period.

Subsection 83A-45(4) requires the employee share scheme to be operated, at all times during the minimum holding period of the ESS interest, on the basis that all participants acquiring an ESS interest under the scheme are constrained from disposing of the ESS interest, or a beneficial interest in a share acquired as a result of the ESS interest during the ESS interest's minimum holding period.

Subsection 83A-45(5) provides that the minimum holding period starts when the ESS interest is acquired under the scheme and ends 3 years later or when the employee's employment ceases, whichever is earlier and subject to paragraph 83A-45(5)(a) which states that the Commissioner has the discretion to shorten the minimum holding period where the Commissioner is satisfied that:

(i) the operators of the scheme intended for subsection [83A-45(4)] to apply to the interest during the 3 years after the acquisition of the interest; and

(ii) at the earlier time that the Commissioner allows, all membership interests in the relevant company were disposed of under a particular scheme;

For the purposes of subparagraph 83A-45(5)(a)(ii), the Commissioner is satisfied that all membership interests in the Company were disposed of under the SPA.

For the purposes of subparagraph 83A-45(5)(a)(i), the Commissioner has regard to whether, when the Option Holders acquired their Options, there was a genuine intention for the Options to be held for the minimum holding period.[1] In that regard, the operator of the scheme fails the test if they allowed the ESS interest holders to dispose of their interests prior to the end of their minimum holding period, or there was objective evidence that the scheme was not operated to prevent the ESS interest holders from doing so.

In determining whether there was a genuine intention for the Options granted under the Option Plan to be held for the minimum holding period, the following Rules of the Option Plan are considered relevant:

• Subject to clauses 4(b) and 7, each Option vests on the 5^th anniversary after the date that it is issued, and each Option Holder cannot apply for Group Securities attaching to the Option until they have held the Option for at least 5 years (clause 4(a)).
• Despite clause 4(a), if a Liquidity Event (including a trade sale of shares and units in the Group) occurs each Option vests and each Option Holder may at that time exercise all Options held by them, even if the Option Holder has not held the Options for 5 years or more (clause 4(b)).
• When an Option vests due to a Liquidity Event not involving an IPO and is exercised at that time, the Exercise Price will be paid on behalf of the Option Holder from the proceeds generated from that Liquidity Event (clause 5(d)).
• When an Option vests due to a Liquidity Event and is not exercised at that time, each Option automatically expires, and no compensation is payable to the Option Holder (clauses 7(d) and 7(e)).
• Options will also automatically expire if not exercised within 10 years after the date of issue or if a Participating Employee leaves their employment (unless they left due to ill health or death and the Board in its discretion determines that the Options do not automatically expire) (clauses 7(a) to 7(c)).

Generally speaking, where the rules of an employee share scheme:

• contain a clause (commonly referred to as a 'tag along' or 'drag along' clause) permitting the acquirer of an ESS interest to dispose of their interest in the event of a trade sale or IPO, or either, at the time of such event; and
• cessation of employment aside, do not contain an overriding restriction on any disposal of their ESS interest in the first 3 years (reflecting the minimum holding period provided for in paragraph 83A-45(5)(a)) unless the Commissioner allows an earlier time by exercising his discretion,

the Commissioner will not be satisfied (for the purposes of subparagraph 83A-45(5)(a)(i)) that there was a genuine intention for the ESS interest to be held for the minimum holding period.

On the occurrence of a Liquidity Event, the Rules permit an Option Holder to exercise their Options and if the Option Holder chooses not to exercise their Options the Rules automatically provide for the expiration of those Options. The Rules providing for the disposal of Options under the Option Plan permit the Option Holder to dispose of their Options in the event of a Liquidity Event, at the time of the event, and do not provide an overriding restriction on any such disposal that is subject to the Commissioner exercising his discretion to allow an earlier time.

Therefore, we are not satisfied that the Option Plan operated to prevent the Option Holders from disposing of their Options prior to the end of their minimum holding period. They were permitted to dispose of the Options, and the fact that the condition for disposal is a Liquidity Event is not inconsequential or immaterial.

As such, the Commissioner will not exercise his discretion under paragraph 83A-45(5)(a) to allow the minimum holding period for Options acquired under the Option Plan to end on the date of Completion of the SPA.

In the absence of the Commissioner having exercised this discretion, the minimum holding period condition under subsection 83A-45(4) does not apply to Options acquired under the Option Plan and the Option Holders cannot reduce the amount of the discount included in their assessable income under subsection 83A-25(1), pursuant to subsection 83A-33(1).

[1] The Explanatory Memorandum for the Tax and Superannuation Laws Amendment (Employee Share Schemes) Bill 2015 explaining the introduction of the Commissioner's discretion in subsection 83A-45(5), at paragraph 1.82.