Private ruling: Employee Share Option Schemes
Published: January 2012
Ruling period: 1 July 2011 to 30 June 2016

Ruling: Q6: Will the Commissioner seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Company A in respect of the non- refundable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition on-market of Company A's Shares by the EST? Advice/Answers No

Relevant facts and circumstances: The scheme that is the subject of this Ruling has been ascertained from the following documents: § Application for Private Ruling § The ESOP and PRP rules § The Trust Deed for the E Trust

Relevant legislative provisions: Section 6-5 of the Income Tax Assessment Act 1997 | Section 8-1 of the Income Tax Assessment Act 1997 | Section 20-20 of the Income Tax Assessment Act 1997 | Section 83A-10 of the Income Tax Assessment Act 1997 | Section 83A-35 of the Income Tax Assessment Act 1997 | Section 83a-205 of the Income Tax Assessment Act 1997 | Section 83A-210 of the Income Tax Assessment Act 1997 | Section 102-5 of the Income Tax Assessment Act 1997 | Section 102-25 of the Income Tax Assessment Act 1997 | Section 104-35 of the Income Tax Assessment Act 1997 | Section 104-155 of the Income Tax Assessment Act 1997 | Section 995-1 of the Income Tax Assessment Act 1997 | Section 139DB the Income Tax Assessment Act 1936 | Section 139E Income Tax Assessment Act 1936 | Section 177A Income Tax Assessment Act 1936 | Section 177C Income Tax Assessment Act 1936 | Section 177D Income Tax Assessment Act 1936 | Section 177F Income Tax Assessment Act 1936 | Section 83A-5 of the Income Tax (Transitional Provisions) Act 1997 | Section 83A-19 Income Tax (Transitional Provisions) Act 1997

Reasons for decision: Summary: Will Company A obtain an income tax deduction, pursuant to section 8-I of the ITAA 1997, in respect of the non-refundable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition on-market of Company A Shares by the EST? Advice/Answers Answer Yes. Detailed reasoning Section 8-1 of the ITAA 1997 provides that you can deduct from your assessable income any loss or outgoing to the extent that it is: (a) Incurred in gaining or producing your assessable income; or (b) Necessarily incurred in carrying on a business for the purposes of gaining or producing your assessable income, However, subsection 8-1(2) denies a deduction to the extent the loss or outgoing is, inter alia: (a) Capital or of a capital nature; (b) Private or domestic nature; or (c) Incurred in relation to exempt income. The purpose of the Incentive Plans is to provide a benefit to employees, in respect of their employment, by allowing them to obtain a share of Company A at a discount or as reward for obtaining a particular goal or objective that increases shareholder value. This approach to staff reward seeks to align employee and shareholder interests through a shared desire to see the value of the share price grow. These contributions to the Trustee are part of the overall employee remuneration costs of Company A, and are therefore deductible under section 8-1 of the ITAA 1997. Importantly, the Incentive Plans are part of Company A's employee remuneration strategy designed to offer a competitive and compelling remuneration structure to attract and retain key employees in an environment of fierce competition for qualified staff. In Spotlight Stores Pty Limited v FC of T ( 2004) ATC 4674 ("Spotlight') and Pridecraft Pty Ltd v PC of T ( 2005) ATC 4001 , the Courts took the view that contributions to employee benefit trusts were not capital in nature as the advantage to be obtained did not have a lasting quality. The advantage to be enjoyed was the maintenance of the employee's trust and confidence in the incentive scheme, thereby improving the taxpayer's profitability. This encouraged them to make a greater effort from year to year thereby improving the taxpayer's profitability. Therefore, the advantage was recurrent. Ongoing, recurring contributions to the EST are required to be made by Company A if and when a Participant is entitled to be allocated Shares under the ESOP, and this is analogous to the Spotlight facts and decision. This supports the view that the provision of benefits to employees as part of a broader remuneration plan is a revenue outgoing, intrinsically connected to the carrying on of a business. Contributions to the EST are revenue and not capital in nature on the basis that they are regular and recurrent employment expenses. As no other exclusion applies, the contributions are tax deductible expenses for Company A under section 8-1 of the ITAA 1997. Will Company A obtain an income tax deduction, pursuant to section 8-1 of the ITAA 1997, in respect of costs incurred in relation to the implementation and on-going administration of the EST? Advice/Answers Answer Yes. Detailed reasoning Company A will incur costs in relation to the implementation and on-going administration of the EST. The view that the costs incurred by Company A are deductible under section 8-1 of the ITAA 1997 is consistent with ATO ID 2002/961, in which it was decided that: The costs incurred by the taxpayer company in implementing and administering its employee share scheme will be deductible under section 8-1 of the ITAA 1997... The operating costs associated with the administration and implementation of the employee share plan are part of the ordinary employee remuneration costs of the taxpayer. Accordingly they are deductible under section 8-1 of the ITAA 1997 in the year that they are incurred. Consistent with the analysis in Question 1 above costs incurred by Company A in relation to the implementation and on-going administration of the EST should be deductible under section 8-1 of the ITAA 1997. This is on basis that they are regular and recurrent employment expenses incurred in gaining or producing the assessable income of Company A, or necessarily incurred in carrying on Company As business for the purpose of gaining or producing the assessable income of Company A. In addition, these expenses are revenue in nature and are not capital items given that they do not create an enduring benefit for Company A but are periodic in nature. Further, the sole purpose of the EST (and therefore the costs incurred as a result) is to operate the company's Incentive Plans which are linked to employee retention, remuneration, attraction and ultimately improved company performance. In this respect the EST establishment and maintenance costs are not materially different from the payment of staff salaries or the costs incurred to pay such salaries (i.e. administration costs). Are non-refundable cash contributions made by Company A to the Trustee of the EST, to fund the subscription for or acquisition on-market of Company A Shares by the EST. deductible to Company A at a time determined by section 83A-210 of the ITAA 1997 in respect of Employee Share Scheme ('ESS") interests that have a deferred taxing point arising after 30 June 2009? Advice/Answers Answer Yes. Detailed reasoning Under certain circumstances, if contributions are made to the EST prior to the acquisition of an ESS interest by Participants, the timing of the income tax deduction in respect of those contributions (claimed pursuant to section 8-1 of the ITAA 1997) will be modified to occur at the time the Participant acquires the relevant ESS interest (pursuant to section 83A-210 of the ITAA 1997). With effect from 1 July 2009, section 83A-210 of the ITAA 1997 determines the timing of a deduction for contributions. | Detailed Reasoning - Transitional provisions:: On 14 December 2009, the Tax Laws Amendment (2009 Budget Measures No. 2) Act 2009 received Royal Assent. As a result, Division 83A of the ITAA 1997 was introduced effective from 1 July 2009 and Division 13A of the ITAA 1936 was subsequently repealed with effect from 1 July 2009. Company A issued a number of Share Options under the ESOP prior to 1 July 2009 A number of these Share Options are yet to vest or have vested but have not been exercised. When they vest and/or are exercised, Shares will be issued or purchased on market for Participants through the EST. Accordingly, consideration of the relevant transitional provisions in the Income Tax (Transitional Provisions) Act 1997 'ITTPA 1997") is required The transitional provisions are only applicable to the ESOP, not the PRP, because the PRP was post introduction of Division 83A of the ITAA 1997. Share Options issued to Participants with the following criteria will fall within the application of subsection 83A-5(2) of the ITTPA 1997: • The Share Options were issued pursuant to the ESOP prior to 1 July 2009, • A section 139E of the ITAA 1936 election has not been made by the Participant; and • The 'cessation time' mentioned in subsection 139B (3) of the ITAA 1936 has not occurred prior to 1 July 2009. On this basis, the taxpayer submitted that Division 83A of the ITAA 1997 also applies in relation to these Share Options when considering the questions outlined to the Commissioner in this Application. Division 83A of the ITAA 1997 also applies in respect of Share Options issued pursuant to the ESOP post 1 July 2009. Company A does not have any Employee Share Options under the ESOP that do not satisfy these conditions (subject to the comment below), Division 83A Share Options and Performance Rights Subsection 83A-20(2) of the ITAA 1997 deems that Division 83A does not apply where a taxpayer has acquired a share as a result of exercising a right under an employee share scheme. Therefore; under the Incentive Plans, shares allocated to Participants upon exercise of the Options are not acquired by the employee under an 'employee share scheme" as described above. However, ATO ID 2010/103 provides that a share purchased by the Trustee to satisfy the option or right to acquire shares under an employee share scheme, is itself provided under the same scheme. On this basis, it is submitted that the contribution of money by Company A to the EST to enable the acquisition by the EST of shares to be allocated to Participants under the Incentive Plans will be deductible in accordance with section 83A-210. As outlined above, section 83A-210 will only allow a deduction to Company A when the ESS interest has been granted to the employee. Therefore, Company A can only deduct contributions to the EST for the acquisition of Shares, when the relevant Share Options or Performance Rights are granted to Participants. Therefore the deduction would be available once the contributions had been made to the Trust, even if the related Shares had not been acquired and allocated, as there has already been an acquisition of Share Options or Performance Rights by the Participants, as required by section 83A-210 of the ITAA 1997. | Detailed Reasoning - Question 4: Are non-refundable cash contributions made by Company A to the Trustee of the EST, to fund the subscription or acquisition on-market of Company A Shares by the EST, deductible to Company A at a time determined by section 139DB of the ITAA 1936 in respect of ESS interests that have a deferred taxing point arising before 1 July 2009? Advice/Answers Answer Yes. Detailed reasoning Division 13A Share Options As discussed above (see Application of Transitional Provisions), Division 13A of the ITAA 1936 will continue to apply to Share Options issued to Participants pursuant to the ESOP before 1 July 2009 where a section 139E election has been made by the Participant. We have not considered the exception under subsection 139C(4) of the ITAA 1936 because the interests acquired by the holders of the Division 13A Share Options are options, rather than shares, When is the contribution to the Trustee deductible? In the present arrangement: the Division 13A Share Options have already been issued. Therefore, the contributions will be made by Company A to the EST after the Division 13A Share Options are acquired for the purposes of s139DB. As the Share Options have been acquired by the Participant prior to the contribution by Company A to the Trustee, section 139DB of the ITAA 1936 is not required to defer the timing of the deduction to Company A. A deduction will be allowed under section 8-1 of the ITAA 1997 in respect of the provision of money to the trustee of the EST in the year of income in which the contribution to the EST is made. | Detailed Reasoning - Question 5: If the Trustee of the EST satisfies its obligations under the Incentive Plans 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 of the ITAA 1997 or trigger a capital gains tax ("CGT') event under Division 104 of the ITAA 1997? Advice/Answers No Summary Detailed reasoning 1. Ordinary Income In the case of GP International Pipecoaters v. Federal Commissioner of Taxation (1990) 170 CLR 124 ("Pipecoaters case"), the full bench of the High Court found that; To determine whether a receipt is of an income or of a capital character, various factors maybe relevant. Sometimes, the character of the receipt will be revealed most clearly by their periodicity, regularity or recurrence The obligations of company A under the Plans is part of Company A's capital management strategy. Furthermore, the funds received do not represent reimbursement of expenditure (as was the case in Reckitt & Colman Pty Limited v FCT (1974) 4 ATR 501) or some form of compensation for a loss or outgoing. Accordingly, the receipt of a subscription price to acquire new Shares should not be treated as ordinary income in the hands of Company A. The receipt from the Trustee of the EST of any subscription price by Company A will be characterised as stemming from an inherently and fundamentally capital transaction and accordingly will not be not assessable as ordinary income pursuant to section 6-5 of the ITAA 1997. This outcome is also consistent with the treatment of proceeds from the subscription of Shares under the capital gains tax provisions (see below). 2. Assessable recoupment Subsection 20-20(2) of the ITAA 1997 states that an amount that you have received as recoupment of a loss or outgoing is an assessable recoupment if you receive the amount by way of insurance or indemnity and the loss or outgoing could be deducted by a taxpayer in the current year or a previous income year. Company A may receive 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 therefore the receipt cannot be considered an insurance receipt. The subscription price paid by the EST does not fall within the definition of indemnity because first, the receipt does not arise because of a statutory right or contract of indemnity and secondly, 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 fulfillment of the obligations under the Incentive Plans. Thus the amount does not constitute an assessable recoupment under subsection 20-20(2) of the lTAA 1997. 3. Assessable Recoupment - Other Recoupment (I.e. not by way of insurance indemnity) Pursuant to subsection 20-20(3) of the ITAA 1997, an amount that Company A receives as recoupment of a loss or outgoing, except by way of insurance or indemnity, is an assessable recoupment if such loss or outgoing is deductible in the current or a prior income year because of a provision listed in the table in section 20-30 of the ITAA 1997. None of the provisions listed in section 20-30 of the ITAA 1997 are relevant to the current circumstances. Therefore, the subscription amount does not constitute an assessable recoupment under subsection 20-20(3) of the TM 1997. 4. Capital Gains Tax Section 102-20 of the ITAA 1997 provides that you can make a capital gain or capital loss if and only if a CGT event happens...". Possible CGT events event D1 (Creating a contractual or other rights) and/or event H2 (Receipt for event relating to a CGT asset). Both CGT event D1 and CGT event H2 are residual events for the purposes of the CGT provisions (per subsection 102-25(3) of the ITAA 1997) and can only apply in circumstances where no other event happens. CGT event D1 is taken to apply in preference to CGT event H2. Creating Contractual or Other Rights. CGT Event D1 CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity (subsection 104-35(1) of ITAA 1997). Subsection 104-35(5)(c) of the ITAA 1997 provides that CGT event Dl does not happen if a company issues or allots equity interests or non-equity shares in the company'. Since the Company A Shares will constitute "equity interests" (see subsection 974-75(1) of the ITAA 1997), CGT event Dl does not apply. Receipt for Event Relating to a CGT Asset: CGT Event H2 As CGT event Dl does not apply, it is necessary to consider the potential application of CGT event H2 (as per subsection 102-25(3) (b)). CGT event H2 happens if an act, transaction or event occurs in relation to a CGT asset that the taxpayer owns and which does not result in an adjustment to the asset's cost base or reduced cost base (subsection 104-155(1) of the ITAA 1997). The subscription proceeds paid by the Participant (i.e. any exercise price paid) arises out of a contractual right of the Participant to acquire Shares in Company A under the Incentive Plans, rather than in respect of any asset that is owned by Company A. Further, subsection 104-155(5)(c) provides that CGT event H2 is taken not to have happened where a company issues or allots equity interests or non-equity shares in the company'. As the ordinary Shares of Company A will constitute equity interests' (see subsection 974-75(1) of the ITAA 1997, CGT event H2 cannot apply. | Detailed Reasoning - Question 6: Will the Commissioner seek to make a determination that Part IVA of the ITAA 1936 applies to deny, in part or full, any deduction claimed by Company A in respect of the non- refundable cash contributions made by Company A to the Trustee of the EST to fund the subscription for or acquisition on-market of Company A's Shares by the EST? Advice/Answers Answer No Detailed reasoning A consideration of all the factors referred to in paragraph 177D (b) of the ITAA 1936 leads to the conclusion that the dominant purpose of the scheme is to provide remuneration to Company A's employees who participate in the scheme, in a form that promotes the taxpayer'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 in full, any deduction claimed by Company A in relation to irretrievable contributions made by Company A to the EST to fund the acquisition of Employer shares in accordance with the scheme as outlined above.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Will Company A obtain an income tax deduction, pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997), in respect of the non-refundable cash contributions made by Company A to the Trustee of the Employee Share Trust (EST) to fund the subscription for or acquisition on-market of Company A Shares by the EST? | Are non-refundable cash contributions made by Company A to the Trustee of the EST, to fund the subscription or acquisition on-market of Company A Shares by the E Trust, deductible to Company A at a time determined by section 139DB of the ITAA 1936 in respect of ESS interests that have a deferred taxing point arising before 1 July 2009?