Private ruling: Employee share scheme
Date of advice: 1 July 2016
Published: August 2016
Ruling period: Income tax year ending 30 June 2015 | Income tax year ending 30 June 2016 | Income tax year ending 30 June 2017 | Income tax year ending 30 June 2018 | Income tax year ending 30 June 2019 | Income tax year ending 30 June 2020 | Question 6 | Is the provision of shares by Company A to employees who are participating in the ESOP ( Participants ) a fringe benefit within the meaning of subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 ( FBTAA )? | Answer | No. | Question 7 | Will the irretrievable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition on-market and/or off-market of Company A's shares, be treated as a fringe benefit within the meaning of subsection 136(1) of the FBTAA? | Answer | No. | Question 8 | Will the Commissioner seek to apply section 67 of the FBTAA to Company A's payment of irretrievable contributions to the Trustee? | Answer | No. | This ruling applies for the following period(s) for Questions 6 to 8 | Income tax year ending 31 March 2015 | Income tax year ending 31 March 2016 | Income tax year ending 31 March 2017 | Income tax year ending 31 March 2018 | Income tax year ending 31 March 2019 | Income tax year ending 31 March 2020
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will Company A obtain an income tax deduction, pursuant to section 8-1, in respect of the irretrievable cash contributions made by it to an independent arm's length trustee company ( Trustee ) acting as trustee of the Company A Employee Share Option Plan Trust ( EST ) to fund the subscription for or acquisition on-market and/or off-market of Company A's shares by the Trustee pursuant to the Company A Limited Employee Share/Option Plan ( ESOP )? | A1: Yes. | Q2: Will Company A obtain income tax deductions, pursuant to sections 8-1, 25-5 or 40-880 in respect of costs incurred in relation to the implementation and ongoing administration of the EST? | A2: Yes. | Q3: Are irretrievable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition on-market and/or off-market of Company A's shares by the EST pursuant to the ESOP (to satisfy Employee Share Scheme interests (ESS interests), deductible to Company A at a time determined by section 83A-210, where the contributions are made before the acquisition of the relevant ESS interests? | A3: Yes. | Q4: If the Trustee of the EST satisfies the relevant ESOP obligations by subscribing for new shares in Company A, will the subscription proceeds be included in the assessable income of Company A under sections 6-5 or 20-20 or trigger a capital gains tax ( CGT ) event under Division 104? | A4: No. | Q5: Will the Commissioner make a determination that Part IVA of the Income Tax Assessment Act 1936 ( ITAA 1936 ) applies to any aspect of the arrangement(s) described in this application to deny, in part or in full, any deduction claimed by Company A in respect of the irretrievable cash contributions made by Company A or any of its subsidiary members to the Trustee of the EST to fund the subscription for or acquisition of Company A shares from existing shareholders by the EST? | A5: No.

Relevant facts and circumstances: Company A is a public company, which listed on the ASX in July 20YY. Company A was incorporated in July 20XX to provide information technology applications (IT Applications). Company A will licence its IT Applications to corporate customers in return for a monthly subscription fee. The fee charged to clients depends on which IT Applications they use. In the IT sector, a large part of Company A's success will be determined by its ability to motivate its staff and maintain longevity of employment, particularly amongst senior management. Company A needs to be able to provide incentives to ensure they attract the right people, especially at the senior management level, and retain high calibre staff to ensure the future success of the group. Company A's remuneration policy is designed to align the economic interests of senior management and other employees with those of Company A's shareholders. This is done by providing an opportunity for employees to earn significant rewards by potentially acquiring an equity interest in Company A, thus motivating the creation of shareholder value. Company A has designed its policy with the intention it will be competitive and equitable. Company A has implemented the ESOP to provide an equity based compensation plan to its key employees. The ESOP will utilise an EST to administer and manage the activities identified in the ESOP Rules ( Rules ). The Trustee will act in accordance with the Trust Deed establishing the EST ( Deed ), which will facilitate the provision of shares in Company A under the ESOP to certain Australian employees of Company A (Participants) via the EST. It is proposed that current ESOP Participants and new employees will be eligible to participate in the equity plan administered by the EST. The establishment of the EST provides Company A with greater flexibility to accommodate its long term incentive arrangements whilst the business continues to expand in terms of operations and employee numbers in future years. The EST will also accommodate capital management flexibility for Company A in that the EST can use the contributions from Company A to either acquire shares in Company A from existing shareholders, or, alternatively, subscribe for new shares in Company A. It also allows for a streamlined approach to the administration of the ESOP. At any time there is a grant of rights pursuant to the ESOP, the grant will be subject to the Rules. Background to the ESOP Rights which have already been issued under the ESOP do not have vesting conditions exceeding two years and it is not expected that any vesting conditions attached to new rights issued under the ESOP will exceed five years. The Company A Employee Share / Option Plan As stated in the ESOP documentation, it is intended to provide Participants with an opportunity to acquire shares and/or options ( Securities ) in Company A so that they can share in the growth in value of Company A and to encourage them to improve the longer-term performance of Company A and its returns to shareholders. The ESOP is also intended to assist Company A to attract and retain skilled and experienced senior employees, providing them with an incentive to have a greater involvement with, and focus on, the longer term goals of Company A. Various terms used below are defined within the ESOP documentation. The ESOP broadly operates as follows: • The Board may at any time decide that the plan should be operated in respect of any Financial Year and at its discretion, the total number of Securities to be offered to each Eligible Employee and the Issue Price at which the Securities are offered. • The Board may in its absolute discretion determine that an employee who otherwise would be an Eligible Employee to acquire Securities is not eligible. • It is at the Board's discretion to extend the invitation of offer to Eligible Employees to apply for a number of Securities (either options or shares). • The offer of shares is to be provided in writing and will specify, amongst other things, the number of shares offered, the Issue Price and the Performance Hurdles applying to the offer. • The offer of options is to be provided in writing and will specify, amongst other things, the number of options, Option Period, Exercise Price and any Performance Hurdles applying to the offer. • Any conditions, such as Performance Hurdles, applicable to the vesting of Securities in a Participant will be of such a nature that they will be objectively considered as being both achievable and realistic in relation to the Participants likelihood of acquiring absolute entitlement to the underlying share or option. • The total number of Securities which may be offered under the ESOP will not at any time exceed 10% of Company A's total issued shares. • When exercisable, each option is convertible into one ordinary share. • To exercise an option, an employee must sign and return an exercise notice in a form prepared by Company A. Options which have not been exercised by the expiry of the Option Period will lapse. • Option holders do not have any right to participate in new issues of Securities in Company A made to shareholders generally. • The option holder does not participate in any dividends unless the options are exercised and the resultant shares of Company A are issued. • If there is a bonus issue to the holders of shares in Company A, the Board may make adjustments to the number of shares to be issued or the exercise price of the options. • The Board at its absolute discretion may offer and issue shares and options upon the terms and conditions it sees fit. • At the relevant time, the Trustee of the EST will be directed by Company A to acquire shares on behalf of each Participant, either through acquisition from existing shareholders, or via a new share issue or allocate any pre-acquired shares. Such shares will rank equally with all other shares in Company A. • While such shares are held on trust in the EST, the Participants will be entitled to dividend and voting rights and to participate in any rights issue. • Employees are absolutely entitled to the shares as against the Trustee from when the shares are allocated to them. By written notice, employees can apply for legal title to the shares held in the EST to be transferred to them. • Administration of the ESOP is vested in the Board. • There are currently x,xxx,xxx options on issue with exercise prices varying from $x.xx to $x.xx. These options typically vest over a 12 month period and have a x year expiry period. Operation of the EST The EST will operate in accordance with the Deed as follows: • The EST will be established for the sole purpose of acquiring and holding Securities for the benefit of Participants in the ESOP (refer to Clause 2.4 of the Deed). • The Securities acquired or issued by the EST will be held on trust for the Participants. • The EST will be managed and administered so that it satisfies the definition of an 'employee share trust' in subsection 130-85(4). • The EST will be funded by contributions from Company A for the purchase of shares under the ESOP. • Upon receipt of notice from the Board, the Trustee will purchase the requisite number of shares, in accordance with the ESOP, either from existing shareholders, via subscription from Company A, or through allocation of shares that are trust assets not being held on behalf of any other Participant. A combination of these acts can also be undertaken to give effect to the purchase. • The shares acquired by the Trustee will be allocated to the relevant Participants. • The structure of the EST and the ESOP Rules, are such that shares allocated to each employee will generally be transferred into the name of the relevant Participant. • The Trustee is a third party acting at arm's length whose role is to administer the facilitation of the ESOP through the EST in accordance with the Deed. • The Trustee will after any relevant restrictions lift, be permitted to sell shares on behalf of an employee where the relevant ESOP Rules permit (subject to any restrictions on transfer that are imposed upon Participants in the ESOP). • The Trustee may not exercise any voting rights, participate in rights issues or hold any bonus shares in relation to unallocated trust shares. The Trustee may, however, apply any capital receipts, dividends or other distributions received in relation to the unallocated shares to purchase further shares to be held on trust. • The Trustee is not permitted to carry out activities which result in the Participants in the ESOP being provided with additional benefits other than the benefits that arise from the relevant Rules. • The Trustee is not permitted to carry out activities that are not matters or things which are necessary or expedient to administer and maintain the EST. • The Trustee's power to subscribe for, purchase or otherwise acquire and to sell, dispose or otherwise deal with any property, rights or privileges which the Trustee is authorised to acquire or dispose is confined to the Deed and is for the benefit of the Participants. Commercial Benefits of the EST The use of an EST for Company A has a range of commercial benefits. In particular, the EST will: • Provide an arm's length vehicle for acquiring and holding shares in Company A, either by way of subscription or acquisition from existing shareholders. • Assist Company A with meeting its Corporations Law requirements in relation to dealing in its own shares. The Corporations Act generally prohibits a company from acquiring its own shares. The use of the EST provides a mechanism to allow for the acquisition of Company A's shares through the EST and the EST is not prohibited from doing so as a result of Company A having no beneficial interest in any shares held by the EST. • Assist Company A in managing any insider trading issues as the Trustee, a party acting independently and with a fiduciary duty to its beneficiaries, is acquiring shares in accordance with a set policy. • Provide Company A with capital management flexibility. That is, shares allocated to employees can be either acquired from other shareholders or through subscription. This is important for Company A's shareholders as, in deciding the appropriate acquisition method, the most effective manner to utilise cash for shareholder benefit, and any concerns that existing shareholders have in relation to dilution of their existing shareholdings, can be considered. • Provide greater flexibility to accommodate its long term incentive arrangements whilst Company A continues to expand in terms of operations and employee numbers in future years. • Provide Company A with better visibility on management's share transactions in respect of shares acquired under the ESOP. The mechanism implemented through the facilitation of the ESOP through the EST assists Company A to better assess which of its employees are fully committed to aligning their interests with those of shareholders. • Provides an efficient structure for giving effect to disposal restrictions/vesting conditions. As the Trustee is the legal owner of the shares, employees as beneficial owners have no ability to deal in the shares, until the shares are released from the Trust. • Provides a single vehicle for the administration of the ESOP and any new plans, resulting in reduced administrative costs. • Allows for easy recycling of shares, without increasing the percentage of ownership of other shareholders. When, for example, options have been issued to a particular Participant, shares have been acquired by the Trustee in advance but have not yet been allocated to be held on behalf of that Participant, and the options do not subsequently vest, Company A can allocate those shares to other future offers to other Participants under the ESOP. • Provides Company A with an efficient mechanism for the administration and operation of any new employee equity plan which it introduces in the future. Costs incurred by Company A in respect to the implementation and administration of the EST Company A will incur various costs in relation to the implementation of the EST, including but not limited to: • taxation and legal advice in respect of the Australian tax and legal implications which may arise for both Company A and the Participants of the ESOP in respect of the EST structure. • legal drafting fees in respect of the various legal documents required in respect of the EST and the ESOP. • professional fees associated with the establishment of the EST including such costs associated with the creation and registration of the EST with various authorities. • taxation fees associated with the drafting and lodgement of the Application with the ATO. Company A will also incur costs associated with the services provided by the Trustee of the EST in respect of the on-going administration and management of the EST, including but not limited to: • Participants plan record keeping. • production and dispatch of holding statements to Participants. • provision of annual income tax return information. • acquisition of shares and allocation to Participants. • management of Participant termination. • costs associated with the acquisition of shares (e.g. brokerage and other fees in allocation of shares to Participants).

Relevant legislative provisions: Fringe Benefits Tax Assessment Act 1986 section 66 | Fringe Benefits Tax Assessment Act 1986 section 67 | Fringe Benefits Tax Assessment Act 1986 subsection 67(1) | Fringe Benefits Tax Assessment Act 1986 subsection 67(2) | Fringe Benefits Tax Assessment Act 1986 subsection 136(1) | Fringe Benefits Tax Assessment Act 1986 paragraph 136(1)(h) | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 section 177A | Income Tax Assessment Act 1936 subsection 177A(1) | Income Tax Assessment Act 1936 subsection 177A(5) | Income Tax Assessment Act 1936 section 177C | Income Tax Assessment Act 1936 subsection 177C(1) | Income Tax Assessment Act 1936 subsection 177CB(2) | Income Tax Assessment Act 1936 subsection 177CB(3) | Income Tax Assessment Act 1936 subsection 177CB(4) | Income Tax Assessment Act 1936 section 177D | Income Tax Assessment Act 1936 subsection 177D(2) | Income Tax Assessment Act 1936 section 177F | Income Tax Assessment Act 1936 subsection 177F(1) | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 subsection 8-1(1) | Income Tax Assessment Act 1997 subsection 8-1(2) | Income Tax Assessment Act 1997 paragraph 8-1(2)(a) | Income Tax Assessment Act 1997 Division 20 | Income Tax Assessment Act 1997 section 20-20 | Income Tax Assessment Act 1997 subsection 20-20(2) | Income Tax Assessment Act 1997 subsection 20-20(3) | Income Tax Assessment Act 1997 subsection 20-25(1) | Income Tax Assessment Act 1997 section 20-30 | Income Tax Assessment Act 1997 section 20-25 | Income Tax Assessment Act 1997 subsection 20-25(1) | Income Tax Assessment Act 1997 section 40-880 | Income Tax Assessment Act 1997 subsection 40-880(2) | Income Tax Assessment Act 1997 subsection 40-880(3) | Income Tax Assessment Act 1997 Division 83A | Income Tax Assessment Act 1997 section 83A-10 | Income Tax Assessment Act 1997 subsection 83A-10(1) | Income Tax Assessment Act 1997 subsection 83A-10(2) | Income Tax Assessment Act 1997 Subdivision 83A-B | Income Tax Assessment Act 1997 Subdivision 83A-C | Income Tax Assessment Act 1997 section 83A-205 | Income Tax Assessment Act 1997 section 83A-210 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 102-25 | Income Tax Assessment Act 1997 Division 104 | Income Tax Assessment Act 1997 subsection 104-35(1) | Income Tax Assessment Act 1997 paragraph 104-35(5)(c) | Income Tax Assessment Act 1997 subsection 104-155(1) | Income Tax Assessment Act 1997 subsection 104-155(5) | Income Tax Assessment Act 1997 paragraph 130-85(4) | Income Tax Assessment Act 1997 paragraph 130-85(4)(a) | Income Tax Assessment Act 1997 paragraph 130-85(4)(b) | Income Tax Assessment Act 1997 paragraph 130-85(4)(c) | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Detailed Reasoning - Detailed reasoning: Section 8-1 provides the general rules in relation to entitlement to an income deduction in relation to a taxpayer's assessable income. The relevant subsections provide: | Detailed Reasoning - 8-1(1): You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a * business for the purpose of gaining or producing your assessable income. | Detailed Reasoning - 8-1(2): However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature… | Detailed Reasoning - The contribution must be incurred: To qualify for a deduction under section 8-1 a contribution to the trustee of an EST must first be incurred. While 'incurred' generally refers to a situation where a taxpayer owes a present money debt that they cannot escape (see Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions ); Draft Taxation Ruing TR 2014/D1 Income tax: employee remuneration trust arrangements provides the Commissioner's current view on a broad scope of taxation consequences for employers, trustees and employees who participate in an employee remuneration trust arrangement (ERT). Paragraph 9 of TR 2014/D1 states that the essential elements of an ERT to which the draft ruling applies when considering the consequences for the employer and trustee are: a) an employer carries on business for the purpose of gaining or producing assessable income; b) Australian resident employees are employed by the employer in the ordinary course of carrying on that business; c) a trust is established by or at the instruction of the employer; d) the trust is a resident trust for the purposes of Division 6; e) the employer makes one or more contributions to the trustee of the trust; f) the trustee applies the contributions to make loans to employees and/or to acquire shares or other assets; g) employees of the employer are capable of benefiting under the trust (for example, in the form of loans, distributions of cash and/or a transfer of assets); and h) the value of any benefits provided to employees is determined by the employer or the trustee, having regard to • the performance of the employees; • the growth in value of, or generation of income from, investments held by the trustee; and/or • objective indices, for example, movements in the value of shares in the employer or a related entity. The way in which the EST has been established and operates is in line with the elements of an ERT to which TR 2014/D1 applies. Paragraph 169 of the explanation to TR 2014/D1 provides that 'a contribution made to the trustee of an ERT is incurred only when the ownership of that contribution passes from an employer to the trustee of the trust and there is no circumstance in which the employer can retrieve any of the contribution ( Pridecraft Pty Ltd y Federal Commissioner of Taxation [2004] FCAFC 339; 2005 ATC 4001; Spotlight Stores Pty Ltd v Commissioner of Taxation [2004] FCA 650 2004 ATC 4674; 55 ATR 745)'. The contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition of Company A shares by the EST are irretrievable and non-refundable under the Deed. The Deed also provides that contributions by Company A will not be repaid, and will constitute accretions to the corpus of the Trust. Under the Deed, upon termination of the EST, the Trustee must transfer the assets held on trust for the Participants. The Trustee must apply the remaining capital or income of the EST in whole or in part for the benefit of an employee, their legal representative or any charitable organisation as determined by the Trustee in its absolute discretion. Thus, the contributions made by Company A to the Trustee of the EST to allow the Trustee to comply with its obligations to Participants by the provision of shares are irretrievable and non-refundable under the Deed. The Deed does not provide for any circumstances in which Company A can retrieve the contribution other than via subscription for shares. Thus the contributions would be incurred for the purposes of section 8-1 at the time these are made to the EST. | Detailed Reasoning - Incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for that purpose: For a contribution by Company A to be deductible under section 8-1, the contribution must have been incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. These are referred to as the two limbs of subsection 8-1(1). An expense will have the relevant connection to the business when it is 'desirable or appropriate in the pursuit of the business ends of the business' ( Ronpibon Tin NL and Tongkah Compound NL v. FC of T (1949) 78 CLR 47 at 55-58; [1949] HCA 15 at [9]-[15] ( Ronpibon ) ; Magna Alloys & Research Pty Ltd v. Federal Commission of Taxation [1980] FCA 150; 80 ATC 4542 at 4559-4561; (1980) 11 ATR 276 at 294-297 ( Magna Alloys )). Paragraph 14 of TR 2014/D1 provides that where an employer: • carries on a business for the purpose of gaining or producing assessable income and engages employees in the ordinary course of carrying on that business; • makes a contribution to the trustee of an ERT; and • at the time the contribution is made, the primary purpose of the contribution is for it to be applied, within a relatively short period, to the direct provision of remuneration of employees (who are employed in that business), then, such a contribution will satisfy the nexus of being necessarily incurred in carrying on that business. Paragraph 178 of TR 2014/D1 provides that: The Commissioner will generally accept a relatively short period of time for the trustee of an ERT to diminish a contribution for the direct provision of remuneration to employees to be up to five years from the date the contribution was made by an employer to the trustee of an ERT. However, where the contribution has been made to facilitate an employee having an interest in the ERT corresponding to a particular number of shares (or rights to acquire shares) in the employer or in its subsidiaries to which Subdivision 83A-C of the ITAA 1997 applies, the statutory scheme is such that a relatively short period of time for these arrangements will generally be accepted as being up to seven years from the date the contribution is made. The Applicant has stated that shares and options that are held under the ESOP are not intended to have a maximum deferral period exceeding five years. Thus, the relatively short period of time criteria should be met in respect of the contributions made by Company A. Thus where: • Company A carries on a business in Australia, and engages employees in that business; • Company A makes irretrievable contributions to the EST in relation to rights that have been offered to employees under the ESOP; • at the time Company A makes contributions to the EST, the primary purpose of the contribution is for it to be applied, within a short period of time, to the provision of remuneration of employees of Company A (in the form of equity based incentives); then, the irretrievable contributions made by Company A to the Trustee under the Rules will satisfy the nexus of being necessarily incurred in carrying on the Company A business under paragraph 8-1(1)(b). | Detailed Reasoning - A contribution that is capital or of a capital nature: Where a contribution satisfies either limb of subsection 8-1(1), it may still be capital or of a capital nature. Pursuant to subsection 8-1(2), the contribution will not be deductible to an employer under section 8-1 to the extent to which it is capital or of a capital nature. There is no statutory definition as to what constitutes a payment on capital account as opposed to one on revenue account. Therefore, it is necessary to consider the principles identified and developed by case law in determining whether an amount is capital or revenue in nature. The decision in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 ( Sun Newspapers ) is a leading authority on the distinction between revenue and capital expenditure, where his Honour said at 363: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. More recently in GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124 ( GP International ); 21 ATR 1; 90 ATC 4413 the High Court pointed out that the character of expenditure is ordinarily determined by reference to the nature of the asset acquired and that the character of the advantage sought by the making of the expenditure is a critical factor in determining the character of what is paid. In Spotlight Stores Pty Ltd v Federal Commissioner of Taxation (2004) 55 ATR 745 and Pridecraft Pty Ltd v Federal Commissioner of Taxation (2004) 58 ATR 210 payments by an employer company to an employee share trust, established to provide incentive payments to employees, were held to be on revenue account and were not capital or of a capital nature. In this case, the contributions made by Company A to the EST are ultimately and in substance applied for the benefit of remunerating employees in connection with the business operations of Company A. The primary advantage sought by Company A in making contributions to the EST under the ESOP is the resultant incentivizing of employees to perform effectively and contribute to the business of Company A. It follows that the irretrievable cash contributions made by Company A to the Trust of the EST is of revenue rather than capital nature. The combined operation of subsections 8-1(1) and 8-1(2) may require apportionment of a loss or outgoing into deductible and non-deductible components, where a single loss or outgoing is incurred for more than one purpose or on items of a differing nature. However, where a contribution is made for the purposes of securing advantages of a capital and revenue nature, no apportionment is required where the advantages of a capital nature are only expected to be very small or trifling by comparison. In this regard, the draft taxation ruling TR 2014/D1 at paragraph 200 states: Where the primary purpose of the employer in making the contribution is to remunerate employees within a relatively short period (as discussed in paragraph 178 of this draft Ruling) of the contribution being made, it is considered that any amount of the contribution attributable to securing a capital structure advantage will only be very small or trifling where the employer: • intends that any direct interest in the employer acquired by the trustee of the ERT (for example shares) will be transferred to employees within that relatively short period, and • does not anticipate that such shares will be on-sold to third parties at that time or shortly thereafter. For these purposes, the Commissioner considers that a relatively short period of time is up to 5 years, increased to 7 years where the benefit in question relates to an employee share scheme (paragraph 178 of TR 2014/D1). In the present circumstances, considering that the vesting conditions associated with the options already issued under the ESOP do not exceed two years, and that future issues of options or shares are not expected to have vesting conditions exceeding five years, and the ESOP is operated such that partial or full vesting can be expected from time to time, it is reasonable to expect that the Trustee will diminish the contributions over a relatively short period of time. The non-refundable contributions made by Company A to the Trustee of the EST for the purposes of procuring shares to satisfy Company A's commitments arising under the ESOP are primarily outgoings incurred by Company A in the ordinary course of carrying on its business. Any capital advantage attained will be small or trifling compared to the advantage expected to be secured by rewarding prior performance of Participants and motivating the Participants to contribute through their employment performance to the income producing activities of Company A. Therefore, such contributions are not considered capital in nature, or any capital component is sufficiently small or trifling such that the Commissioner would not seek to apportion the deduction. Accordingly, the irretrievable cash contributions Company A makes to the Trustee of the EST to enable it to acquire shares, are allowable tax deductions for Company A under section 8-1. | Detailed Reasoning - Cost of ongoing administration of EST - section 8-1: As discussed above (Question 1), Company A can deduct an amount under section 8-1 if the expense is incurred in gaining or producing assessable income, or is necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income. The view that costs incurred by Company A for administering the EST are deductible under section 8-1 is consistent with ATO ID 2014/42 which provides that costs incurred in implementing and administering an employee share scheme will be deductible under section 8-1 as they are part of the ordinary employee remuneration cost. The facts in ATO ID 2014/42 reveal that the deductible costs include brokerage fees, audit fees, bank charges and other ongoing administrative expenses necessarily incurred in running the employee share scheme. Company A incurs various costs in relation to the implementation and on-going administration of the EST. For example, Company A will incur costs associated with the services provided by the EST, including but not limited to: • Participants plan record keeping. • production and dispatch of holding statements to Participants. • provision of annual income tax return information. • acquisition of shares and allocation to Participants. • management of Participant termination. • costs associated with the acquisition of shares (e.g. brokerage and other fees in allocation of shares to Participants). These expenses form part of ordinary employee remuneration costs. The costs are revenue and not capital in nature on the basis that they are regular and recurrent employment expenses. Accordingly the costs are deductible under section 8-1 in the year they are incurred. | Detailed Reasoning - Cost of establishment of EST - section 40-880: Company A will also incur various costs in relation to the establishment and implementation of the EST, including but not limited to: • taxation and legal advice in respect of the Australian tax and legal implications which may arise for both Company A and the Participants of the ESOP in respect of the EST structure. • legal drafting fees in respect of the various legal documents required in respect of the EST and the ESOP. • professional fees associated with the establishment of the EST including such costs associated with the creation and registration of the EST with various authorities. • taxation fees associated with the drafting and lodgement of the Application with the ATO. Consistent with the Commissioner's views in ATO ID 2014/42 such costs are considered to be incurred 'in implementing and administering the Employee Share Scheme', and are deductible under section 8-1. Had these costs not been deductible under section 8-1, then it would have been appropriate to consider the application of section 40-880. | Detailed Reasoning - Cost of managing tax affairs - section 25-5: Company A will incur various costs relating to tax advice associated with the implementation of the EST, including: • taxation fees associated with the drafting and lodgement of the private ruling application with the ATO. Subsection 25-5(1) provides a specific deduction for expenditure incurred to the extent that it is for managing your tax affairs. Tax affairs is defined in section 995-1 as 'affairs relating to tax'. As applying for a private ruling is an expense referred to in the example of subsection 25-5(4) as deductible under section 25-5, the tax costs incurred by Company A in relation to implementation of the EST are deductible under section 25-5 on the basis that such costs are not capital in nature. Consistent with the Commissioner's views in ATO ID 2014/42, and what has been previously identified in relation to section 40-880, such costs are considered to be incurred 'in implementing and administering the Employee Share Scheme', and are deductible under section 8-1. As such costs are deductible under section 8-1 and section 25-5, Company A can deduct only under the provision that is most appropriate (section 8-10). Therefore, costs relating to tax advice associated with the implementation of the EST are deductible under section 25-5, which is the more specific provision relating to managing tax affairs. | Detailed Reasoning - Detailed reasoning: As discussed above (Question 1), the provision of money to the Trustee of the EST by Company A for the purpose of remunerating the Participants under the ESOP is an outgoing incurred in carrying on Company A's business and is deductible under section 8-1. The deduction under section 8-1 would generally be allowable in the income year in which Company A incurred the outgoing but, under certain circumstances, the timing of the deduction is specifically determined under section 83A-210. Section 83A-210 determines the timing of a deduction for contributions, as follows: 83A-210 If: (a) at a particular time, you provide another entity with money or other property: (i) under an arrangement; and (ii) for the purposes of enabling an individual (the ultimate beneficiary) to acquire, directly or indirectly, an ESS interest under an employee share scheme in relation to the ultimate beneficiary's employment (including past or prospective employment); and (b) that particular time occurs before the time (the acquisition time) the ultimate beneficiary acquires the ESS interest; then, for the purposes of determining the income year (if any) in which you can deduct an amount in respect of the provision of the money or other property, you are taken to have provided the money or other property at the acquisition time. The term 'arrangement' is defined by subsection 995-1(1) as any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings. Under the ESOP, Company A will contribute money to the Trustee of the EST. The implementation of the ESOP undertaken by Company A satisfies the definition of an arrangement. This satisfies paragraph 83A-210(a)(i). ATO Interpretative Decision ATO ID 2010/103 considers the timing of deductions for money provided to the trustee of an employee share trust. The ATO ID determines that section 83A-210 applies to determine the timing of the deduction, but only in respect of the amount of money provided to the trust to purchase shares in excess of the number required to meet obligations arising in the year of income from the grant of options, under an employee share scheme. Section 83A-210 will only apply if there is a relevant connection between the money provided to the EST, and the acquisition of ESS interests (directly or indirectly) by Company A employees under the ESOP, in relation to the employee's employment. The ESOP is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest (i.e. a beneficial interest in an option to acquire a beneficial interest in a share of Company A), is provided to Participants in relation to their employment in Company A in accordance with the ESOP Rules. An ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company or a beneficial interest in a right to acquire a beneficial interest in a share in the company. Under the ESOP, a share or option granted to a participant is an ESS interest as it is a right to acquire either a share, or a beneficial interest in a share in Company A. The granting of the ESS interests, the provision of money to the Trustee of the EST under the arrangement, the acquisition and holding of shares by the Trustee of the EST and the allocation of those shares to Participants are all interrelated components of the employee share scheme. All the components of the scheme must be carried out so that the scheme can operate as intended. As one of those components, the provision of money to the Trustee of the EST necessarily allows the scheme to proceed. Consequently, the provision of money by Company A to the Trustee of the EST to acquire Company A shares is considered to be for the purposes of enabling the Participants, indirectly as part of the employee share scheme, to acquire ESS interests in the form of shares or options. Therefore, after Company A makes an irretrievable cash contribution to the Trustee of the EST, a deduction for the purchase of shares to satisfy the obligations arising from the grant of ESS interests is allowable under section 8-1 to Company A in the year in which the money was paid to the Trustee. However, if an amount of money is used by the Trustee to purchase excess shares intended to meet obligations arising from a future grant of ESS interests, the excess payment therefore occurs before the Participants acquire the relevant ESS interests under the Plan. Section 83A-210 will apply and the excess payment will only be deductible to Company A in the year of income when ESS interests are subsequently granted to the Participants. This is consistent with the ATO view expressed in ATO Interpretative Decision ATO ID 2010/103. However, section 83A-210 will not apply to a deduction for the purchase of shares to satisfy the obligation arising from options that have already been granted. In summary, the contribution of money by Company A to the EST would be deductible at the following times: • where a contribution to the EST is made in an income year prior to the income year in which the share or option is granted, the contribution is deductible in the year that the share or option is granted to a Participant(s); and • where a contribution to the EST is made in the income year in which the share or option is granted or an income year following the year in which the share or option is granted, the contribution is deductible in the year in which the contributions are made. | Detailed Reasoning - Section 6-5 Income according to ordinary concepts: Section 6-5, provides that a taxpayer's assessable income includes income according to ordinary concepts, which is called ordinary income. To the extent that a taxpayer is an Australian resident for tax purposes, the assessable income of the taxpayer includes ordinary income derived directly or indirectly from all sources. The expression 'income according to ordinary concepts' is not defined for the purposes of the income tax legislation, however principles to determine whether a receipt is income according to ordinary concepts have been developed by case law. In determining whether a receipt is income according to ordinary concepts, it is necessary to apply the relevant principles developed by case law to the facts of the particular case. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 21 ATR 1; 90 ATC 4413, the High Court considered the following factors were important in determining the nature of a receipt: To determine whether a receipt is of an income or of a capital character, various factors may be relevant. Sometimes, the character of the receipt will be revealed most clearly by their periodically, regularity or recurrence; sometimes, by the character of the 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 recipients purpose in engaging in the transaction, venture or business. Periodicity, recurrence and regularity are regarded as the most visible indicators of ordinary income. As a more general rule, amounts received as a result of carrying on a business should also represent ordinary income. Importantly, however, receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business. As discussed above in relation to Question 1, Dixon J in Sun Newspapers outlined the three matters to be considered in determining whether a payment is on capital or revenue account, as follows: • the character of the advantage sought by the payment • the way it is to be used or enjoyed, and • the means adopted to obtain it. ATO Interpretative Decision ATO ID 2010/155 considers the assessability as ordinary income for an employer of the option exercise price paid direct to the employer by the employee. Whilst not considered in the decision as part of the ATO ID, the reasons for decision provide some insight into the assessability of the subscription price as ordinary income of the exercise price received by the employer company. The reasons for decision provide that when the trustee of the EST subscribes to the company for an issue of shares and pays the full subscription price for the shares using contributions provided by the employer in accordance with an employee share scheme, the company is taken to have received a contribution of share capital from the trustee. The subscription price received by the company is a capital receipt of the company, not ordinary income. As stated previously in this ruling, Company A has established the ESOP as part of its remuneration policy with the intention of recognising and rewarding employees for performance and attracting and retaining high performing employees. The act of subscribing for Company A shares by the Trustee of the EST is governed by the Deed and any directions the Trustee receives from Company A (either to acquire shares on-market or subscribe for shares). Notwithstanding that the Trustee's subscription for shares relates to the satisfaction of Company A's obligations under the Rules, the subscription for shares is part of Company A's capital management strategy. The character of the share subscription proceeds received by Company A from the Trustee of the EST can be determined by the character of the right or thing disposed of in exchange for the receipt. Here, Company A is issuing the Trustee with new shares in itself. The character of the newly issued share is one of capital. Therefore, it can be concluded that the receipt, being the subscription proceeds, takes the character of share capital, and accordingly, is also of a capital nature. Based on the above, the subscription proceeds are capital receipts and accordingly not assessable as ordinary income pursuant to section 6-5. | Detailed Reasoning - Section 20-20 Assessable recoupments: Under Subdivision 20-A, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable. Under subsection 20-20(2), an amount you have received as recoupment of a loss or outgoing is an assessable recoupment if: (a) you received the amount by way of insurance or indemnity; and (b) you can deduct an amount for the loss or outgoing for the *current year, or you have deducted or can deduct an amount for the loss or outgoing for an earlier income year under any provision of this Act. "Indemnity", is defined in the Shorter Oxford English Dictionary as "compensation for loss, or a sum paid by way of compensation" which includes a receipt in the nature of compensation by way of statutory right as well as a receipt under a contract of indemnity. In the present case, Company A receives an amount for the subscription of shares by the EST which by its very nature does not represent an insurance or indemnity receipt. There is no insurance contract involved. The subscriptions received by Company A from the EST are for shares and are integral to the arrangement whereby the acquisition and holding of the shares by the Trustee and the allocation of shares to the Participants are all interrelated components of the ESOP. The character of the subscriptions paid to Company A for shares is not one of 'insurance, indemnity or other recoupment'. It follows that the subscriptions received do not constitute an assessable recoupment under subsection 20-20(2). The subscription price paid by the EST does not fall within the definition of "indemnity". This is because the receipt does not arise because of a statutory right or contract of indemnity and the receipt is not in the nature of compensation. The receipt is simply an incident of the transaction flows for the funding of the EST and fulfilment of the obligations under the ESOP Rules. Subsection 20-20(3) makes an amount received as a recoupment of a loss or outgoing, otherwise than by way of insurance or indemnity, an assessable recoupment if such a loss or outgoing is deductible in the current or a prior income year under a provision listed in section 20-30. The ordinary meaning of recoupment is extended by subsection 20-25(1) to include: (a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described; and (b) a grant in respect of a loss or outgoing. However, none of the provisions listed in section 20-30 are relevant to the current circumstances. Therefore the subscription proceeds will not be an assessable recoupment under subsection 20-20(3). For the above reasons, the subscription proceeds received by Company A do not constitute assessable recoupments under subsection 20-20(2) or under subsection 20-20(3). | Detailed Reasoning - Capital Gains Tax: Subsection 102-5(1) provides that your assessable income includes your net capital gain for the income year. Section 102-20 provides that 'you can make a capital gain or capital loss if and only if a CGT event happens...'. Given that a capital gain or capital loss is made only if a CGT event happens, the initial step is to ascertain whether such an event has occurred. Section 104-5 lists the types of CGT events. In the present case, the transaction is the payment of subscription proceeds by the Trustee of the EST to Company A for the issue of shares, which is a capital receipt, the possible CGT events are: • D1 Creating contractual or other rights; or • H2 Receipt for event relating to a CGT asset. Subsection 102-25(3) provides that CGT event D1 applies in preference to CGT event H2. Subsection 104-35(1) states that CGT event D1 'happens if you create a contractual right or other legal or equitable right in another entity'. CGT event D1 would therefore apply to Company A in circumstances where the receipt of the subscription proceeds was for the creation by Company A of a contractual, legal or other equitable right in another entity. However, paragraph 104-35(5)(c) states that event D1 does not happen where a company issues or allots equity interests in the company which is the case when the Trustee subscribes for Company A shares. As CGT event D1 is excluded, it is necessary to consider the possible application of CGT event H2 (as per paragraph 102-25(3)(b)). CGT event H2 happens if an act, transaction or event occurs to a CGT asset owned by a taxpayer and the occurrence does not result in an adjustment to the cost base or reduced cost base (subsection 104-155(1)). However, paragraph 104-155(5)(c) provides that CGT Event H2 does not happen where a company issues or allots equity interests in the company, which is applicable here. It follows, for these reasons, CGT Event H2 does not occur. Accordingly, a CGT event under Division 104 does not arise when the Trustee subscribes for shares in the capital of Company A. Therefore, the subscription proceeds will not be included in the assessable income of Company A under section 6-5 or section 20-20 and will also not trigger a CGT event under Division 104. | Detailed Reasoning - Detailed reasoning: Law Administration Practice Statement PS LA 2005/24 provides instructions and practical guidance to Tax Officers on the application of Part IVA of the ITAA 1936 and other General Anti-Avoidance Rules. Part IVA of the ITAA 1936 is a general anti-avoidance provision. Part IVA gives the Commissioner the discretion to cancel a tax benefit that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. The discretion is found in subsection 177F(1) of the ITAA 1936. Before the Commissioner can exercise his discretion to make a determination in respect of Part IVA under subsection 177F(1) of the ITAA 1936, three requirements must be met: 1. there must be a scheme within the meaning of section 177A of the ITAA 1936 2. a tax benefit must arise based on whether a tax effect would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, and 3. having regard to the matters in subsection 177D(2) of the ITAA 1936, the scheme is one to which Part IVA of the ITAA 1936 applies (dominant purpose). | Detailed Reasoning - The scheme: Subsection 177A(1) of the ITAA 1936 provides that 'scheme' means: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct. It is considered that this definition is sufficiently wide to cover the establishment of the ESOP, which consists of the creation of the EST, the payment of the irretrievable contributions by Company A to the Trustee, the acquisition of shares in Company A and the allocation of those shares to Participants. | Detailed Reasoning - Tax Benefit: The words 'tax benefit' are relevantly defined in subsection 177C(1) of the ITAA 1936 as follows: (1) Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to: (a) … (b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or (c) … Determination of whether Company A will derive a tax benefit from this scheme requires a consideration of subsections 177CB(2) and (3) of the ITAA 1936 which provide two alternative bases upon which it may be demonstrated whether the tax effect (that is, whether a deduction is allowable where the whole or a part of that deduction would not have been allowable if the scheme had not been entered into or carried out) has occurred or might reasonably be expected to have occurred. Subsection 177CB(2) of the ITAA 1936 states: (2) A decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme). Subsection 177CB(2) of the ITAA 1936 requires that a decision that a tax effect 'would have' occurred if the scheme had not been entered into or carried out, must be made solely on the basis of a postulate comprising all of the events or circumstances that actually happened or existed, other than those that form part of the scheme. When postulating what would have occurred in the absence of the scheme, the scheme must be assumed not to have happened, that is it must be 'annihilated' or extinguished. However, the alternative postulate must incorporate all the events or circumstances that actually happened or existed. Subsection 177CB(3) of the ITAA 1936 states: (3) A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme. Subsection 177CB(3) of the ITAA 1936 requires that a decision that a deduction 'might reasonably be expected not to have been allowable' if the scheme had not been entered into or carried out, must be made on the basis of a postulate that is a reasonable alternative to the scheme. Subsection 177CB(4) requires that in order for a postulate to be a reasonable alternative to a scheme under subsection 177CB(3) of the ITAA 1936 it must be worked out having particular regard to the substance of the scheme and its results and consequences for the taxpayer, and disregarding any potential tax results and consequences. As the scheme achieves a number of non-tax commercial consequences for Company A it is not appropriate to determine the existence of a tax benefit by applying subsection 177CB(2) of the ITAA 1936. Subsection 177CB(3) of the ITAA 1936 provides the most appropriate method for determining whether a tax benefit has occurred or would be expected to occur if the scheme had not been entered into or carried out. Rather than entering into the Scheme, other alternatives include: Alternative 1 - Company A could fund purchase of shares on-market: The Applicant has put forward as an alternate postulate that Company A could have funded the purchase of shares on-market in the name of the Participant upon vesting of the share. Under this alternative arrangement a tax deduction would be available for Company A for the purchase cost of the shares. Alternative 2 - Company A could remunerate its employees in the form of cash or bonuses: The Applicant has put forward as an alternative postulate that Company A could provide remuneration to Participants in the form of cash payments or salary bonuses (i.e. cash equivalent amounts based on the value of shares). Under this alternative arrangement a tax deduction would be available to Company A in respect of the total remuneration provided. Alternative 3 - Company A could issue shares directly to participants A further alternative postulate is that Company A could issue new shares directly to Participants. However, under the general income tax law an employer cannot deduct any amount for directly providing shares or options in itself to its employees. That is because the issue of share capital would not be a loss or outgoing (as it merely creates a dilution of the existing share capital) even though it relates to the remuneration of its employees. However, under this alternative a deduction may be available, capped at $1,000 per employee, for the cost of issuing and transferring the shares under section 83A-205. The deduction under section 83A-205 is to be contrasted with the deduction that would be obtained under the scheme. That is, a deduction limited to $1,000 per employee compared to a deduction for the amount of irretrievable cash contributions (which are equivalent to the market value of the shares). The alternate postulate reveals that a tax benefit has occurred and can be expected to occur for the purposes of subsection 177C(1) of the ITAA 1936 in relation to the scheme as a result of the greater deductions that will be allowable for contributions to the EST under section 8-1. | Detailed Reasoning - Sole or Dominant Purpose: In deciding whether Part IVA of the ITAA 1936 applies to a scheme, it is necessary to consider whether, having regard to each of the factors set out in paragraph 177D(b) of the ITAA 1936, it would be concluded that the person, or one of the persons who entered into the scheme or any part of it, did so for the purpose of enabling a relevant taxpayer to obtain a tax benefit in connection with the scheme. However notwithstanding that an examination of the counterfactuals would likely reveal no tax benefit, regard will be had to each of these factors in the event that a tax benefit was identifiable. | Detailed Reasoning - Subsection 177D(2) of the ITAA 1936: Subsection 177D(2) of the ITAA 1936 sets out certain factors that must be considered in deciding whether a scheme was entered into for the purpose of obtaining a tax benefit. Subsection 177A(5) of the ITAA 1936 requires obtaining a tax benefit to be the 'dominant purpose' for undertaking a scheme in order for there to be an application of Part IVA of the ITAA 1936. In considering whether Part IVA applies, it is necessary to compare the scheme as proposed and the relevant alternate postulate in light of the following factors from subsection 177D(2) of the ITAA 1936: (a) the manner in which the scheme was entered into or carried out; (b) the form and substance of the scheme; (c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; (e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; (f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; (g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out; (h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f). The manner of the scheme The inclusion of the EST in the scheme gives rise to a tax benefit, but it is contended that the presence of the EST provides other commercial benefits. The applicant has stated that the dominant purpose of entering into the scheme is to facilitate and administer the ESOP to provide a long term incentive for employees. Whilst the funding of the EST and how the EST uses such funds will be directed by the Board of Company A, this is common practice in relation to employee share trusts. Further, the directions that the Board give to the Trustee will be made for commercial purposes (e.g. whether to subscribe for shares in Company A or buy shares from existing shareholders). For example, there may be a desire by Company A to retain cash for growth (supporting a decision to issue new shares) or a desire to prevent dilution (supporting a decision to purchase shares from existing shareholders). Employee share trusts are common commercial vehicles which have been used by taxpayers for many years to provide remuneration benefits to employees. Their usage is widespread amongst public and private companies in Australia and overseas. It is to be expected that a company would seek to establish an employee share scheme that is widely used in ordinary commercial dealings and by competitors in the market. The establishment of the EST is explicable by reference to a number of commercial reasons and ordinary business arrangements. Further, the Applicant contends that employees will be motivated and encouraged by being able to participate in the success of Company A through share ownership under the ESOP. The alternate postulate would not enable employees to participate in the same manner anticipated by the scheme and arguably may not incentivise employees in the same fashion. It is noted that the arrangement is not blatant, contrived or artificial and intentionally established close to the end of the Company A income year nor is it intended that Company A will provide large up-front payments to provide for the operation of the EST for several years into the future (as happened in Pridecraft Pty Ltd v FC of T [2004] FCAFC 339; 2005 ATC 4001; 58 ATR 210.) Rather, Company A will fund the EST on a recurring basis as the need arises. It is accepted that the use of the EST provides some benefits to the operation of the scheme that would not be available under the alternative postulate where the shares are provided to employees directly by Company A. The form and substance This factor directs attention to whether there is a discrepancy between the form of the scheme and its substance, meaning its commercial and economic substance. A discrepancy between the business and practical effect of a scheme on one hand and its legal form on the other, may well indicate the scheme has been implemented in a particular form as the means to obtain a tax benefit if the substance of the scheme may be achieved or available by some other more straightforward or commercial transaction or dealing (paragraph 95 of PS LA 2005/24). The substance of the scheme is the provision of remuneration in the form of shares to participants who participate in the ESOP. It takes the form of irretrievable contributions by Company A to the Trustee of the EST which will acquire shares for Participants. While existence of the EST confers a tax benefit, it cannot be concluded that it is the only benefit provided as outlined above. The Applicant has argued there is nothing in this factor to suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit and this is accepted. It is accepted that there is no apparent discrepancy between the effect of the scheme under the ESOP, and its form. The timing of the scheme The scheme has not been established to provide a substantial year-end deduction to Company A, nor with a contribution sufficiently large to fund the EST for several years. The contributions will be made progressively over future years in accordance with the terms of the ESOP. Furthermore, the length of the scheme is not intended to be for a short period. The scheme is intended to remain in place indefinitely provided the commercial benefits outweigh the respective costs of administration. There is nothing regarding this factor that suggests that the EST was established for the sole or dominant purpose of obtaining a tax benefit. The result of the scheme The result of the scheme is that Company A will be entitled to a deduction for the contributions it makes to the EST. However, it is noted that the contributions are irretrievable and reflect a genuine non-capital outgoing on the part of Company A to achieve a business outcome. It is to be expected that a deduction would normally be allowable in these circumstances. There is nothing in this factor to suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit. Any change in the financial position of the company As noted above, Company A makes irretrievable cash contributions to the EST and those contributions constitute a real expense with the result that Company A's financial position is changed to that extent. While it is arguable that the quantum of the deductions is higher with the EST as part of the scheme, in contrast to Company A providing shares to Participants directly, there is nothing artificial, contrived or notional about Company A's expenditure. There is nothing in this factor to suggest that the scheme has been carried out for the dominant purpose of obtaining a tax benefit. Any change in the financial position of other entities or persons The contributions by Company A to the Trustee will form part of the corpus of the EST and must be dealt with by the Trustee in accordance with the terms of the Deed, that is, for the acquisition/subscription of shares to ultimately be provided to Participants in the ESOP. Company A is not a beneficiary of the EST and its contributions cannot be returned to it in any form except where the Trustee acquires shares from Company A by subscribing for new shares at market value. Therefore, the contributions made by Company A amount to a real change to the financial position of the Trustee. The financial position of employee participants in the scheme will also undergo a real change. It is accepted that there is nothing artificial, contrived or notional about these changes. Any other consequence This factor is not relevant in the present case. The nature of any connection between the company and any other persons The relationship between Company A and the Participants is one of employer/employee. It is accepted that the relationship will therefore generally be at arm's length. The Trustee is an independent third party, unrelated to Company A and under a fiduciary obligation to act in the interests of the Participants in the ESOP. There is nothing to suggest that the parties to the scheme are not acting at arm's length to one another. Accordingly, there is nothing in relation to this factor to indicate a dominant purpose of obtaining a tax benefit. | Detailed Reasoning - Conclusion: A consideration of all the factors referred to in subsection 177D(2) of the ITAA 1936 leads to the conclusion that the sole or dominant purpose of the parties to the scheme is not to obtain a tax benefit. Rather the sole or dominant purpose is to provide remuneration to Company A's employees who participate in the scheme in a form that promotes Company A's business objectives, rather than to obtain a tax benefit. Accordingly, the Commissioner will not make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Company A in relation to irretrievable contributions made by Company A to the EST to fund the acquisition of shares in accordance with the scheme. | Detailed Reasoning - Detailed reasoning: An employer's liability to pay fringe benefits tax ( FBT ) arises under section 66 of the FBTAA which provides that tax is imposed in respect of the fringe benefits taxable amount of an employer for the relevant year of tax. The fringe benefits taxable amount is calculated under the FBTAA by reference to the taxable value of each fringe benefit provided. In general terms, 'fringe benefit' is defined in subsection 136(1) of the FBTAA as being a benefit provided to an employee or an associate of an employee by the employer or an associate of the employer in respect of the employment of the employee. However, certain benefits are excluded from being a fringe benefit by virtue of paragraphs (f) to (s) of the 'fringe benefit' definition. Paragraph (h) of the definition of a fringe benefit contained in subsection 136(1) of the FBTAA specifically excludes from the definition of a fringe benefit: A benefit constituted by the acquisition of an ESS interest under an employee share scheme (within the meaning of the Income Tax Assessment Act 1997) to which subdivision 83A-B or 83A-C of that Act applies; An ESS interest in a company is a beneficial interest in a share in the company, or a beneficial interest in a right to acquire a beneficial interest in a share in the company (subsection 83A-10(1)). An employee share scheme is a scheme under which ESS interests in the company are provided to employees (or associates of employees) of the company or subsidiaries of the company, in relation to the employee's employment (subsection 83A-10(2)). The Participants (Company A's employees) will receive beneficial interests in shares or options to acquire beneficial interests in shares in respect of their employment, upon acceptance of participation in the ESOP in accordance with its Rules. The Commissioner accepts that the scheme described in the facts is an employee share scheme under which relevant ESS interests (being beneficial interests in rights and options to acquire shares) are acquired by employees of Company A (or 'associates of those employees'), and the acquisition of those ESS interests are in relation to the employment of those employees. Therefore, the provision of those rights will not be subject to fringe benefits tax because they are specifically excluded from the definition of fringe benefit. The shares acquired by the Trustee of the EST under the ESOP to satisfy the options are also provided to employees under that same employee share scheme. However, shares granted to Participants under the ESOP to satisfy the provision of options acquired on acceptance of participation in the ESOP are not ESS interests acquired under an employee share scheme to which Subdivision 83A-B or 83A-C apply (see subsection 83A-20(2) of the and paragraph 83A-105(1)(a)). Therefore the providing of these shares will not be specifically excluded from the definition of fringe benefits under paragraph (h) of the definition in subsection 136(1) of the FBTAA. As stated above, a fringe benefit will only arise under subsection 136(1) of the FBTAA where the benefit is provided by an employer to an employee or associate of the employee in respect of the employment of the employee. The situation is similar to that which existed in Federal Commissioner of Taxation v. McArdle 89 ATC 4051; (1988) 19 ATR 1901 where an employee was granted valuable rights in respect of his employment which he subsequently surrendered in return for a lump sum payment. Davies, Gummow and Lee JJ noted that what had occurred under the surrender agreement was not the granting of a valuable benefit, but the exploitation of rights received from the employer in previous years. In the present circumstances, when an employee accepts an offer to participate in the ESOP, he or she obtains a right to acquire a beneficial interest in a share in Company A and this right constitutes an ESS interest. When this right is subsequently exercised, any benefit received, that is, a beneficial interest in shares, would be in respect of the exercise of the right, and not in respect of employment. (Refer to ATO Interpretative Decision ATO ID 2010/219 Fringe Benefits Tax Fringe benefit: shares provided to employees upon exercise of rights granted under an employee share scheme) Therefore, the benefit that arises to a Participant after the vesting period under the ESOP, being the beneficial interest in the share or option, does not give rise to a fringe benefit as no benefit has been provided to the employee 'in respect of the employment relationship'. | Detailed Reasoning - Detailed reasoning: Subsection 136(1) of the FBTAA defines a 'fringe benefit', in relation to an employee, as a benefit in respect of the employment of the employee, and paragraph (ha) of that definition excludes: a benefit constituted by the acquisition of money or property by an employee share trust (within the meaning of the Income Tax Assessment Act 1997); An 'employee share trust' is defined in subsection 995-1(1) as having the meaning given by subsection 130-85(4). Subsection 130-85(4) provides: Meaning of employee share trust | Detailed Reasoning - 130-85(4): an employee share trust, for an employee share scheme, is a trust whose sole activities are: (a) obtaining shares or rights in a company; and (b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of: (i) the company; or (ii) a subsidiary of the company; and (c) other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b). The right to acquire a beneficial interest in an employer share is an ESS interest within the meaning of subsection 83A-10(1). 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 (including past or prospective employees) in relation to the employees' employment. The scheme is an employee share scheme within the meaning of subsection 83A-10(2) because it is a scheme under which rights to acquire beneficial interests in shares in the company are provided to employees in relation to the employee's employment. Under the ESOP, Company A has also established the EST to acquire shares in Company A and to allocate those shares to Participants. Therefore, paragraphs 130-85(4)(a) and (b) are satisfied because: • the EST's sole activities are to acquires shares in Company A, and • the operation of the EST ensures that the ESS interests, being the right to beneficial interests in either Shares or options, are provided under an employee share scheme, to the Participants in accordance with the Trust Deed and Rules of the ESOP. Undertaking the activities mentioned in paragraphs 130-85(4)(a) and 130-85(4)(b) will require that the Trustee undertake incidental activities that are a function of managing the plans and administering the EST. The incidental activities are covered by paragraph 130-85(4)(c). The EST is an employee share trust, as defined in subsection 995-1(1), as the activities of the trust in acquiring and allocating ESS interests meet the requirements of paragraphs 130-85(4)(a) and 130-85(4)(b) and its other activities are merely incidental to those activities in accordance with paragraph 130-85(4)(c). As such, paragraph (ha) of the definition of fringe benefit in subsection 136(1) of the FBTAA excludes the contributions to the Trustee of the EST from being a fringe benefit. Accordingly, Company A will not be required to pay FBT in respect of the irretrievable cash contributions it makes to the Trustee of the EST to fund the acquisition of Company A shares in accordance with the Deed. | Detailed Reasoning - Detailed reasoning: Law Administration Practice Statement PS LA 2005/24 has been written to assist those who are contemplating the application of Part IVA or other general anti-avoidance rules to an arrangement, including in a private ruling. It succinctly explains how section 67 of the FBTAA operates. Most notably, paragraphs 145-148 provide as follows: 145. Section 67 is the general anti-avoidance provision in the FBTAA. The operation of section 67 is comparable to Part IVA, in that the section requires the identification of an arrangement and a tax benefit, includes a sole or dominant purpose test and is activated by the making of a determination by the Commissioner. The definition of 'arrangement' in subsection 136(1) of the FBTAA is virtually identical to the definition of 'scheme' in section 177A of Part IVA. 146. Subsection 67(1) of the FBTAA is satisfied where a person or one of the persons who entered into or carried out an arrangement or part of an arrangement under which a benefit is or was provided to a person, did so for the sole or dominant purpose of enabling an eligible employer or the eligible employer and another employer(s) to obtain a tax benefit. 147. An objective review of the transaction and the surrounding circumstances should be undertaken in determining a person's sole or dominant purpose in carrying out the arrangement or part of the arrangement. Section 67 differs from paragraph 177D(b) in Part IVA in that it does not explicitly list the factors that should be taken into account in determining a person's sole or dominant purpose. 148. Subsection 67(2) of the FBTAA provides that a tax benefit arises in respect of a year of tax in connection with an arrangement if under the arrangement: (i) a benefit is provided to a person; (ii) an amount is not included in the aggregate fringe benefits amount of the employer; and (iii) that amount would have been included or could reasonably be expected to have been included in the aggregate fringe benefits amount, if the arrangement had not been entered into. Therefore, the Commissioner would only seek to make a determination under section 67 of the FBTAA if the arrangement resulted in the payment of less fringe benefits tax than would be payable but for entering into the arrangement. The point is made effectively in the now withdrawn Miscellaneous Taxation Ruling MT 2021 under the heading "Appendix, Question 18" where, on the application of section 67, the Commissioner states: …As mentioned in the explanatory memorandum to the FBT law, section 67 may only apply where there is an arrangement under which a benefit is provided to a person and the fringe benefits taxable amount in respect of that benefit is either nil or less than it would have been but for the arrangement... Further, paragraph 151 of Practice Statement 2005/24 provides: 151. The approach outlined in this practice statement (refer to paragraphs 69 to 113) to the counterfactual and the sole or dominant purpose test in Part IVA is relevant and should be taken into account by Tax officers who are considering the application of section 67 of the FBTAA. In the present case, the benefits provided to the Trustee by way of irretrievable contributions to the EST and to Participants by way of the provision of shares and options under the ESOP are excluded from the definition of a fringe benefit as explained in Questions 6 and 7. Therefore, as these benefits have been excluded from the definition of a fringe benefit and as there is also no FBT currently payable under the plans, the FBT liability is not any less than it would have been but for the arrangement. Accordingly, the Commissioner will not make a determination that section 67 of the FBTAA applies to include an amount in the aggregate fringe benefits amount of Company A in relation to a tax benefit obtained under the scheme from irretrievable contributions made by Company A to the Trustee of the EST to fund the acquisition of Company A shares under this scheme.

Subject: Employee share scheme: All references are to the Income Tax Assessment Act 1997 unless otherwise stated.