Private ruling: Fringe Benefits Tax: Loan fringe benefits - otherwise deductible rule
Date of advice: 16 April 2019
Published: May 2019
Ruling period: Year ending 31 March 2018
Date scheme commenced: 1 April 2017

Ruling: Q2: Is the requirement to provide employee declarations in the approved format waived under subparagraph 19(1)(c)(ii) of the FBTAA? Answer Yes.

Relevant facts and circumstances: 1. Company X (‘the Company’) is a public company. 2. The Company has offered certain employees the opportunity to participate in an Incentive Plan (‘the Plan’). The purpose of the Plan is to reward individual performance against objectives and achievement against the Company’s and subsidiaries’ financial and operating targets. 3. Under the rules of the Plan, employee participants are offered options to acquire shares in the Company at a pre-determined price, subject to satisfying the relevant vesting conditions and the payment of the relevant fee and exercise price. 4. A fee is payable to acquire the options. The Company advanced a loan to each participant to fund the fee payable to acquire the options. The loans are interest-free and limited recourse. 5. The fee is equal to the market value of the options as determined by the income tax regulations in Division 83A of the Income Tax Assessment Regulations 1997 . 6. The options can only be exercised on the fourth anniversary of the date they were approved by the Board of the Company and lapse if not exercised. The options are not transferable. 7. The loan is repayable on the lapse, forfeiture, exercise or buy-back of the options. 8. The options are beneficially owned by the employees at all times when the loans are outstanding. 9. The Company has a history of paying dividends on its shares.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109D | Income Tax Assessment Act 1997 Section 8-1 | Fringe Benefits Assessment Act 1986 Section 16(1) | Fringe Benefits Assessment Act 1986 Section 19 | Fringe Benefits Assessment Act 1986 Subsection 19(1) | Fringe Benefits Assessment Act 1986 Paragraph 19(1)(b) | Fringe Benefits Assessment Act 1986 Paragraph 19(1)(c) | Fringe Benefits Assessment Act 1986 Subparagraph 19(1)(c)(ii) | Fringe Benefits Assessment Act 1986 Subsection 136(1)

Reasons for decision: Summary: Employee participants would not be entitled to claim a once-only income tax deduction under the Income Tax Assessment Act 1936 or the Income Tax Assessment Act 1997 , had they incurred interest on the loan and therefore do not satisfy the requirements of paragraph 19(1)(b). | Detailed Reasoning - Otherwise Deductible Rule: 1. An employee share loan benefit is defined in subsection 136(1) of the FBTAA as: … in relation to a year of tax, means a loan fringe benefit in relation to an employee in relation to an employer in relation to the year of tax where: (a) the sole purpose of the making of the loan is to enable the employee to acquire shares, or rights to acquire shares, in a company, being: (i) the employer; or (ii) an associate of the employer; and (b) the shares or rights were beneficially owned by the employee at all times during the period during the year of tax when the employee was under an obligation to repay the whole or any part of the loan. 2. A loan fringe benefit is defined in subsection 136(1) as ‘a fringe benefit that is a loan benefit.’ Subsection 136(1) states that a ‘loan benefit means a benefit referred to in subsection 16(1)’, which provides: Where a person (in this subsection referred to as the provider ) makes a loan to another person (in this subsection referred to as the recipient ), the making of the loan shall be taken to constitute a benefit provided by the provider to the recipient and that benefit shall be taken to be provided in respect of each year of tax during the whole or a part of which the recipient is under an obligation to repay the whole or any part of the loan. 3. The loan provided by the Company to employee participants meets the definition of loan benefit. It must also satisfy the definition of a fringe benefit to be a loan fringe benefit. 4. Subsection 136(1) relevantly provides that a fringe benefit includes benefits provided to an employee by their employer in respect of their employment but does not include certain loans within the meaning of section 109D of the Income Tax Assessment Act 1936 (ITAA 1936). As the Company is a public company, section 109D has no application. Thus, the loan benefit is a fringe benefit. 5. As the loan is made for the sole purpose of enabling the employee to acquire rights to acquire shares in the Company which is the employer of the employee, and the rights are beneficially held by the employee at all times during which they are under an obligation to repay the loan, the loan is considered to be an employee share loan benefit. 6. Where the benefit qualifies as a loan fringe benefit, section 18 provides that the taxable value is the amount by which the notional amount of interest exceeds the amount of interest that has accrued on the loan in respect of the year of tax. In this case, this would be the entirety of the notional amount of interest, as no interest has accrued on the loan. 7. However under section 19, this taxable value is reduced by the amount that the employee would have been able to claim as a once-only income tax deduction under the Income Tax Assessment Act 1936 or the ITAA 1997, had they actually incurred interest on the loan. This is referred to as the otherwise deductible rule. 8. Subsection 19(1) relevantly provides that the taxable value may be reduced where: (a) the recipient of a loan fringe benefit in relation to an employer in relation to a year of tax is an employee of the employer; and (b) if the recipient had, on the last day of the period (in this subsection called the loan period ) during the year of tax when the recipient was under an obligation to repay the whole or any part of the loan, incurred and paid unreimbursed interest (in this subsection called the gross interest ), in respect of the loan, in respect of the loan period, equal to the notional amount of interest in relation to the loan in relation to the year of tax - a once-only deduction (in this subsection called the gross deduction ) would, or would if not for section 82A of the ITAA 1936, and Divisions 28 and 900 of the Income Tax Assessment Act 1997 , have been allowable to the recipient under either of those Acts in respect of the gross interest; … | Detailed Reasoning - Deductions for interest: 9. Under section 8-1 of the ITAA 1997, interest is deductible to the extent that it is incurred in gaining or producing the taxpayer’s assessable income or in carrying on a business for that purpose and is not of a capital, private or domestic nature. 10. Whether the requisite connection exists is a question of fact and degree, determined by reference to the circumstances of the particular case. 11. In determining the deductibility of interest, the courts and tribunals have looked at the purpose of the borrowing and the use to which the borrowed moneys have been put ( Fletcher & Ors v FC of T 91 ATC 4950; (1991) 22 ATR 613, FC of T v Energy Resources of Australia Limited 96 ATC 4536; (1996) 33 ATR 52, and Steele v FC of T 99 ATC 4242; (1999) 41 ATR 139). Using the borrowed money for the purpose of gaining assessable income connects the interest paid on the borrowed money to the income derived from its use. 12. Paragraph 16 of Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities highlights that although the concepts of the use to which funds are put and of subjective purpose are useful tools in determining the deductibility of interest, the statutory issue is whether the interest outgoing was incurred in (i.e. in the course of) the income producing activity. (see Hill J in Kidston Goldmines Ltd v Federal Commissioner of Taxation 91 ATC 4538; (1991) 22 ATR 168; and FC of T v JD Roberts 92 ATC 4380 (1992); 23 ATR 494) | Detailed Reasoning - Expenditure incurred prior to assessable income: 13. A loss or outgoing may be deductible under section 8-1 even though it produces assessable income in a year of income later than the year in which the loss or outgoing was incurred. 14. In Ronpibon Tin NL v FC of T (1949) 8 ATD 431 at 436; (1949) 78 CLR 47 at page 57, Latham CJ, Rich, Dixon, McTiernan and Webb JJ said: [I]t is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income 15. However, expenditure incurred before the commencement of an income-generating activity may be excluded from deductibility under section 8-1 where it lacks the necessary nexus. 16. In FC of T v Total Holdings (Australia) Pty Ltd (1979) 24 ALR 401 at 406; 79 ATC 4279 at 4283, Lockhart J stated: ... [ I]f a taxpayer incurs a recurrent liability for interest for the purpose of furthering his present or prospective income-producing activities, whether those activities are properly characterised as the carrying on of a business or not, generally the payment by him of that interest will be an allowable deduction under s 51 [now section 8-1] ... I say `generally' as some qualification may be necessary in appropriate cases, for instance, where interest is paid by a taxpayer as a prelude to his being in a position whereby he may commence to derive income. In such cases the requirement that the expenditure be incidental and relevant to the derivation of income may not be satisfied. 17. Paragraph 9 of Taxation Ruling IT 2606 Income tax: Deductions For Interest on Borrowings to Fund Share Acquisitions explains: As a general rule, interest on money borrowed to acquire shares will be deductible under the first limb of subsection 51(1) [now paragraph 8-1(1)(a)] where it is expected that dividends or some other assessable income will be derived from the investment. Such an expectation will usually exist as shares by their very nature are inherently capable of generating dividends, whether in the short or long term. However, such an expectation must be reasonable and not a mere theoretical possibility; there must be a prospect of dividends or other assessable income being received. 18. Accordingly interest incurred on a loan to purchase shares will generally have the required connection to assessable income where there is a reasonable prospect of dividends being received. 19. However interest incurred on a loan to purchase options to acquire shares does not have the same connection with the expectation of dividend income. 20. TR 2004/4 at paragraph 33 uses this as an example of an outgoing that is not deductible because the outgoing is incurred ‘too soon’, ‘preliminary’ or a ‘prelude’. Interest incurred on a loan used to purchase options to acquire shares as the options do not give rise to an entitlement to dividends. Although the options may be converted into shares at a later date, from which dividends may be expected, the interest expense is considered to be both preliminary to and remote from any possible derivation of assessable income. 21. In the present case, employee participants are offered options to acquire shares in the Company at a pre-determined price. 22. Features of the options include: ′ subject to vesting conditions ′ require payment of a fee ′ may only be exercised on the fourth anniversary of the date they were approved by the Board of the Company ′ lapse if not exercised on the exercise date ′ not transferable ′ exercise of the options is at a pre-determined exercise price. 23. The purpose of the Plan is to reward the employee participants by offering value to them through ownership of company shares. The Company’s shares have a history of paying dividends. However, unlike shares, the options acquired by the taxpayer have no entitlement to dividends and whilst the taxpayer may in the future, exercise the options and acquire shares from which they may expect to receive dividends, the taxpayer will not otherwise derive assessable income from holding the options. 24. The options can only be exercised four years after approval and will lapse if not exercised at that time. They may also lapse where relevant performance criteria are not met or where an employee ceases employment. The options are not transferable. 25. An employee will anticipate that the underlying share value will be maintained or increase in the four years such that the employee will derive value by exercising the options at a pre-determined price, but this is not certain. 26. Consequently, the options may never be exercised. 27. Notwithstanding that based on past performance the shares have genuine potential to generate assessable income, the options do not have a sufficiently close connection to this potential income so that expenditure in purchasing the options is incurred in gaining or producing income. The interest expense is incurred before the employee commits to purchasing the shares to earn income and is thus of a preliminary nature. 28. The interest expenditure is considered to be both preliminary to and remote from the derivation of assessable income in the event that an option is converted to a share (which is not certain). The interest expense also lacks the necessary connection to an income producing purpose. 29. Accordingly, employee participants would not be able to claim a once-only income tax deduction under the Income Tax Assessment Act 1936 or the Income Tax Assessment Act 1997 , had they incurred interest on the loan and therefore do not satisfy the requirements of paragraph 19(1)(b) of the FBTAA. | Summary: The requirement to provide employee declarations in the approved format in respect of the loan concerned is waived under subparagraph 19(1)(c)(ii) because the fringe benefit is an employee share loan benefit in relation to the year of tax. | Detailed Reasoning - Declaration by employee: 1. Before an employer can claim a reduction in taxable value of a loan fringe benefit, the employee must give the employer a declaration in respect of the loan: paragraph 19(1)(c). This obligation applies unless the loan is an employee credit loan benefit or an employee share loan benefit. 2. This fringe benefit is an employee share loan benefit, therefore under sub paragraph 19(1)(c)(ii) of the FBTAA 1986, the recipient is not required to provide a declaration in respect of the loan.

Question 1: Would employees be entitled to a once-only deduction in respect of the gross interest on employee share loans if the employee had incurred the interest expense, thereby satisfying the requirements of paragraph 19(1)(b) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)? | Question 1: Would employees be entitled to a once-only deduction in respect of the gross interest on employee share loan benefits if the employee had incurred the interest expense, thereby satisfying the requirements of paragraph 19(1)(b) of the FBTAA?