Private ruling: Employee share plan
Published: December 2011
Ruling period: Year ending 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2009

Ruling: Question and answer | 1. Will the employee include the shares they acquire as assessable income? | No. | 2. Will the loan constitute a dividend? | Yes. | 3. Will the employee be required to include an amount in the employee's assessable income in respect of the loan; | a. For the year of income during which the shares are acquired | No. | b. For any other year of income during which the loan is outstanding | No. | 4. When a dividend is paid on the shares out of the Company's profits, and is applied towards repayment of the loan, will the employee's assessable income include the dividend? | Yes. | 5. When an amount of salary or bonus, after deducting applicable PAYG is applied towards repayment of the loan, will this attract further income tax? | No. | 6. If the shares are repurchased from the employee for the shares' original acquisition price as a result of the employee ceasing employment before the end of 2 years after acquiring the shares; | a. If the Company buys back the shares (and funds the buy back solely from share capital) will the employee make a capital gain? | Yes. | b. If some other person or entity purchases the shares, will the employee make a capital gain? | No. | 7. If the employee sells the shares more than 12 months after acquisition for a capital gain, will the capital gain be a discount capital gain? | Yes. | 8. When a franked distribution is made to the employee as a shareholder, will the employee be entitled to a tax offset under Division 207 of Part 3-5 of the Income Tax Assessment Act 1997? | Yes . | 9. If the shares are repurchased from the employee upon ceasing employment before the end of 2 years after acquiring the shares, or as a bad leaver, in full and final satisfaction of the loan balance at a time when the value of the shares is less than the amount of the loan balance: | a. Will there be an adjustment to the tax attributes of the employee pursuant to Division 245 of Part 3-10 of the Income Tax Assessment Act 1997? | No | b. Will there be forgiveness of a debt pursuant to Division 7A of Part III of the Income Tax Assessment Act 1936? | No


Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 15-2(3)(e) | Income Tax Assessment Act 1997 section 15-2(3)(d) | Income Tax Assessment Act 1997 Division 83A | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 245-35 | Income Tax Assessment Act 1997 section 245-60 | Income Tax Assessment Act 1997 section 245-65 | Income Tax Assessment Act 1997 section 245-75 | Income Tax Assessment Act 1936 subsection 109C(4). | Income Tax Assessment Act 1936 section 109Y. | Income Tax Assessment Act 1936 paragraph 159GZZZM(a). | Income Tax Assessment Act 1936 subsection 159GZZZP(1). | Income Tax Assessment Act 1936 subsection 159GZZZQ(1). | Income Tax Assessment Act 1936 subsection 159GZZZQ(2). | Income Tax Assessment Act 1936 section 159GZZZQ.

Reasons for decision: Detailed Reasoning - Will the employee include the shares they acquire as assessable income?: Your assessable income includes income according to ordinary concepts, which is called ordinary income. If you are an Australian resident, your assessable income includes the ordinary income you derived directly or indirectly from all sources, whether in or out of Australia, during the income year. In working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct. Division 83A of the ITAA 1997 states that your assessable income for the income year in which you acquire an employee share scheme interest includes the discount given in relation to the interest. In your situation the shares are acquired for their market value and are not acquired at a discount, therefore, an amount will not be included as assessable income. | Detailed Reasoning - Will the loan constitute a dividend?: Under subsection 109D(1) of the ITAA 1936 an amount lent by a private company to a shareholder during the current year is taken to be a dividend for the purposes of Division 7A if the loan is not fully repaid before the private company's lodgement day for that income year, and Subdivision D of Division 7A of the ITAA 1936 does not otherwise prevent the private company from being taken to have paid a dividend to the shareholder. Under subsection 109D(1AA) of the ITAA 1936 the amount of the dividend taken to have been paid is the amount of the loan that has not been repaid before the private company's lodgement day for the current year, subject to section 109Y of the ITAA 1936. Section 109Y of the ITAA 1936 limits the total amount of dividends taken to have been paid by the private company under Division 7A of the ITAA 1936 to the company's distributable surplus as at the end of its year of income. In your case the private company has made a loan to you (the shareholder) which is taken to be a dividend under section 109D of the ITAA 1936, and the amount of the dividend is reduced to nil because the company will have a nil distributable surplus. | Detailed Reasoning - d. For any other year of income during which the loan is outstanding: As the loan made to you by the company is considered to be a dividend with a value of nil it will not be included as assessable income in the year they were acquired or any other year that the loan is outstanding. When a dividend is paid on the shares out of the Company's profits, and is applied towards repayment of the loan, will the employee's assessable income include the dividend? Under section 44(1) of the ITAA 1936 the assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes: (a) if the shareholder is a resident: (i) dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and (ii) all non-share dividends paid to the shareholder by the company. Therefore, a dividend paid on shares from the company's profits which is applied towards repayment of the loan will be included in your assessable income. The fact that the dividend is applied to the loan does not change it being considered assessable income as section 6-5 of the ITAA 1997 provides that you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct. | Detailed Reasoning - When an amount of salary or bonus, after deducting applicable PAYG is applied towards repayment of the loan, will this attract further income tax?: Your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you (including any service as a member of the Defence Force). This is so whether the things were provided in money or in any other form. However, the value of the following are not included in your assessable income under this section: (a) a superannuation lump sum or an employment termination payment; (b) an unused annual leave payment or an unused long service leave payment; (c) a dividend or non-share dividend; (d) an amount that is assessable as ordinary income under section 6-5; (e) ESS interests to which Subdivision 83A-B or 83A-C (about employee share schemes) applies. In your case your salary or bonuses are taxed as ordinary income through PAYG and will not be taxed again when applied towards repayment of the loan. If the shares are repurchased from the employee for the shares' original acquisition price as a result of the employee ceasing employment before the end of 2 years after acquiring the shares; | Detailed Reasoning - c. If the Company buys back the shares (and funds the buy back solely from share capital) will the employee make a capital gain?: Under section 159GZZZK of the ITAA 1936, where a company buys a share in itself from a shareholder in the company (a share buy-back), the share is not a share that is listed on a stock exchange and the buy-back is not made in the ordinary course of trading on that stock exchange, the buy-back is an off-market purchase. In this case, shares sold to the company will not be listed on the stock exchange, therefore the buy-back by the company will be an off-market purchase. Under paragraph 159GZZZM(a) of the ITAA 1936, the purchase price in respect of a buy-back is, if the seller as a shareholder has received or is entitled to receive an amount or amounts of money as a result of or in respect of the buy-back, that amount or the sum of those amounts. Under subsection 159GZZZP(1) of the ITAA 1936, where a buy-back of a share is an off-market purchase, the difference between the purchase price and the part (if any) of the purchase price which is debited against amounts standing to the credit of the company's share capital account, is a dividend. The dividend is taken to be paid by the company to the seller in the company out of profits derived by the company on the day the buy-back occurs. The dividend is required to be included in the seller's assessable income under section 44 of the ITAA 1936. Subsection 159GZZZQ(1) of the ITAA 1936 provides that the buy-back price of the share is, for general income tax and capital gains tax purposes, the amount actually received. If the full purchase price is less than the share's market value, the market value is used as the disposal consideration (subsection 159GZZZQ(2) of the ITAA 1936). The consideration per share represents the capital proceeds for CGT purposes under section 116-20 of the ITAA 1997. A participating shareholder will make a capital gain on a share if the consideration per share exceeds the cost base of that share. The capital gain is the amount of the excess (subsection 104-10(4) of the ITAA 1997). A participating shareholder will make a capital loss if the consideration per share is less than the reduced cost base of the share. The capital loss is the amount of the difference (subsection 104-10(4) of the ITAA 1997). The shares are taken to have been disposed of for CGT purposes on the buy-back contract date under subsection 104-10(3) of the ITAA 1997. | Detailed Reasoning - d. If some other person or entity purchases the shares, will the employee make a capital gain?: As the employee and the Company will deal with each other at arms length in connection with the event the usual market value substitution rule will not apply. Since the market value of the shares at the time equals the acquisition price, the deemed capital proceeds (the acquisition price) will equal the shares' cost base (the acquisition price), and no capital gain or loss will arise. | Detailed Reasoning - If the employee sells the shares more than 12 months after acquisition for a capital gain, will the capital gain be a discount capital gain?: To be a discount capital gain, the capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event. The Employee Share Ownership Plan requires employees to hold their shares for two years before they can be sold except in the case of a liquidity event. If a liquidity event occurs more than 12 months after acquisition then the capital gain will be a discount capital gain. When a franked distribution is made to the employee as a shareholder, will the employee be entitled to a tax offset under Division 207 of Part 3-5 of the Income Tax Assessment Act 1997? If an entity makes a franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the franking credit on the distribution. This is in addition to any other amount included in the receiving entity's assessable income in relation to the distribution under any other provision of this Act. The receiving entity is entitled to a tax offset for the income year in which the distribution is made. The tax offset is equal to the franking credit on the distribution. If the shares are repurchased from the employee upon ceasing employment before the end of 2 years after acquiring the shares, or as a bad leaver, in full and final satisfaction of the loan balance at a time when the value of the shares is less than the amount of the loan balance: | Detailed Reasoning - Will there be an adjustment to the tax attributes of the employee pursuant to Division 245 of Part 3-10 of the Income Tax Assessment Act 1997?: Section 245-35 provides that a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full. If the value of the shares is less than the outstanding loan balance there will be a debt forgiveness. However, as the debt is a non-recourse debt sub-section 245-60(1) and item 2 of the table in subsection 245-65(1) operate to give no gross forgiven debt and therefore subdivisions 245-D to 245-F do not apply. | Detailed Reasoning - Will there be forgiveness of a debt pursuant to Division 7A of Part III of the Income Tax Assessment Act 1936?: Subsection 109F(4) of the ITAA 1936 provides that the discharge of a debt by transfer of property is not a debt forgiveness under Section 109F of the ITAA 1936. Instead it is considered under section 109C of the ITAA 1936, as the company has no distributable surplus the amount of any dividend so calculated would be reduced to nil by section 109Y of the ITAA 1936

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: Your employer is proposing to establish and employee share ownership plan (ESOP). | The draft plan deed offers a number ordinary shares in the company to the employee on the terms of the ESOP and in accordance with the draft Offer Letter and Plan Booklet. | The ESOP is a loan-style share plan that enables employees to exercise voting rights and share in financial rewards from growth in the Company's shares, and from dividends and capital distributions. | Employees will acquire ordinary shares upfront in their own name by new issue or transfer for their market value. | They are funded by an interest free loan from the company that is repayable over a maximum of 5 years from after-tax salary, bonuses and dividends. | The ESOP does not involve any form of salary sacrifice. | The employee cannot sell the shares during this period (except in the case of a liquidity event involving a more than 50% change in ownership). | If the employee ceases employment during that 2 year period, the employee's shares will be repurchased for an amount equal to the original acquisition price - without gain or loss, except the employee would retain the benefit of any prior dividends or capital distributions on the shares. | The commercial objective of the ESOP is to provide key employees with incentive to remain employed with the group and to provide greater contribution towards the profitability of the group through having a sense of ownership, broader participation and additional financial rewards. | The shares will be issued or transferred by the company for an acquisition price of $ each, which can be assumed to be the market value of an ordinary share in the company. | The total acquisition price for the shares will be $A being X ordinary shares times the acquisition price of $Y. | Prior to the shares being issued or transferred to the employee, the company will end an amount equal to the total acquisition price to the employee, and the employee will use the loaned funds to pay the total acquisition price. | The loan will be interest free while there is no default. | The loan will be repayable as follows: | § by deduction from each monthly after-tax salary payment of an amount. | § by deduction from each after tax bonus of an amount equal to a fixed percentage of the after tax bonus | § any dividends or capital distributions (less a small portion paid to the employee to fund tax on the dividends or capital distributions) to be applied against the loan, and | § the balance to be paid shortly after cessation of employment. | If the employee ceases employment before the end of 2 years after acquiring the shares, the shares will be repurchased for an amount equal to the original acquisition price by a nominee of the company (and the company may nominate itself or any other person or entity). | The employer company will have a nil distributable surplus for each financial year covered by the ruling.