ATO Interpretative Decision
ATO ID 2007/174
Income Tax
Employee Share Options: taxing rights on gain from sale of shares by an Australian resident taxpayer where the options to purchase those shares were granted to the taxpayer when they were working in the United States of AmericaFOI status: may be released
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This ATO ID contains references to repealed provisions, some of which may have been re-enacted or remade. The ATO ID is current in relation to the re-enacted or remade provisions.
Australia's tax treaties and other agreements except for the Taipei Agreement are set out in the Australian Treaty Series. The citation for each is in a note to the applicable defined term in sections 3AAA or 3AAB of the International Tax Agreements Act 1953.
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Does a resident individual taxpayer include a capital gain made on the sale of shares acquired under an employee share scheme in their net capital gain or loss, where the option to purchase the shares was granted to the taxpayer when they were a resident of the United States of America (US) and the US has correctly taxed the entire gain on exercise of the option in accordance with Article 15 of the tax treaty between Australia and the US (US Convention) contained in Schedule 2 to the International Tax Agreements Act 1953 (Agreements Act)?
Decision
Yes. A resident taxpayer does include a capital gain from the sale of the shares acquired under an employee share scheme in their net capital gain or loss, even though the US has source country taxing rights under Article 15 of the US Convention in respect of the gain made on the exercise of employee share options.
Facts
The taxpayer was granted employee share options in a US public company (US Company), while the taxpayer was a resident of the US.
These options were granted solely in relation to the taxpayer's performance prior to the options being granted.
While the options required a three year holding period prior to vesting, there were no other conditions attached to them. Accordingly, the options were granted as a reward for service which was carried out entirely in the US.
The taxpayer subsequently relocated to Australia and immediately became an Australian resident.
The taxpayer continued to work for an associate of the US Company in Australia until the taxpayer exercised the options. The shares acquired as a result of the options were disposed of immediately.
The facts were such that the taxpayer was unable to choose a tax deferral under Division 13A of the Income Tax Assessment Act 1936 (ITAA 1936).
Reasons for Decision
On exercise of the options, a capital gains tax (CGT) event C2 happened in relation to each option (subsection 104-25(1) of the Income Tax Assessment Act 1997 (ITAA 1997)). The taxpayer's capital gains from this event, however, were disregarded and the cost base of the options became part of the cost base of the shares acquired by the exercise of the options (subsections 134-1(1) and 134-1(4) of the ITAA 1997).
On the sale of the shares, a CGT event A1 happened in relation to each share (subsection 104-10(1) of the ITAA 1997). There was a capital gain from the disposal of each share equal to the amount by which the capital proceeds from the disposal of the share exceeded the cost base of the share (subsection 104-10(4) of the ITAA 1997). These capital gains included the capital gains on the exercise of the options, because of the cost base calculation described in the preceding paragraph.
A capital gain can be reduced under section 118-20 of the ITAA 1997 if, because of the CGT event that resulted in that capital gain, an amount is included in the taxpayer's assessable income or exempt income. This raises the question of whether all or part of the gain on the employee shares is foreign earnings within the meaning of subsection 23AG(7) of the ITAA 1936 and possibly exempt under section 23AG of the ITAA 1936.
While the discount on the grant of options to the taxpayer is considered to be employment related income, in accordance with the decision in Donaldson v. FC of T 74 ATC 4192; (1974) 4 ATR 530, the benefit they obtain from the exploitation of those options (that is from the holding of the options from grant time to exercise time and subsequent disposal of the underlying shares) is capital in nature and does not constitute 'foreign earnings' within the meaning of subsection 23AG(7) of the ITAA 1936 (see FC of T v. McArdle 89 ATC 4051; (1988) 19 ATR 1901).
Accordingly, the capital gain on the employee shares is not reduced by section 118-20 of the ITAA 1997.
In determining liability to Australian tax, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the Agreements Act. Schedule 2 of the Agreements Act contains the US Convention.
Article 15 of the US Convention provides that remuneration derived by a resident of one of the Contracting States in respect of employment exercised in the other State may be taxed in that other State. It is accepted that the employment that gives rise to the gain on the employee share option is entirely carried out in the US and, accordingly, the US has correctly taxed such gain under Article 15.
However, the Article does not prevent the country of residence of the taxpayer from also taxing the gain. That much is clear from the words of the Article which prima facie only permits the country of residence of the taxpayer to tax the remuneration, unless the employment is exercised in the other country, in which case the remuneration may be taxed by that other country. The words 'may be taxed' in this context do not mean that the other country is the only one entitled to tax that income. Under international tax law principles, the residence country (in this case Australia) may also continue to tax such remuneration (see paragraph 23 of Taxation Ruling TR 2001/13). However, double taxation is avoided by the residence country providing appropriate credit relief.
Accordingly, there is nothing in Article 15 or any part of the US Convention that prevents Australia from taxing the gain on the disposal of the shares acquired under the employee share scheme in accordance with its normal domestic tax law provisions.
Consequently, the entire capital gain made on the sale of the shares is taken into account in calculating the taxpayer's net capital gain or loss.
Year of income: Year ended 30 June 2000
Legislative References:
Income Tax Assessment Act 1936
Division 13A
section 23AG
subsection 23AG(7)
subsection 104-10(1)
subsection 104-10(4)
subsection 104-25(1)
section 118-20
subsection 134-1(1)
subsection 134-1(4) International Tax Agreements Act 1953
section 4
Schedule 2, Article 15 New International Tax Arrangements (Foreign-owned Branches and Other Measures) Act 2005
The Act Tax Laws Amendment (2006 Measures No 1) Act 2006
The Act
Case References:
Donaldson v. FC of T
74 ATC 4192
(1974) 4 ATR 530
89 ATC 4051
(1988) 19 ATR 1901
Related Public Rulings (including Determinations)
Taxation Ruling TR 2001/13
ATO ID 2007/173
Keywords
Double tax agreements
Employee share schemes & options
United States
Capital gains tax
Capital gains
Capital receipts
CGT capital proceeds
CGT event A1 - disposal of a CGT asset
CGT events C1-C3 - end of a CGT asset
ISSN: 1445-2782