Private ruling: Employee share scheme - ESS deferred taxing point
Date of advice: 28 May 2020
Published: July 2020
Ruling period: Income year ended 30 June 20YY
Date scheme commenced: 1 July 20YY

Ruling: Q1: Is the deferred taxing point under section 83A-120 of the Income Tax Assessment Act 1997 (ITAA 1997) for options granted on XX 20YY, the ZZ 20YY when the disposal restrictions on the underlying shares lifted? | A1: Yes. The deferred taxing point under section 83A-120 of the ITAA 1997 for options granted in XX 20YY is the ZZ 20YY when the disposal restrictions on the underlying shares lifted. | Q2: Is the deferred taxing point under section 83A-120 of the ITAA 1997 for performance rights granted on XX 20YY, the ZZ 20YY when the disposal restrictions on the underlying shares lifted? | A2: Yes. The deferred taxing point under section 83A-120 of the ITAA 1997 for performance rights granted on XX 20YY is the ZZ 20YY when the disposal restrictions on the underlying shares lifted.

Relevant facts and circumstances: While the Taxpayer was an employee of Company A, they participated in an employee share schemes (ESS) offered by Company A. The Taxpayer is an Australian tax resident at all relevant times. The Taxpayer does not hold a beneficial interest in 10% of the shares in Company A nor are they able to influence 10% of the votes that may be cast at a general meeting of shareholders. This 10% takes into account and includes any shares and any voting rights that the Taxpayer would have by exercising any rights they have over the shares and the holdings of their associates. The options and performance rights were both granted after 1 July 2015. On XX 20YY the Taxpayer was granted options ("Options") under the following terms: · The Options vest on XX 20YY (Vesting Date A) and will become exercisable on that date. · Where the Taxpayer ceases employment prior to vesting the Options will be forfeited. · The Shares received on exercise of the Options will be subject to the escrow condition outlined below. · The escrow condition, the Taxpayer is not permitted to sell, assign, transfer or otherwise deal with the shares received upon exercise of the Options until YY 20YY. On XX 20YY the Taxpayer was granted performance rights ("Performance Rights") under the following terms: · Where the Taxpayer ceases employment prior to vesting and is not regarded as a 'Good Leaver' the Performance Rights will be forfeited. · The Performance Rights vested on XX 20YY (Vesting Date B) and a corresponding number of shares were delivered to the Taxpayer. The Company A operates a share trading policy under which the Taxpayer is not able to trade unless the following conditions are met: 1. The proposed trade does not fall within a Prohibited Period (as defined in the policy). 2. The Taxpayer must provide confirmation that they are not in possession of 'Inside Information'. The Company A's share trading policy has been in effect for the relevant period. The Taxpayer provided a statement to the Commissioner that states, at the time the escrow condition lifted on the Options, the Taxpayer was in possession of Inside Information and therefore continued to be subject to a restriction in respect of the shares. In addition at the time the Performance Rights vested and the Taxpayer received the corresponding shares, the Taxpayer was in possession of Inside Information and therefore continued to be subject to a restriction in respect of the shares. The Taxpayer continued to be restricted from trading by the operation of the share trading policy until ZZ 20YY.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 83A.

Reasons for decision: Summary: The deferred taxing point under section 83A-120 for options granted on XX 20YY, is ZZ 20YY when the disposal restrictions on the underlying shares lifted. | Summary: The deferred taxing point under section 83A-120 for performance rights granted on XX 20YY, is ZZ 20YY when the disposal restrictions on the underlying shares lifted. | Detailed Reasoning - Detailed reasoning: The employee share scheme (ESS) provisions are contained in Division 83A. For the purposes of Division 83A, an ESS interest in a company is defined under subsection 83A-10(1) as a beneficial interest in: a) a share in the company; or b) a right to acquire a beneficial interest in a share in the company. 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, of the company, or subsidiaries of the company, in relation to the employees' employment. In summary, the ESS provisions recognise the dual nature of ESS interests as both a component of an employee's remuneration package and also as an ongoing investment. The ESS provisions provide a mechanism for recognising an appropriate value for remuneration purposes and an adjustment to the purchase price for investment purposes to reflect the amount treated as remuneration. The employee share scheme provisions achieve this outcome by determining: · When the Employee needs to include any discount received in relation to ESS interests in their assessable income, and · The amount of the discount. | Detailed Reasoning - Subdivision 83A-C: Under Subdivision 83A-B the Employee is generally assessed on the discount in the year that an ESS interest is acquired. However, subdivision 83A-C provides that where certain conditions are satisfied, the discount in relation to an ESS interest is not included in the Employee's assessable income when they acquire the ESS interest under Subdivision 83A-B. Instead, under section 83A-110, the assessable income of the Employee will include the market value of the ESS interest at the ESS deferred taxing point reduced by the cost base of the ESS interest. The conditions to be satisfied to be eligible for the deferred taxing point are listed in subsection 83A-105(1) and summarised as follows: · subdivision 83A-B would, but for section 83A-105, have applied to the ESS interest · paragraphs (aa) and (ab) of subsection 83A-105(1) must be satisfied · the employee is an employee of the company issuing the ESS interest, or a subsidiary of the company, at the time they acquire the ESS interest · all ESS interests available under the scheme must relate to ordinary shares in the company · immediately after the ESS interest is acquired, the employee will not hold a beneficial interest in greater than 10% of the company's shares on issue, or be in a position to control the casting of greater than 10% of the votes that might be cast at a general meeting of the company (taking into account and including any shares and any voting rights that they would have by exercising any rights they have over shares (subsection 83A-45(7)) and the holdings of their associates (83A-305(2)) · the predominant business of the company, in which the ESS interests are acquired, is not the acquisition, sale or holding of shares, securities or other investments (directly or indirectly) or, if it is, the employee is not employed by the company and also a subsidiary or holding company of the company, or a subsidiary of the holding company, and · When the taxpayer acquires the interest either: - there is a real risk that under the conditions of the scheme they will forfeit or lose the interest (other than by disposing of it, exercising the right or letting the right lapse) or forfeit or lose the beneficial interest in the share (other than by disposing of it); or - the scheme genuinely restricted the taxpayer from immediately disposing of the right and the governing rules of the scheme expressly stated that subdivision 83A-C applies to the scheme. | Detailed Reasoning - ESS deferred taxing point: Section 83A-120 applies if the ESS interest is a beneficial interest in a right to acquire a beneficial interest in a share. The deferred taxing point for the ESS interest is the earliest of the times mentioned in subsections 83A-120(4) to (7) of the ITAA 1997, summarised below: · When the ESS interest has not been exercised, there is no real risk of forfeiting the ESS interest, and the scheme no longer genuinely restricts disposal of the ESS interest (subsection 83A-120(4)) · When the Employee ceases the relevant employment (subsection 83A-120(5)) · The end of the 15 year period starting when the Employee acquired the ESS interest (subsection 83A-120(6)) · When the ESS interest is exercised and there is no real risk of forfeiting the share and the scheme no longer genuinely restricts disposal of the share (subsection 83A-120(7)) Subsection 83A-120(7) of the ITAA 1997, provides as follows: The 4th possible taxing point is the earliest time when: (a) you exercise the right; and (c) there is no real risk that, under the conditions of the scheme, after exercising the right, you will forfeit or lose the beneficial interest in the share (other than by disposing of it); and (d) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately disposing of the beneficial interest in the share if you exercised the right-the scheme no longer so restricts you. | Detailed Reasoning - Genuine restriction of disposal of shares: The phrase 'genuinely restricts' is not defined in the legislation. However the Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 (the EM), which introduced Division 83A, outlines a number of key principles: · If disposal of an ESS interest would be a criminal offence, for example under a law regulating insider trading, then the employee would be considered genuinely restricted from disposing of the share. · A company's internal share trading policy is only considered to be a restriction preventing disposal for the purposes of deferring the taxing point if the penalty for breaking the policy constitutes an effective sanction. · A restriction that otherwise meets the conditions for a genuine restriction, but is able to be lifted in cases of severe financial hardship, is nonetheless considered to be a genuine restriction. · Restrictions preventing disposal are considered to be lifted once an opportunity arises in which an Employee can realise the share. · In the case of a trading window, or restrictions that may lift and then re-engage, if the employee does not avail themselves of the opportunity to dispose of the share and the window subsequently closes, there is no further delay in the taxing point. The taxing point would still be at the commencement of the first trading window. · A genuine restriction should not be open to manipulation, for example requiring the employee to apply for approval before trading (giving the employee a choice regarding whether and when to apply for approval). However, the ESS deferred taxing point for the interest is the time the taxpayer disposes of the interest (other than by exercising the right) or the beneficial interest in the share if that time occurs within 30 days after the time worked out above: subsection 83A-120(3). | Detailed Reasoning - Amount included in assessable income: Under section 83A-110, the amount to be included as assessable income, in the income year in which the ESS deferred taxing point occurs, is the market value of the ESS interest at the ESS deferred taxing point, reduced by the cost base of the ESS interest. | Detailed Reasoning - Application to the circumstance: Subdivision 83A-C applies to the Options and the Performance Rights as the conditions in 83A-105(1) are met, as follows: · The Options and Performance Rights are ESS interests - being rights to acquire beneficial interests in shares in a company · The relationship between the Taxpayer, Company A and the grants of Options and Performance Rights constitute an employee share scheme · The Options and Performance Rights were granted at a discount to their market value (calculated as at the date of grant) · The conditions in paragraphs 83A-105(1)(aa) and (ab) are met. · The conditions in 83A-45(1),(2),(3) and (6) are met; · There is a real risk under the conditions of the schemes that the taxpayer will forfeit or lose the ESS interest. As Subdivision 83A-C applies to the Options and Performance Rights, the discount received in relation to the Options and Performance Rights will be included in the assessable income of a the Taxpayer under subsection 83A-110(1) in the income year when an ESS deferred taxing point happens to the ESS interest. When determining the deferred taxing point for the Options and Performance Rights, the facts of the Taxpayers situation are such that section 83A-120 applies to the Taxpayer in the following manner: - Subsection 83A-120(4) will not apply to the ESS interests as the Taxpayer was restricted from transferring the Options and Performance Rights until they are exercised - Subsection 83A-120(5) will not apply to the ESS interests as the Taxpayer is a continuing employee of Company A - Subsection 83A-120(6) will not apply to the ESS interests as the Options and Performance Rights were granted less than fifteen years ago respectively The first three possible deferred taxing points have not occurred for either the Options or the Performance Rights. Therefore we will be considering the fourth possible deferred taxing point contained in subsection 83A-120(7). Options In regards to the Options granted to the Taxpayer on XX 20YY, the first two conditions within the fourth possible deferred taxing point (83A-120(7)) were met on XX 20YY (Vesting Date A) when the Options vested and Company A shares were issued. We then need to consider condition (d) within the fourth possible taxing point to determine what is the earliest time when the scheme no longer genuinely restricts the Taxpayer from immediately disposing of their beneficial interest in the shares (after XX 20YY (Vesting Date A)). In regards to the Options, under the escrow condition, the Taxpayer is not permitted to sell, assign, transfer or otherwise deal with the shares received upon exercise of the Options until YY 20YY. The escrow conditions are a genuine disposal restriction. The Taxpayer is also restricted from disposing of the Company A shares under the Companies Securities Trading Policy. Under the Policy, the Taxpayer is prohibited from dealing in Company Securities if they possess any Inside Information. The Taxpayer provided us with material that stated they held information that would be considered Inside Information under Company A's Securities Trading Policy. There were also applicable prohibited trading periods under the trading policy. The Taxpayer provided us with material that stated they held Inside Information for the whole of the period from YY 20YY until a date during a Prohibited Period under the trading policy that ended on ZZ 20YY. In accordance with the EM the Taxpayer holding Inside Information, and a genuinely enforced prohibited trading period, are genuine restrictions preventing the disposal of Company A shares by the Taxpayer. The Taxpayer was genuinely restricted from disposing of the shares issued under the Options in the Company from the XX 20YY (Vesting Date A) until ZZ 20YY. Therefore, the deferred taxing point under section 83A-120 of the ITAA 1997 for the options granted on XX 20YY is ZZ 20YY when the disposal restrictions on the underlying shares lifted. Performance Rights In regards to the Performance Rights granted to the Taxpayer on the XX 20YY, the first two conditions within the fourth possible deferred taxing point were met from XX 20YY (Vesting Date B) when the Performance Rights vested and the Company A shares were issued. We then need to consider option (d) within the fourth possible taxing point to determine what is the earliest time when the scheme no longer genuinely restricts the Taxpayer from immediately disposing of his beneficial interest in the shares (after XX 20YY (Vesting Date B)). The Taxpayer provided us with material that stated they held Inside Information for the whole of the period from XX 20YY (Vesting Date B) (the earliest date at which the shares could have been disposed of) until a date during a Prohibited Period under the trading policy that ended on ZZ 20YY. In accordance with the EM the Taxpayer holding Inside Information, and a genuinely enforced prohibited trading period, are genuine restrictions preventing the disposal of the Company shares by the Taxpayer. The Taxpayer was genuinely restricted from disposing of the shares issued under the Performance Rights in the Company from the XX 20YY (Vesting Date B) until ZZ 20YY. Therefore, the deferred taxing point under section 83A-120 of the ITAA 1997 for Performance Rights granted on XX 20YY is ZZ 20YY when the disposal restrictions on the underlying shares lifted.