Private ruling: Assessable income – remuneration package – special payment
Date of advice: 28 May 2018
Published: July 2018
Ruling period: 20xx-xx income year | 20xx-xx income year | 20xx-xx income year
Date scheme commenced: 1 July 20xx

Ruling: Q1: Is the right granted to the Taxpayer under the Agreement to receive a Share Sale payment an employee share scheme (ESS) interest as defined by subsection 83A-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is the payment received by the Taxpayer in accordance with the Deed assessable under either section 6-5 or section 15-2 of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: The Taxpayer was at all relevant times a key manager of the Company . The Taxpayer is an Australian resident for tax purposes and exercises employment with the Company substantially in Australia. Profit Share and Sale Share Agreement The Taxpayer entered into a Special Purpose Agreement (the Agreement ) with the Company and the Shareholder in about 20xx. The Agreement contained recitals relating to: The Taxpayer being a valued employee to the Company and that the Agreement provides an incentive for them to maximise efforts on the Company’s behalf. The Taxpayer being entitled to a percentage of operating profits on the terms outlined in this Agreement, whilst an employee of the Company. The Taxpayer being entitled to a percentage of the sale profit in the event of a sale of the Company. This Agreement will terminating in the event of the Taxpayer terminating their employment with the Company or the sale of the Company. By entering into this Agreement, the Taxpayer became entitled in certain circumstances to a percentage of profits of the Company (referred to in the Agreement as Profit Share ). Additionally, by entering into the agreement the Taxpayer was potentially entitled to proceeds on a sale of business assets, or of shares in the Company (the Sale Share ). The Agreement states that the Taxpayer’s right and entitlement to Profit Share subsists while the Shareholder continues to hold shares. The Agreement also provides that the rights and entitlements under the Agreement are additional to ordinary rights available to the Taxpayer as an employee, and prevails over the employment agreement in the event of inconsistency. A Share Sale payment prevents a later right to a later Share Sale payment arising. A payment under a Share Sale is not severable from the rights available to the Taxpayer under the Agreement as a whole. Recital D of the Agreement suggests a Sale Share payment may terminate the Agreement. The Agreement included clauses related to termination of employment, withholding of tax and the transferability of the Taxpayer’s rights under the Agreement. (They couldn’t be transferred.) Variation to Terms of Agreement It was agreed between the directors of the Company that the Taxpayer’s entitlements would vary as a result of increased involvement with a related business but the terms of the variation were not completed before the sale. Sale of the Company by the Shareholder Subsequently, all the issued equity in the Company was sold by Shareholder to an independent third party, together with the sale of the related business. The third party was not a party to the original Agreement. As consideration for the purchase of all shares of the Company the Shareholder received a Downpayment amount from the Purchaser. Deed of Discharge & Payment The Taxpayer became entitled to receive a portion of the Downpayment amount (described as the Release Payment ) shortly afterward under a Deed of Discharge & Payment (the Deed ). The Deed contained recitals about: The Taxpayer being a key employee of the Company. The existence of the Agreement referenced as ‘a performance incentive arrangement with the [Taxpayer] whereby certain phantom equitable entitlements were granted in accordance with the documents and terms outlined in Schedule 1 (Equity Entitlement Scheme)’ . It being a condition of the sale that the Agreement was terminated. The Taxpayer accepting the Release Payment as the final agreed percentage entitlement under the Equity Entitlement Scheme in exchange for its termination. A cash payment was made to the Taxpayer about a week later. The Taxpayer’s employment continues under the Deed and certain entitlements to payments are conditional upon remaining employed. New Employment Agreement The Taxpayer has also entered into a new Employment Agreement with the Company requiring the Taxpayer to work exclusively for the Company and for the related business. This new Employment Agreement also acknowledges that the phantom equity entitlements have ceased to exist. The Shareholder was a signatory to the new Employment Agreement as Secretary/Director of the Company. Deed of Deferred Payments The Taxpayer is potentially entitled to additional future payments under the Deed of Deferred Payments . This Deed makes the following statements described as ‘Background’: The Taxpayer is an employee of the Company. The Parties have entered into the Deed of Discharge & Payment concurrent with their entry into this Deed. The Deed of Discharge & Payment terminated the Equity Entitlement Scheme in consideration for the Release Payment. In addition to the Release Payment, the Taxpayer may be paid certain Deferred Payments, subject to the terms and conditions of this Deed.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 15-2 | Income Tax Assessment Act 1997 Division 83A | Fringe Benefits Tax Act 1986 Section 136

Reasons for decision: Summary: The right granted to the Taxpayer under the Agreement to receive a Share Sale payment is not an ESS interest as defined by subsection 83A-10(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 83A-10(1) of the ITAA 1997 defines ‘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 a company. It is easy to conclude that an ESS interest has been granted if the grant is specifically a share or a right to acquire a share. However, the tax law has to apply to employment agreements that may allow more novel forms of payment or for the form of payment to be determined after the employment agreement commences. For example, an employee may become eligible to receive a bonus, but the employer may reserve the right to pay the bonus in cash, property or shares. We would describe such an employee as having an indeterminate right. The indeterminate right would only become a right to acquire a share once the employer committed to providing the bonus as a share or as a right to acquire a share. Section 83A-340 of the ITAA 1997 provides consequences for an indeterminate right that later become a right to acquire a beneficial interest in a share. In short, it is treated as if the right was always a right to acquire a beneficial interest in the share. The Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 makes the following statements about indeterminate rights: | Detailed Reasoning - Employment benefits that later become ESS interests: 1.367 At the time of acquisition it may be unclear whether a right to an employment benefit will result in the receipt of an ESS interest, or it may be unascertainable how many ESS interests will be received. In such circumstances, that right will be considered to have been an ESS interest from the time that the original right to an employment benefit was acquired, if and when it becomes clear that the right to the employment benefit will result in the receipt of a definite number of ESS interests. [Schedule 1, item 1, section 83A-340] 1.368 This is to ensure that employment benefits provided in the form of discounted shares or rights to shares are taxed consistently and appropriately under the employee share scheme rules. 1.369 This provision will apply, for example, to an employment benefit that is a right to an indeterminate number of shares, or to a benefit that may be received in shares, in cash, or in some other form. 1.370 When the nature of the right to an employment benefit as an ESS interest becomes clear, the Commissioner may amend an employee's income tax assessment for the income year in which the taxing point for the ESS interest occurred (based on the treatment of the right as an ESS interest from the time of its acquisition). The Commissioner can amend an assessment relating to an employee share scheme at anytime, for the purposes of a taxing an employment benefit which becomes an ESS interest. [Schedule 1, item 19, item 35 in the table in subsection 170(10AA) of the ITAA 1936] What this means is that the ESS provisions will only apply if the form of payment chosen for the remuneration is the grant of shares in a company or a right to acquire a share in a company. In this case, the Agreement did not nominate what form any Share Sale payment would take. The Agreement merely provided a mechanism for calculating the amount of any Share Sale payment. The subsequent actions by all of the relevant parties resulted in the Share Sale payment being made in the form of cash in accordance with the Deed. There is no evidence: ● that it was ever expected or intended that the Share Sale payment would be made in the form of shares or rights to acquire shares, or ● that the cash payment was made to terminate a right to acquire shares. Therefore, the conditions for the right to be an ESS interest are not satisfied. | Summary: The payment received by the Taxpayer in accordance with the Deed is assessable under either section 6-5 or section 15-2 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: There is an order to be followed when considering the potential application of remuneration related provisions to payments made to an employee. The order for situations such as that applying to the Taxpayer can be stated as follows: ● ESS (Division 83A of the ITAA 1997) ● Termination payments (Divisions 80 to 83 of the ITAA 1997) ● Fringe benefits (Fringe Benefits Tax Act 1986 (FBT Act)) ● Ordinary income (Section 6-5 of the ITAA 1997) ● Other remuneration benefits (Section 15-2 of the ITAA 1997) This order arises because: ● Paragraph 82-135(m) of the ITAA 1997 prevents ESS discounts from also being employment termination payments ● Paragraphs (h) and lc) of the definition of ‘fringe benefit’ in subsection 136(1) of the FBT Act prevent employee share scheme discounts and employment termination payments from also being fringe benefits ● Section 23L of the Income Tax Assessment Act 1936 (ITAA 1936) prevents a fringe benefit from also being assessable income ● Section 6-25 of the ITAA 1997 prevents amounts of statutory income from also being assessable as ordinary income ● Subsection 15-2(3) of the ITAA 1997 prevents amounts that fall into any of the remuneration categories mentioned above from also being assessable under section 15-2 In practical terms, a traditional asset should cease to be considered to relate to employment once it has been taxed as employment income. For example, shares would generally be considered to be an investment asset once the ESS provisions had applied. Independently from the above, it may be concluded that a payment made to an employee might relate to a capital gains tax (CGT) asset and cause a CGT event to happen that might result in a capital gain or a capital loss. Then, the anti-overlap provision in section 118-20 of the ITAA 1997 would apply to reduce the amount of any capital gain so that the payment was not taxed twice (if another CGT exemption did not also apply). For the reasons given above, the ESS provisions do not apply to the Share Sale payment. Neither can the payment be a termination payment because the Taxpayer’s employment with the Company is continuing. | Detailed Reasoning - Fringe benefits v assessable income under sections 6-5 and 15-2 of the ITAA 1997: Theoretically, every right that is created under an employment relationship could give rise to a fringe benefit. Were that to be the case, then even the right to receive ordinary salary and wages would be fringe benefits as performing the role of being an employee creates the right to be paid remuneration. But the actual salary or wage payment that extinguished the right could be considered to be separate and distinct from the creation of the right. So the physical payment could also be taxable – meaning double taxation. Paragraph (f) of the definition of ‘fringe benefit’ in subsection 136(1) of the FBT Act avoids this issue by excluding payments of salary or wages (even if exempt income) from the definition of fringe benefit. The term ‘salary or wages’ is defined for FBT purposes in subsection 136(1) of the FBT Act as including: a payment from which an amount must be withheld (even if the amount is not withheld) under a provision in Schedule 1 to the Taxation Administration Act 1953 listed in the table, to the extent that the payment is assessable income Section 12-35 of Schedule 1 to the Taxation Administration Act 1953 states: An entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee (whether of that or another entity). This matter was raised at a series of FBT Subcommittee meetings of the National Taxation Liaison Group in 2004 and 2005 with the Australian Taxation Office (ATO) advising that cash settled stock appreciation rights were assessable to the recipient under either section 6-5 of the ITAA 1997 or paragraph 26(e) of the ITAA 1936. The ATO view on this matter is the Class Ruling CR 2001/76 (Brightstar) which is about an employee incentive plan using phantom options. Ultimately, the conclusion reached was that in these types of schemes, the cash amount awarded to participants is a cash bonus received in the context of an employment relationship. Cash bonuses, like salary and wages, are assessable on receipt. The participant does not have any entitlement to a future cash amount under these plans due entering into them. Taxation Ruling TR 2010/6 considers a similar issue involving an employee benefit trust arrangement and similarly concludes that the cash receipts are assessable under either section 6-5 or 15-2 of the ITAA 1997. Section 6-5 of the ITAA 1997 is the only provision in the list above that is actually limited in application to receipts of a revenue nature. The primary issue in the remainder of the provisions is the relationship to the employment of the taxpayer and capital receipts can be taxable under them. | Detailed Reasoning - The nature of the Agreement and your arguments: The terms of the Agreement indicate that it operates as an addendum to the employment contract between the Taxpayer and the Company. Consequently, the benefits provided under it or a related entitlement would ordinarily be considered to be remuneration for the reasons given above. However, you have posed questions asking whether the payment might be considered to be the exploitation of a valuable right that is independent of any employment and be capital in nature such that it might constitute a capital gain. In support of your position, you have cited the following cases: McArdle v FCT 88 ATC 4222 and FCT v McArdle 89 ATC 4051 This case involved options granted under a stock option plan. Stock appreciation rights were granted as an adjunct to the options due to other potential adverse legal consequences. Both options and stock appreciation rights were capable of being exercised after employment ended in limited situations. Ordinary shares would be acquired if the options were exercised. These shares would be subject to normal trading rules. The taxpayer negotiated the surrender of the options and stock appreciation rights in exchange for a cash payment. Held, the employee share scheme provisions prevented any amount being assessable under section 25 or paragraph 26(e) of the ITAA 1936. But for the above, section 25 or paragraph 26(e) of the ITAA 1936 might have applied when the options were granted and this event occurred in an earlier year ( Donaldson v FCT 74 ATC 4192 and Abbot v Philbin (1961) A.C. 352). Note: this case involves grants before the commencement of the fringe benefits provisions. Coward v FCT 99 ATC 2166 This case held that a particular compensation payment made many years after employment ended was capital in nature. Blank v FCT [2016] HCA 42, [2015] FCAFC 154 and This case held that payments of ‘deferred compensation’ that was expected to be paid after termination of employment for services to be provided after the agreement commenced were ordinary income. Payne v FCT 96 ATC 4407 This case held that certain benefits obtained under a personal frequent flyer program where the points were accumulated from travel paid by the employer were not assessable at the time they were used. | Detailed Reasoning - Analysis of the case law: In practical terms, section 15-2 of the ITAA 1997 will generally only apply to receipts that are of a capital nature as section 6-5 would apply in preference to revenue receipts. As an example in support of this statement, Bowen CJ stated in Donaldson v FCT 74 ATC 4192 at page 4205: Forensic or judicial glosses upon the section are no substitute for its words, which seem plain enough. However, the points raised do concentrate attention on specific areas of contention in the application of the section. As to (i) the words of sec. 26(e) suggest that any item which falls squarely within its terms is rendered assessable income. So far as the words of the section are concerned, it seems to matter not whether the item would otherwise be of an income or capital nature according to ordinary concepts. Your mention of the term ‘exploitation of valuable rights’ emerges from the English case Abbott v Philbin (1961) A.C. 352 which considers the nature of options granted in that case in determining whether remuneration was earned when the options were granted or when they were exercised. In that case, Lord Radcliffe stated: I think that the Revenue are right in saying that a line has to be drawn somewhere between convertible and non-convertible benefits, and that somehow we have to put a general meaning on the not very precise language used in Tennant v. Smith. What I do not think, however, is that a non-assignable option to take up freely assignable shares lies on that side of the line which contains the untaxable benefits in kind. The option, when paid for, was thereafter a contractual right enforceable against the company at any time during the next 10 years so long as the holder paid the stipulated price and remained in its service. That right is, in my opinion, analogous for this purpose to any other benefit in the form of land, objects of value or legal rights. It was not incapable of being turned into money or of being turned to pecuniary account within the meaning of these phrases in Tennant v. Smith merely because the option itself was not assignable. What the option did was to enable the holder at any time, at his choice, to obtain shares from the company which would themselves be pieces of property or property rights of value, freely convertible into money. Being in that position he could also at any time, at his choice, sell or raise money on his right to call for the shares, even though he could not put anyone he dealt with actually into his own position as option holder against the company. I think that the conferring of a right of this kind as an incident of service is a profit or perquisite which is taxable as such in the year of receipt, so long as the right itself can fairly be given a monetary value, and it is no more relevant for this purpose whether the option is exercised or not in that year, than it would be if the advantage received were in the form of some tangible form of commercial property. The claim to tax the advantage obtained in the year 1955-56 is not claimed by the Revenue if the right view is that the option itself was taxable in 1954-55. Even if there were no taxable subject in the earlier years I should regard the 1955-56 claim as failing on its own terms. The advantage which arose by the exercise of the option, say £ 166, was not a perquisite or profit from the office during the year of assessment: it was an advantage which accrued to the appellant as the holder of a legal right which he had obtained in an earlier year, and which he exercised as option holder against the company. The quantum of the benefit, which is the alleged taxable receipt, is not in such circumstances the profit of the service: it is the profit of his exploitation of a valuable right. Bowen CJ stated at page 4206 in relation to certain English cases including Abbott v Philbin (1961) A.C. 352: These cases turn upon the provisions of the English Income Tax Legislation - in particular Schedule E of the Income Tax Acts , ranging from the Act of 1842 to the Act of 1918, and later the Act of 1952. The wording of these provisions is markedly different from our sec. 26(e), particularly with its reference to ``perquisites'' of office or employment. But in its practical application in many respects it is not dissimilar. I think it is fair to say that in these days, such benefits are regarded as being in the nature of a bonus or an addition to salary and are of an income nature, where they are conferred in relation to the employment or to services rendered. The issue has more recently been considered in the case Sent v FCT [2012] FCAFC 187 and [2012] FCA 382 where the right to receive past and future bonuses was converted into a different form involving units in a trust and shares. The Full Federal Court stated: 33. It was argued on behalf of the appellant that the payment of the $11,600,000 was capital in the hands of the appellant on the basis that the right to be issued the shares in Primelife was a capital asset and the payment in lieu partook of the same character. With respect, the argument is misconceived. It is as much an error to characterise a receipt by reference to a "juristic classification of the legal rights, if any, secured, employed or exhausted in the process" as it is to characterise an outgoing as being on revenue or capital account by reference to such matters: Hallstroms Pty Ltd v Commissioner of Taxation (1946) 72 CLR 634 at 648.10 per Dixon J. 34. The payment of $11,600,000 was in substitution for the appellant's entitlement to his right to receive remuneration for his services in the form of the issue to him or his nominee of five million shares in Primelife. The appellant accepted that payment as the performance of Primelife's obligation under the Share Issue Deed to pay him for his services by the issue of those shares. The arrangement under which the appellant gave up his right to the five million shares and accepted the money in its place could be not characterised as converting a receipt of an income character (the right to be issued the shares) into one of a capital character (the payment of the money in substitution for the right to receive the shares). From a "practical and business point of view" ( Hallstroms 72 CLR at 648.10), both forms of receipt were intended to reward the appellant for his service to Primelife. 35. If an employer is obliged to furnish an employee remuneration in one form, the fact that the parties treat the employer's obligation as having been discharged because the remuneration is furnished in a different or substitute form, does not alter the character of the receipt in the employee's hands. Murphy J in the Federal Court stated: The amount in issue was in consideration of Mr Sent waiving an entitlement to bonuses under his employment agreement - it was paid as a reward for services. 44. The fact that some of Mr Sent's bonus entitlements were contingent and subject to claw back in that they were based on Primelife's future performance, and may be viewed as having been paid before the services were provided, does not mean that the Payment loses its character as income. The timing of a payment as against the provision of the services is not determinative of its character. As Hill J held in Reuter in the passage at 540 cited above: "So, too, for income tax purposes, it would be immaterial whether an amount which is a reward for services is paid to the taxpayer in advance of the service is being performed (e.g. a signing on fee) or after the services have been performed....What will matter is the character of the payment as a reward for services or, as it was put by Fullagar J in Hayes v Federal Commissioner of Taxation (1956) 96 CLR 47, 57-8, whether the receipt is a "product" of the taxpayer's services." Murphy J further stated: 46. In this case the Payment was ultimately in substitution for income by way of bonuses that were earned but not received, together with bonuses that were likely to be earned but had not yet been received. An entitlement to five million Primelife shares was initially substituted for Mr Sent's bonus entitlements, and then that entitlement to shares was substituted for the Payment. The Payment maintained its character as income, being a reward for services. 47. The fact that a double substitution has occurred in this case does not alter the maintenance of its income character. For example, in Tagget a taxpayer contracted to provide services then and in the future to a developer. His reward under the contract was a particular lot of land, or in default, a cash sum. The developer did not pay the taxpayer either the land or the cash sum so the taxpayer sued. The proceeding was settled on the basis that the taxpayer receive another different lot of land. Nicholas J held at [68] to [69] that the initial payment comprised of a lot of land was of the character of income as a reward for services provided and to be provided. Notwithstanding the double substitution that then ensued the substitute lot of land retained the character of income. The Full Court comprised of Dowsett, Jessup and Gordon JJ upheld the decision: Tagget v Federal Commissioner of Taxation 2010 ATC ¶20-210; (2010) 188 FCR 128 (" Tagget (FC) "). 48. In any event, it is not correct to describe Mr Sent's entitlements as contingent or subject to claw back at the time of the Payment. Some of Mr Sent's bonus entitlements were contingent until 30 November 2001 insofar as they related to the future financial performance of Primelife. Some of the bonus entitlements could also be described as being subject to claw back until that date as Primelife's future performance could reduce his accruing entitlement. However, once the Share Issue Deed was executed and then approved by the shareholders on 30 November 2001, Mr Sent had an unconditional entitlement to be issued with five million Primelife shares in substitution of these bonus entitlements. It is even clearer that at the time the Payment was made on 21 December 2001 there was no longer any contingency as to the entitlement to the Payment or possibility of its claw back. 49. I also reject as without merit, Mr Sent's contention that because the Payment was paid in respect of the surrender of rights and formed a part of the capital of the Trust it was of a capital nature rather than having the character of income. Under the arrangement between Mr Sent and Primelife he was to continue as Managing Director and CEO and there was no payment for loss of office or the like. In the absence of such a basis it is a hopeless argument that giving up an entitlement to bonuses from employment has a capital nature. The question being posed by most of these cases is about whether the benefit obtained is a reward for service or the exploitation of a valuable right independent of that service and is based on whether the right has an existence that is independent of the employment relationship. In both the McArdle case and Abbot v Philbin , the taxpayer had the right to exercise options and acquire shares that would then have been freely tradeable independently of employment. In the Payne case, the benefit (being the airline tickets) was provided by a third party who was not associated with the employer and had never been so associated. The Commissioner has since issued Taxation Ruling TR 1999/6 which states that an employee would not derive assessable income but an employer might be subject to fringe benefits tax in these situations. Dividend equivalent payments under an ESS that uses a trust structure are another instance where employees receive cash payments that are somewhat removed from the ordinary forms of remuneration. Taxation Determination TD 2017/26 provides the ATO view for these arrangements and states that such a payment will be remuneration if ‘the payment has a sufficient connection with your employment’. The analysis from this Determination is of assistance here. It states: | Detailed Reasoning - When will a dividend equivalent payment paid to you have the character of remuneration?: … 16. Benefits (in the form of money or money's worth) that you receive for, or in respect of, services you provide as an employee, or, similarly, payments which have a sufficient connection with your employment, will be characterised as remuneration and therefore ordinary income. 17. The character of the benefit must be determined in the hands of the recipient. It is irrelevant whether: ● it is paid in advance of the services to be performed or after ● the remuneration is paid by the employer or another entity ● it is paid from the income or the capital of a trust, or ● it is paid from an amount previously assessed to a trustee under the trust assessing provisions in an earlier year. When is a dividend equivalent payment for, or in respect of, services you provide as an employee, or when does the payment have a sufficient connection with your employment? 18. It is not necessarily the case that a dividend equivalent payment will have the necessary connection with your employment just because you are an employee at the time you receive it. For instance, if you receive the payment other than in your capacity as an employee, the payment is unlikely to be for, or in respect of, services provided as an employee, as the consideration for the dividend equivalent payment is not your services. 19. Factors that indicate a dividend equivalent payment is for, or in respect of, your services as an employee include the following: ● it is agreed that the dividend equivalent payment is consideration for services rendered by you ● the dividend equivalent payment arises from a contract, arrangement or plan established by your employer to enable or facilitate the delivery of employment benefits (such as ESS interests) to you ● the dividend equivalent payment can be provided by your employer ● the dividend equivalent payment is conditional on you meeting individual or specific employment-related targets ● the dividend equivalent payment depends upon your continued employment with your employer and is forfeited on cessation of employment, or ● the dividend equivalent payment is provided at the discretion of your employer or the trustee (based on your employer's direction or recommendations). 20. Factors that indicate a dividend equivalent payment is not for, or in respect of, services you provide as an employee include the following: ● the dividend equivalent payment is consideration for an arm's length surrender, exercise or disposal of an asset (property or rights) and that asset was acquired in return for valuable and arm's length consideration (or as remuneration and those rights were appropriately dealt with as such) ● the dividend equivalent payment arises because you are a beneficiary of the trust and the trustee has exercised its power under the deed to provide those benefits to you independent of an arrangement or understanding with, or direction by, your employer ● the dividend equivalent payment does not arise from a contractual agreement to which you and your employer are party ● the dividend equivalent payment does not depend on your continuing employment ● the dividend equivalent payment does not have regard to, and is not conditional upon you satisfying, your employment-related targets, or ● the timing and amount of the dividend equivalent payment is identical in respect of all recipients who hold the same property or rights, regardless of their employment relationship with your employer. | Detailed Reasoning - The Taxpayer’s situation: The Taxpayer has a continuing employment relationship with the Company. The Taxpayer receives remuneration in return for the provision of services to the Company. Such remuneration is ordinarily considered to be revenue in nature. The Taxpayer is not an owner of the Company and is not selling shares in the Company. The remuneration derived by the Taxpayer is generally assessable on a ‘receipts’ basis irrespective of when the services are provided. The Taxpayer is not assessable on an ‘earnings’ basis. The remuneration strategy for a key individual within an organisation often contains special elements such as bonuses to reflect that key individual’s effect on the organisation. The form that these special elements take can also affect the organisation. Such bonuses can also be situational and be paid at times when special rewards or incentives are considered appropriate. The Agreement acknowledges that the Taxpayer is a key individual within the Company and that the Taxpayer’s efforts have an effect on the performance of the Company and perhaps any potential sale price for the Company that might be realised by the Shareholders. The Agreement is intended to provide an incentive to the Taxpayer to ‘maximise efforts on the Company’s behalf’. The form of the incentive is that the Taxpayer would receive Profit Share payments and potentially a Sale Share payment if the Taxpayer remained as an employee of the Company. The reward for effort nature of the incentive strongly indicates that it is remuneration – a bonus that the Taxpayer was to receive whose amount was to be calculated in accordance with the formula in the Agreement. The Taxpayer has not received a Share Sale payment under the Agreement. Instead, the Taxpayer has surrendered the rights under the Agreement and received the cash payment under the Deed. In effect, the Deed merely quantifies the amount that the Taxpayer was to receive under the Agreement due to being a continuing employee as required by the Agreement. The Company as the Taxpayer’s employer and the entity that was expected to pay the Share Sale payment is a party to the Deed. The Shareholder was still the owner of the Company when the Deed was entered into. Murphy J states in Sent v FCT (quoted above) that an amount paid in consideration for waiving a right to receive a bonus or bonuses under an employment agreement is itself a reward for services. Therefore, it would be assessable under section 6-5 of the ITAA 1997. The Taxpayer’s rights under the Agreement and the Deed do not have an existence that is independent of the employment in the manner contemplated by the McArdle Case or Abbott v Philbin or Payne. In the first two cases, the taxpayers could have exercised the options and sold the resulting shares on the open market. They were not relying on receiving or expecting to receive cash payments from their employers (or their associates). In the third case, the arrangement involved an unrelated third party and was the same deal was available to most frequent flyers. There is no evidence to support your contention that the nature of the Taxpayer’s entitlements under the Agreement were altered by the Deed. The effect of the Deed from the Taxpayer’s perspective was to merely quantify an acceptable amount to be the Share Sale payment that was payable under the Agreement and that the Taxpayer had earned as a continuing employee of the Company. The payment under the Deed is still a bonus (see Sent v FCT quoted above). However, if the payment under the Deed is considered to be capital in nature then it will be assessable under section 15-2 of the ITAA 1997 due to its relationship with the Taxpayer’s employment. The fact that the payment under the Deed is being made by the Shareholder does not change any of the above. This is discussed in Taxation Ruling TR 2001/10, which states: | Detailed Reasoning - Payments to an employee by associates of the employer: 84. Amounts paid to an employee under an ineffective SSA by someone associated with the employee's common law employer are payments of salary or wages. It is our view that an employer includes a person who pays salary or wages to an employee for services rendered to his or her common law employer under his or her employment contract, regardless of whether or not the person making the payment is the common law employer. Section 12-35 of Schedule 1 to the TAA requires that an entity withhold an amount from salary, wages, commissions, bonuses or allowances that it pays to an individual as an employee (whether of that or another entity). 85. The decision of Merkel J in Dean & Anor v. FC of T 97 ATC 4762; (1997) 37 ATR 52 supports this view. His Honour found that the employee retention payments made by a company associated with the common law employer were 'salary or wages' and agreed with comments by Hill J in Newcastle Club Ltd v. FC of T 94 ATC 4594 at 4595; (1994) 29 ATR 216 at 218-9 that the definition of salary or wages clearly contemplates payments from persons other than the common law employer. Similarly, Taxation Ruling TR 2009/2 about genuine redundancy payments makes the following statements about this form of remuneration: 225. While redundancy payments would ordinarily be made by the employer of the terminating employee, the character of a payment as a 'genuine redundancy payment', or indeed as a termination payment more generally under Part 2-40, does not depend on whether an employer makes the payment. Also Taxation Determination 2017/26 (mentioned above) states that it is the reason for the payment that matters, not who makes it. The payers do not need to be associated with the Taxpayer’s employer at the time the payment is made. While your focus has been drawn to the payment that the Taxpayer has received, the reality of your ‘exploitation of a valuable asset’ argument is that you are suggesting that the Taxpayer earned ‘remuneration’ when the Agreement was made in relation to the Share Sale payment. However, the manner in which the Agreement was intended to operate with Profit Share payments is more consistent with a bonus scheme which would mean that the Sale Share was an additional bonus payment. The Agreement merely provides a mechanism for determining the amount of the Taxpayer’s Profit Share and Sale Share entitlements. The Deed refers to the Agreement as ‘a performance incentive arrangement’ and ‘the Equity Entitlement Scheme’ and that the Taxpayer received ‘certain phantom equitable entitlements’. The key obligation imposed on the Taxpayer was to continue in employment with the Company. The Taxpayer’s rights under the Agreement were not severable from this employment. Class Ruling 2001/76 (Brightstar) states the Commissioner’s opinion that employees are assessable on receipt of the cash amounts in respect of: …a bonus program, offering a payment of a cash amount at a future date calculated by using a pre-determined formula. The payment of the cash amount is based upon the growth of the employer partnership, BEP. A phantom option structure has been created to provide an incentive program that, as close as possible, resembles a real equity plan. The primary objective of the phantom option structure is to provide an incentive for the employees of BEP to benefit from the performance of the business of BEP. The Agreement operated in a manner that is largely consistent with the bonus program operated by Brightstar. Consequently, the payments that were expected to be made under the Agreement would have related to the Taxpayer’s employment and been assessable under either section 6-5 or 15-2 of the ITAA 1997. For the reasons expressed in Sent v FCT , the payment under the Deed due to the cancellation of the Agreement is likewise a payment that is related to the Taxpayer’s employment and assessable under either section 6-5 or 15-2 of the ITAA 1997. It may be arguable that the Taxpayer also makes a capital gain due the termination of rights under the Agreement, but any capital gain would be reduced to $nil as the payment the Taxpayer has received is also assessable under another taxing provision. | Detailed Reasoning - Conclusion: The Taxpayer received the payment due to the Taxpayer’s association with the Company. The nature of this association is that the Taxpayer is an employee who provides employment services to the Company and to the related business. The Taxpayer is a key employee of the Company and the services that the Taxpayer provides are of sufficient importance to the profits and value of the Company that the Taxpayer was offered additional rewards under the Agreement. The form of these additional rewards being the Profit Share and the Sale Share were intended to aid the Company in retaining the Taxpayer’s services and to provide an incentive to the Taxpayer to maximise efforts on the Company’s behalf. The Taxpayer fulfilled the requirements of the Agreement to be entitled to receive a Share Sale payment. The Deed cancelled the Agreement in return for the payment. This payment satisfied the Taxpayer’s rights under the Agreement. All of the payments received by the Taxpayer are a reward for the services that the Taxpayer provides to the Company and to the related business because the Taxpayer is receiving them as an employee of the Company. Therefore, the payment is assessable under either section 6-5 or 15-2 of the ITAA 1997. Note that much of the case law refers to provisions that have been re-written, so section 25 of the ITAA 1936 was re-written as section 6-5 of the ITAA 1997, and paragraph 26(e) of the ITAA 1936 was re-written as section 15-2 of the ITAA 1997.