Private ruling: Acquisition and exercise of options under a scheme
Date of advice: 8 October 2019
Published: November 2019
Ruling period: 1 July 2019 to 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: Are the returns of partnership monies from the Partnership to you, which are applied to: · purchase the Options, and · exercise the Options part of the net income of the trust estate, by virtue of it being assessable as ordinary or statutory income under sections 6-5 and 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is the issuing of the Options to you assessable as ordinary or statutory income under sections 6-5 and 6-10 of the ITAA 1997? | A2: No. | Q3: Will the first element of your CGT cost base and reduced cost base of each Option acquired be equal to the Subscription Price for the Options in accordance with sections 110-25 and 110-55 of the ITAA 1997 respectively? | A3: Yes. | Q4: Will any capital gain or capital loss made by you from exercising the Options be disregarded in accordance with subsection 134-1(4) of the ITAA 1997? | A4: Yes. | Q5: To the extent that the Options expire before they are exercised, will you make a capital loss equal to the Subscription Price upon expiry of the Options in accordance with subsection 104-25(3) of the ITAA 1997? | A5: Yes. | Q6: If the resolution to vary the Partnership Agreement is approved, will the implementation of the fee variations by the Partnership give rise to a capital gain or loss for you under section 104-155 of the ITAA 1997? | A6: No. | Q7: If the Options are exercised, will the first element of your cost base and reduced cost base of each Security acquired be equal to the total of the Subscription Price and the Exercise Price for the Options in accordance with Item 1 of subsection 134-1(1) of the ITAA 1997? | A7: Yes. | Q8: If the Options are exercised, will you be taken to have acquired your Securities at the time the Options are exercised in accordance with section 109-10 of the ITAA 1997? | A8: Yes.

Relevant facts and circumstances: Background 1. You are acting in your capacity as trustees of the Trust, an Australian discretionary trust, which is an Australian resident trust. 2. You are a member of the Partnership, an Australian tax law partnership which operates as a managed investment scheme. 3. You hold your interest in the rights provided by the Partnership on capital account and do not hold them as an item of trading stock in accordance with Division 70 of the ITAA 1997. 4. You are not subject to the Taxation of Financial Arrangements (TOFA) rules in Division 230 of the ITAA 1997 in relation to financial arrangements under the scheme. 5. The Partnership's operation is governed by the Partnership Agreement. 6. The Partnership is managed by the Manager. 7. The Trustee holds the Partnership's property on trust as bare trustee for the members of the Partnership. 8. As part of a scheme you are entitled to participate in the Offer The Offer 9. Under the Offer, you will be entitled to purchase Options. The number of Options that you are entitled to purchase is calculated by reference to the value of your investment in the Partnership. 10. You will receive an Option Application and Investor Details Form which you are required to sign and return in order to receive the Options. 11. In order to fund the purchase of the Options, the Partnership will make a return of monies to you equal to the Subscription Price of the Options. In addition, on receiving notice that the exercise conditions for the Options have been satisfied, the Partnership will make a further return of monies to you equal to the Exercise Price of the Options. 12. If you accept the Offer, by signing the Option Application and Investor Details Form, the return of corpus will be automatically applied by the Partnership to acquire the Options. 13. If you do not accept the Offer, the return of monies will be paid to you as a cash distribution. 14. The Options will be issued pursuant to the Option Agreement, which has the following terms: (i) Each Option will be issued at the Subscription Price. (ii) Each Option will have an Exercise Price. (iii) Each Option entitles the holder to subscribe for one Security. (iv) The Options are not able to be sold, assigned, transferred or otherwise disposed of. Furthermore, the holders cannot enter into any other option over the Options or create a security or other interest or right over the Options. (v) The Options will expire at the Expiry Time. (vi) The Options will automatically exercise on satisfaction of specified conditions prior to the Expiry Time. (vii) On receiving notice that the above conditions have been satisfied, the Exercise Price of must be paid, unless you have authorised the Manager to withhold the Exercise Price from a further return of monies in respect of your interest in the Partnership. (viii) You will be issued with the Securities. The variation of the Partnership Agreement 15. As part of this scheme, you will also be invited to vote on a resolution to vary the Partnership Agreement. 16. The variation will involve increasing the fees payable by the Partnership to the Manager and extending the term of the Partnership. 17. You are not entitled to receive any money or other consideration and you will not incur any incidental expenses in relation to the variation of the Partnership Agreement. Assumptions 1. You will sign and return the Option Application and Investor Details Form in order to receive the Options. 2. You will authorise the Manager to withhold the Exercise Price from a return of monies in respect of your interest in the Partnership and provide it to satisfy the payment requirements upon exercise of the Options. 3. You will hold your Securities on capital account and will not hold them as an item of trading stock in accordance with Division 70 of the ITAA 1997.

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 104-155 | Income Tax Assessment Act 1997 subsection 104-25(3) | Income Tax Assessment Act 1997 section 109-10 | Income Tax Assessment Act 1997 section 110-25 | Income Tax Assessment Act 1997 section 110-55 | Income Tax Assessment Act 1997 subsection 134-1(1) | Income Tax Assessment Act 1997 subsection 134-1(4)

Reasons for decision: Detailed Reasoning - Detailed reasoning: The net income of a trust estate for a particular year is calculated in accordance with section 95 of the Income Tax Assessment Act 1936 (ITAA 1936). Broadly, it is the amount that would have been the trustee's taxable income if it were assumed that the trustee was a resident taxpayer. As such, in determining the net income of the trust estate consideration must be made to the provisions of the ITAA 1997 and the ITAA 1936. | Detailed Reasoning - Amounts from a partnership not included in assessable income: Subsection 6-5(1) provides that your assessable income includes income according to ordinary concepts, which is called ordinary income. In working out whether you have derived an amount of ordinary income, subsection 6-5(4) provides that you are taken to have received the amount as soon as it is applied or dealt with on your behalf or as you direct. In Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 10 AITR 367; (1966) 14 ATD 286, Windeyer J stated at CRR 526, AITR 375; ATD 293 that: Whether or not a particular receipt is income depends upon its quality in the hands of the recipient. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1, the High Court unanimously stated that the following factors were important in determining the nature of a receipt: To determine whether a receipt is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts 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. Consideration The Partnership's distributions of monies to you, which were applied or dealt with on your behalf to acquire and exercise the Options, were the distribution of an asset that was already held by you as a member of the Partnership. They do not have the quality of income in your hands. Therefore, they are not ordinary income under subsection 6-5(1). | Detailed Reasoning - Statutory income - partnership: Subsection 6-10(1) includes amounts that are not ordinary income as your assessable income where those amounts are included by statutory provisions about assessable income. Subsection 92(1) of the ITAA 1936 states that: The assessable income of a partner in a partnership shall include: (a) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident; and (b) so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was not a resident and is also attributable to sources in Australia. Subsection 102-5(1) includes net capital gains made under Chapter 3 in your assessable income. Subsection 106-5(1) specifically applies in relation to CGT events for partnerships: Any capital gain or capital loss from a CGT event happening in relation to a partnership or one of its CGT assets is made by the partners individually. Each partner's gain or loss is calculated by reference to the partnership agreement, or partnership law if there is no agreement. Consideration The Partnership's distributions of monies to you, which were applied or dealt with on your behalf to acquire and exercise the Options, were distributions of assets that were already held by you as a member of the Partnership. They do not represent an amount of the net income of the partnership. Therefore, they are not assessable to you as partnership income under subsection 92(1) of the ITAA 1936. In addition, upon the payment to you of the monies, no CGT event occurs to an asset that you hold as a partner in the Partnership. Furthermore, according to Taxation Determination TD 2002/25 Income tax: capital gains: is Australian currency a CGT asset under section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) if it is used as legal tender to facilitate a transaction? (TD 2002/25), the cash paid to you is not a CGT asset under section 108-5 as it is used as legal tender to facilitate a transaction. In these circumstances, the provision to you of Australian currency, which is subsequently applied to purchase and exercise the Options, serves as a medium of exchange and no capital gain or capital loss arises from its use as legal tender. | Detailed Reasoning - Conclusion: The return of monies by the Partnership manager, which is applied on your behalf to acquire and exercise the Options, is not assessable as ordinary income under section 6-5. Furthermore it is not assessable as statutory income under section 6-10. | Detailed Reasoning - Question 2: Is the issuing of the Options to you assessable as ordinary or statutory income under sections 6-5 and 6-10? | Detailed Reasoning - Ordinary income: Subsection 6-5(1) provides that a taxpayer's assessable income includes income according to ordinary concepts (ordinary income) as is set out above. Consideration Whilst you receive something of value (the Options), their acquisition will not be ordinary income for you as you will have paid to receive the Options, as funded by the return of monies by the Partnership. | Detailed Reasoning - Statutory income: Subsection 6-10(1) includes amounts that are not ordinary income as your assessable income where those amounts are included by statutory provisions about assessable income. Subsection 102-5(1) includes net capital gains made under Parts 3-1 and 3-3 in your assessable income. Relevantly, there are a number of CGT events that could apply to when you receive the Options. CGT event C3 Subsection 104-30(1) states that CGT event C3 occurs if an option a company or a trustee of a trust granted to an entity to acquire shares in the company, units in the trust or debentures in the company or trust ends. CGT event D1 Subsection 104-35(1) states that CGT event D1 occurs if you create a contractual right or other legal or equitable right in another entity. CGT event D1 will be excluded from happening in certain circumstances as outlined relevantly in paragraphs 104-35(5)(e) and 104-35(5)(f) which state: CGT event D1 does not happen if: ... (e) a company grants an option to acquire equity interests, non-equity shares or *debentures in the company; or (f) the trustee of a unit trust grants an option to acquire units or debentures in the trust; or ... CGT event D2 Subsection 104-40(1) states that CGT event D2 occurs if you grant an option to an entity, or renew or extend an option you had already granted. CGT event D2 is specifically excluded from occurring by subsection 104-40(6), which states: This section does not apply to an option granted, renewed or extended by a company or the trustee of a unit trust to acquire a CGT asset that is: (a) shares in the company or units in the unit trust; or (b) debentures of the company or unit trust. CGT event H2 Subsection 104-155(1) states that CGT event H2 happens if: (a) an act, transaction or event occurs in relation to a CGT asset that you own; and (b) the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base. You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred that relate to the event. You make a capital loss if those capital proceeds are less (subsection 104-155(3)). According to subsection 104-155(5), CGT event H2 will not happen if: (e) a company grants an option to acquire equity interests, non-equity shares or debentures in the company; or ... (f) the trustee of a unit trust grants an option to acquire units or debentures in the trust; ... Consideration The issuing of the Options will not result in assessable statutory income under the CGT provisions to you as, relevantly: · CGT event C3 will not happen at the time that the Options are issued, but rather at the time when they expire (being the Expiry time) according to subsection 104-30(2). · CGT event D1 will not happen due to the exclusions in paragraphs 104-35(5)(e) and 104-35(5)(f). · CGT event D2 is specifically excluded from occurring by subsection 104-40(6). · CGT event H2 will not happen due to the similar exclusions in paragraphs 104-155(5)(e) and 104-155(5)(f). | Detailed Reasoning - Conclusion: The issuing of the Options, which occurs when the return of monies is applied on your behalf, does not give rise to an amount of ordinary or statutory income. | Detailed Reasoning - Question 3: Will the first element of your CGT cost base and reduced cost base of each Option acquired be equal to the Subscription Price for the Options in accordance with sections 110-25 and 110-55? | Detailed Reasoning - Detailed reasoning: Subsection 110-25(2) states that the first element of the cost base of a CGT asset is the total of: (a) the money you paid, or are required to pay, in respect of acquiring it, and (b) the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out at the time of the acquisition). Subsection 110-55(2) states that all of the elements (except the third one) of the reduced cost base of a CGT asset are the same as those for the cost base. As such, the first element of the cost base and reduced cost base of a CGT asset will be the same. In relation to the Options you acquired you paid the Subscription Price. This payment was met by the return of monies by the Partnership, which would have otherwise been paid to you in cash, had you not accepted the Offer. As such, the first element of your CGT cost base and reduced cost base for each Option you acquired is the Subscription Price. | Detailed Reasoning - Question 4: Will any capital gain or capital loss made by you from exercising the Options be disregarded in accordance with subsection 134-1(4)? | Detailed Reasoning - Detailed reasoning: At the time you exercise the Options, CGT event C2 (about a CGT asset ending) happens in relation to the Options (section 104-40). However, subsection 134-1(4) states: A capital gain or capital loss the grantee makes from exercising the option is disregarded. However, this rule does not apply if the grantee acquired the option under a trust restructure (see Subdivision 124-N) and, on exercising the option, held the resulting asset as an item of trading stock. As you did not acquire the Options under a trust restructure any capital gain or capital loss you make from exercising the Options is disregarded. | Detailed Reasoning - Question 5: To the extent that the Options expire before they are exercised, will you make a capital loss equal to the Subscription Price upon expiry of the Options in accordance with subsection 104-25(3)? | Detailed Reasoning - Detailed reasoning: CGT event C2 occurs for you under paragraph 104-25(1)(c) at the time that the Options expire. According to subsection 104-25(2), the time of the event will be when the Options end, which is at the Expiry Time. Subsection 104-25(3) details whether you make a capital gain or capital loss upon the event: You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. You will not receive any capital proceeds upon the Options expiring. The first element of your CGT cost base and reduced cost base for each Option you acquired is the Subscription Price, as established above. As such, based upon the assumption that none of the other cost base elements will be applicable to you, upon expiry of the Options you will make a capital loss equal to the Subscription Price. | Detailed Reasoning - Question 6: If the resolution to vary the Partnership Agreement is approved, will the implementation of the fee variations by the Partnership give rise to a capital gain or loss for you under section 104-155? | Detailed Reasoning - Detailed reasoning: Subsection 104-155(1) states that CGT event H2 happens if: (a) an act, transaction or event occurs in relation to a CGT asset that you own; and (b) the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base. Paragraphs 108-5(2)(c) and (d) provide that an interest in an asset of a partnership and an interest in a partnership that is not covered by paragraph (c) are both CGT assets. When the fee variations are implemented by amending the Partnership Agreement an act, transaction or event occurs in relation to your interest in the Partnership, which is a CGT asset that you own. When the fee variations are implemented by amending the Partnership Agreement the cost base or reduced cost base of your interest in the partnership is not adjusted. As the requirements in subsection 104-155(1) are satisfied, CGT event H2 happens. You make a capital gain if the capital proceeds because of the CGT event are more than the incidental costs you incurred that relate to the event. You make a capital loss if those capital proceeds are less (subsection 104-155(2)). The table in subsection 116-20(2) states that the capital proceeds for CGT event H2 are: The money, or other consideration you received, or are entitled to receive, because of the act, transaction or event. You are not entitled to receive any money or other consideration and you will not incur any incidental expenses in relation to the variation of the Partnership Agreement. You will, therefore, not receive any capital proceeds because of CGT event H2 and will not have any incidental costs. As such, you will not make a capital gain or capital loss upon the implementation of the fee variations by the Partnership. | Detailed Reasoning - Question 7: If the Options are exercised, will the first element of your cost base and reduced cost base of each Security acquired be equal to the total of the Subscription Price and the Exercise Price for the Options in accordance with Item 1 of subsection 134-1(1)? | Detailed Reasoning - Detailed reasoning: Item 1 in the table in subsection 134-1(1) sets out the effects of the exercise of an option on the first element of the cost base and reduced cost base of the asset acquired for the grantee of the option. It provides that where a grantor creates (including grants or issues) a CGT asset the first element of the cost base and reduced cost base for the CGT asset for the grantee will be what the grantee paid for the option (or to renew or extend it) plus any amount the grantee paid to exercise it. Upon exercise of the option you will receive Securities. The cost base and reduced cost base of the Securities will, therefore be the total of what you paid for the option (being the Subscription Price which was funded via the first return of monies by the Partnership) plus any amount you paid to exercise the option (being the Exercise Price which was funded by the second return of monies by the Partnership). | Detailed Reasoning - Question 8: If the Options are exercised, will you be taken to have acquired your Securities at the time the Options are exercised in accordance with section 109-10? | Detailed Reasoning - Detailed reasoning: You acquired your Securities at the Issue Date, when the Manager procured the company to issue you with shares and the responsible entity of the trust to issue you with units. The table in section 109-10 sets out specific rules when a CGT asset is acquired otherwise than as a result of a CGT event happening. In particular, Items 2 and 3 in the table state: | Detailed Reasoning - You acquire the asset at this time:: ........... 2 A company issues or allots *equity interests or *non-equity shares in the company to you when contract is entered into or, if none, when equity interests or non-equity shares issued or allotted ........... 3 A trustee of a unit trust issues units in the trust to you when contract is entered into or, if none, when units issued Based upon the above table, you will, therefore, be taken to have acquired the Securities at the time when the contract was entered into to bring about the relevant acquisitions. In accordance with the decision in Van v FC of T [2002] AATA 1313, (2002) 51 ATR 1153, 2002 ATC 2325, the date you will be taken to have acquired the Securities is the date that the Options are exercised.

Reasons for decision: All legislative references are to the ITAA 1997 unless specified otherwise.