Private ruling: Share capital tainting
Date of advice: 25 November 2019
Published: February 2020
Ruling period: The relevant years
Date scheme commenced: The relevant date

Ruling: Q1: Will the accounting entries made by the Company, to account for the provision of shares or rights under its employee equity programs for the Performance Options and Rights, result in an amount to which Division 197 of the Income Tax Assessment Act 1997 applies? | A1: No.

Relevant facts and circumstances: The Company's Share Plan The Company operates one employee share scheme (the Scheme) within the meaning of Division 83A of the Income Tax Assessment Act 1997 (the 1997 Act). Various offers of shares and rights have been made under the Scheme to Participating Employees. Rights issued have included Performance Options and Performance Rights. A Performance Option grants a right to a Participating Employee to exercise for a fully paid up share in the Company upon the payment of the exercise price from the date of vesting to the expiry date of the option. A Performance Right entitles the participating employee to be issued a fully paid up share in the Company for no consideration. The entitlement to the quantum of Performance Options and Performance Rights are subject to the achievement of performance targets and continuity of employment during the period from grant date to vesting date pursuant to terms and conditions set out at the grant date. Accounting treatment The Company is required to apply the accounting treatment set out in AASB 2 "Share based payment" (the Standard) in relation to the Scheme. The Standard requires the recognition of an expense for all share based remuneration granted to employees, irrespective of whether it is satisfied through the issue or purchase of shares. In this regard the Standard provides: The objective of this Standard is to specify the financial reporting by an entity when it undertakes a share-based payment transaction. In particular, it requires an entity to reflect in its profit or loss and financial position the effects of share-based payment transactions, including expenses associated with transactions in which share options are granted to employees. Following the Standard, the Company's accounts record: (a) Expense entries: the expensing of the share or rights offers as part of employee remuneration expense; and (b) Exercise entries: in respect of offers made of rights or options, the exercising of those rights or options by the Participating Employees. There are also entries to record: (a) the sourcing of the shares to be provided to the Participating Employees in relation to these offers; and (b) the tax effects on the Company for the various payments. The Standard requires the Company to determine the value of the services provided to the Company by its employees, in respect of which the Performance Rights and Performance Options are being issued or purchased from the time they are granted to the employee. The fair value of the Performance Rights and Performance Options when granted is based on the Binomial Option Pricing Model. This model uses the weighted average share price of the Company's shares traded on the Australian Stock Exchange over the 5 business days up to the day before the grant date as one of its variables due to the Performance Rights and Performance Options not being traded on the open market. The option and right fair value valuations have been undertaken by external valuers.


Reasons for decision: Detailed Reasoning - Application of Division 197 of the 1997 Act: Section 197-5 of the 1997 Act provides that Division 197 of the 1997 Act should apply, subject to a number of exclusions, to: an amount (the transferred amount) that is transferred to a company's * share capital account from another of the company's accounts, if the company was an Australian resident immediately before the time of the transfer. Subdivision 197-A of the 1997 Act contains a number of exclusions which prevent Division 197 from applying. Relevantly, section 197-10 provides that: This Division does not apply to the transferred amount if it could, at all times before the transfer, be identified in the books of the company as an amount of share capital. Accordingly, Division 197 of the 1997 Act should apply to an amount recorded in the Company's "share capital account" if the amount: (a) is "transferred" to the Company's "share capital account" from another of the Company's accounts; and (b) that amount could not, at all times before the transfer, be identified in the books of the Company as being an amount of "share capital". | Detailed Reasoning - The Company's paid up capital "account" is its "share capital account" for the purposes of Division 197 of the 1997 Act: In order to determine whether Division 197 of the 1997 Act will apply to the Company's accounting treatment of the provision of shares or options under its employee equity programs, it is necessary to determine which of the Company's accounts form part of its "share capital account" for the purposes of Division 197 of the 1997 Act. | Detailed Reasoning - Meaning of "share capital account" and "share capital": "Share capital account" is specifically defined in subsection 975-300(1) of the 1997 Act for these purposes as follows: A company's share capital account is: (a) an account that the company keeps of its share capital; or (b) any other account (whether or not a share capital account) that satisfies the following conditions: (i) the account was created on or after 1 July 1998; (ii) the first amount credited to the account was an amount of share capital. There is no definition of "share capital" in the 1997 Act. The Explanatory Memorandum to the bill which introduced the Act (the Explanatory Memorandum)provides at [4.10] that: Under its ordinary meaning, share capital includes amounts received by a company in consideration for the issue of shares. In Re Swan Brewery Co Ltd (1976) 3 ACLR 164, Gillard J stated that " when one talks about share capital, in my view, it means capital raised by the company from the issue of its shares ". Taxation Ruling TR 2012/1 Income tax: retail premiums paid to shareholders where share entitlements are not taken up or are not available states at paragraph 49: In the Commissioner's view the... case law, corporate law text book definitions and Explanatory Memoranda provide clear support that all amounts proffered in consideration for the issue of shares are paid, credited or given to the company, whether directly or indirectly through its agents. As ... the shares are issued in consideration of the whole of the amounts being proffered, the whole of the amounts is paid to the company and constitutes share capital of the company. On this basis, the Company's "paid up capital" account forms part of the Company "share capital account" for the purposes of Division 197 of the 1997 Act. In accounting for shares provided under its employee equity program, the amounts credited by the Company to its "paid up capital" account reflect the services received by the Company from its employees in consideration for the provision of shares under its employee equity programs. These amounts are regarded as "share capital" for the purposes of section 975-300(1)(a) of the 1997 Act, as they comprise "amounts received by the Company in consideration for the issue of shares". That the "amounts received" are not amounts of money or property, but services from its employees, does not prevent these "amounts" from being "share capital". The consideration required for an issue of shares does not have to be provided in a cash form. That the value of the amounts credited to the Company's "paid up capital" account, are based on the value of the shares provided to the employees does not prevent the relevant amounts from being "share capital". This is because the value of the shares provided, represents, in accordance with the accounting standards, the Company's estimate of the value of the services provided to the Company from its employees. On this basis, in accounting for the provision of the Performance Options and Performance Rights to employees under the Company's employee equity program, the amounts credited to the Company's paid up capital account are regarded as share capital as those amounts either represent: (a) the issue of shares for services; (b) amounts received in payment for the issue of shares, in conjunction with an issue of shares for services; or (c) an amount reflecting an increase in equity where a deferred tax asset arises which is in excess of the related income tax expense. The Company's "paid up capital" account is considered a "share capital account" for the purposes of Division 197 of the 1997 Act under paragraph 975-300(1)(a) of the 1997 Act, as it is an account used by the Company to record its "share capital". The Company's "paid up capital" account is also the Company's "share capital account" under paragraph 975-300(1)(b) of the 1997 Act as it was created after 1 July 1998, and the first amount credited to the account was an amount of "share capital". The first amount credited to the Company's "paid up capital" account would have been the balance of the Company's previous "share premium account" and "capital redemption reserve" which was transferred into the "paid up capital" account in transition to the Corporations Act 2001 (Cth). These amounts represent amounts of "share capital" as they represent amounts previously received by the Company in respect of the issue of its shares. | Detailed Reasoning - "Equity payment reserve" account does not form part of "share capital account": Where a company has more than one account which is a "share capital account" within the meaning of subsection 975-300(1) of the 1997 Act, the accounts are taken, for the purposes of the 1997 Act, to be a single account (subsection 975-300(2)). The accounts other than the "paid up capital" account used by the Company in accounting for the provision of shares or options under its employee equity programs does not form part of the Company's "share capital" as none of these accounts satisfy the description of a "share capital account" under subsection 975-300(1) of the 1997 Act. Importantly, the "equity based payment reserve" account does not qualify as a "share capital account" under subsection 975-300(1) of the 1997 Act. The "equity based payment reserve" account is used by the Company to record the potential impact of the grant of shares or options under the Company's employee equity program, prior to those shares or options becoming vested and shares being provided by the Company in satisfaction of those shares or options. The Standard requires that the potential impact of the grant of shares or options under the Company's employee equity program be recognised in an equity account. Accordingly, when amounts are recorded in the Company's "equity based payment reserve" account, the amounts have not yet become "share capital". The "equity based payment reserve" account records the equity amounts arising in relation to the provision of shares, rights and options prior to those shares, rights and options being vested and certain tax effects of the offers. The Company's "equity based payment reserve" account is an account in the nature of a "reserve" for accounting purposes, as it records amounts which are not "share capital" (as the value of the services provided are not yet determined) but which, at the relevant time, have already been recognised as a share based expense. The "equity based payment reserve" account does not qualify as a "share capital account" under paragraph 975-300(1)(a) of the 1997 Act as it is an account which records amounts of equity other than "share capital", and so is not an account which the Company keeps of its "share capital" for the purposes of that paragraph. Similarly, the "equity based payment reserve" account does not qualify as a "share capital account" under paragraph 975-300(1)(b). Although the "equity based payment reserve" account was created after 1 July 1998, the first amount credited to the account was not an amount of "share capital". | Detailed Reasoning - No amounts are "transferred" to the Company's "share capital account" for the purposes of Division 197 of the 1997 Act: The amounts to which Division 197 of the 1997 Act potentially apply, subject to the relevant exclusions, are amounts which are "transferred" to the Company's "share capital account" from another of the Company's accounts. As the Company's "share capital account" for these purposes is its "paid up capital" account, Division 197 of the 1997 Act potentially applies to any amounts which are "transferred" into that account from another of the Company's accounts. | Detailed Reasoning - Meaning of "transfer": Although "transferred" is not defined in the 1997 Act, the Explanatory Memorandum to the Act provides some guidance as to its meaning in the context of Division 197 of the 1997 Act. The Explanatory Memorandum states that: An amount is transferred from one account to another where that amount is moved from one account to another. This, in turn, requires the balance of the first account to be reduced, while the balance of the second account is increased by the same amount. An amount is not transferred from one account to another where the particular accounting entries result in the balances of both accounts increasing in size. Accordingly, an accounting entry of the form 'debit asset, credit share capital account' does not represent a transfer in the relevant sense. Furthermore, a transfer to the share capital account will not arise if an expense account is debited at the same time that the share capital account is credited. | Detailed Reasoning - No amounts are "transferred" to the Company's "share capital account": In accordance with the Standard, the Company's accounts record: (a) the expensing of the employee option or rights offers; (b) the sourcing of the shares to be provided to the Participating Employees in relation to these offers; (c) in respect of offers made of rights or options, the exercising of those rights or options by the Participating Employees; and (d) the tax effecting of the employee equity plans for the Company. No amounts are "transferred" into the Company's share capital account, being its "paid up capital" account, for the purposes of Division 197 in recording these transactions. The recording of each of the types of transactions are considered below. | Detailed Reasoning - Expense Entries: In accounting for the provision of Performance Options and Performance Rights to employees under its employee equity programs, the only time the Company's "share capital account" (being its "paid up capital" account) increases is to the extent that an expense is effectively recognised by the Company in respect of the provision of shares to its employees or where the realised tax benefit in respect of the shares exceeds the tax effect of the shares based expense account. There is no "transfer" into the Company's "paid up capital account" for the purposes of Division 197 of the 1997 Act as the recording of the expense in relation to the provision of shares, rights and options results in the balances of both accounts (being the relevant expense and "paid up capital") increasing in size. Rather than being a transfer, these entries record the fact that an expense of the Company has been met by the Company through the issue of shares. The purpose and outcome of the relevant transactions is the payment of one of the Company's expenses (the cost of services from its employees) through the issue of shares. This is not a transfer of the Company's profits into its "share capital account". Accordingly, in accounting for the provision of each category of shares or rights under the Company's employee equity program, no amounts have been "transferred" from another of the Company's accounts to its "share capital account" for the purposes of Division 197 of the 1997 Act under the expensing account entries. | Detailed Reasoning - Source Entries: The Company's accounts record whether a share has been: (a) issued for full consideration; (b) purchased on market; and (c) re-allocated from a previous grant, where relevant. At the time a share is issued for consideration to the Trustee an amount is credited to the Company's share capital account. In that case, the relevant corresponding debit entry is to an asset account. That is the increase in paid up capital is reflected in the receipt and corresponding increase in the cash asset account. There is: (a) an increase (debit) in the Company's cash account; and (b) an increase (credit) in the Company's "paid up capital" account. In this regard the Explanatory Memorandum states: An amount is not transferred from one account to another where the particular accounting entries result in the balances of both accounts increasing in size. Accordingly, an accounting entry of the form 'debit asset, credit share capital account' does not represent a transfer in the relevant sense. Accordingly the source account entries do not give rise to a transfer for the purposes of Division 197. | Detailed Reasoning - Exercise Entries: The Company's accounts record entries to recognise the receipt of the exercise price for shares. These entries do not give rise to a transfer for the purposes of Division 197, but rather represent an accretion to the Company's assets which occurs as a result of providing shares in return for the employee subscribing for capital in the Company. | Detailed Reasoning - Tax Effecting Entries: The Company recognises deferred tax assets where a tax deduction is available in relation to payments made under its employee equity programs. In certain circumstances the extent of the deduction, if any, may exceed the related cumulative accounting expense. Where this occurs the tax effect is recognised as a deferred tax asset in part in the profit and loss account (to the extent of the corresponding expense) and in part as an equity item. The equity item is recognised as an increase in the equity based payment reserve account. This account operates as a holding account until the extent of the share based expense (and the corresponding extent of the deferred tax asset) may be quantified. At the time the share based expense exceeds the extent of the related deferred tax asset, any previously recognised excess amount, which had been recognised in the equity based payment reserve account, may be debited to that account and credited to the deferred tax asset. The Company only claims a tax deduction when a relevant contribution is made to the employee share trust. The deferred tax asset is adjusted accordingly at that time. The only amounts which are recognised as an increase in the paid up capital account are amounts which have been finally determined as share based expenses or an increase in a deferred tax asset which exceeds the related income tax expense. The process for determining the precise amount of the share based expense, including the tax impact of that share based expense, involves the use of the equity based payment reserve account. | Detailed Reasoning - Conclusion: The accounting entries set out in this ruling request record the expensing, sourcing, exercise and tax effecting of the Company's employee equity plan. These are a series of entries utilising the "equity based payment reserve" account which are critical to ensuring the correct amounts are recorded over the correct period. Only once the correct amounts are known is there an amount recognised in paid up capital. In these circumstances Division 197 does not operate to regard these transactions as giving rise to a 'tainting' of the Company's share capital account.