Private ruling: Employee Share Ownership Plan
Date of advice: 24 November 2016
Published: April 2017
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will any amount be included in the Employee's assessable income in respect of acquiring shares under the Offer? | A1: No | Q2: If unvested shares are purchased from the Employee on ceasing employment in full and final satisfaction of the applicable loan balance and: a. If the value of shares is more than the sale price and the purchase does not take place as a share buy-back, will the Employee make a capital gain? | A5: No | Q3: If vested shares are purchased from the Employee on ceasing employment in partial satisfaction of the applicable loan balance and: a. If the value of shares is more than the sale price and the purchase does not take place as a share buy-back, will the Employee make a capital gain? | A9: No | Q4: If vested shares are sold by the Employee more than 12 months after acquisition, will any capital gain be a discount capital gain for the purposes of Division 115 of Part 3-1 of the Income Tax Assessment Act 1997 ? | A10: Yes | Q5: Will the Commissioner seek to make a determination that Part IVA of the Income Tax Assessment Act 1936 applies to deny a tax benefit to the Employee as a result of participating in the Plan under the Offer? | A11: No

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. Background: ● X (Employee) is an employee of Y (Employer). ● To attract the Employee to join the Employer, the Employer offered to the Employee the prospect of share ownership as an incentive to grow the business. ● The Employee was made an offer (the Offer) by the Holding Company, XY (Holding Company), to participate in an Employee Share Ownership Plan (the Plan). ● By participating in the Plan, the Employee is able to: ● Acquire shares in the Holding Company; ● Vote at shareholder meetings; ● Receive shareholder information; ● Receive rewards in the form of dividends and capital distributions; ● Access loss protection before shares have vested; and ● Once shares have vested, subject to the Shareholders Agreement, sell shares for a gain if and when the Holding Company's shares increase in value. ● As specified in the Shareholders Agreement of the Holding Company (Shareholders Agreement), the current shareholder is XYZ Pty Ltd as trustee for the XXYZ Family Trust (Shareholder). ● Currently, the Holding Company has ordinary shares on issue, which are owned by the Shareholder. ● Under the Plan, the Holding Company has agreed to issue a certain number of shares in the Holding Company which will represent X% of the Holding Company's issued capital immediately post issue. Purpose: ● The purpose of the Offer is to: ● Provide a long term incentive for the Employee; ● Reward their loyalty; and ● Align their rewards with shareholder wealth. ● Specifically, the goal is to align the interests of the Employee, as the new Employee Officer with the Shareholder's interests, by having the Employee own a X% stake. ● This alignment is to be achieved by 'presuming success' - that is, enabling the Employee to own such a significant stake upfront on the presumption that the Employee will succeed in increasing the Holding Company's value to at least $XY over a set period of time, but with protections for the Holding Company if they do not do so. ● This incentive is intended by the parties to provide the benefits of ownership of Holding Company shares, including from dividends or capital distributions, and on selling the shares a reward from future growth, rather than a share of past growth as reflected in present value. ● The nature of the intended commercial incentive, and the anticipated psychology that goes with it, ruled out other Plan alternatives, like free options or free or discounted shares (e.g. via zero exercise-price options, sometimes referred to as 'performance rights'). Details of the Offer: ● To achieve this goal, the Employee was given, and the Employee accepted, an offer for: ● An issue of new shares in the Holding Company which would result in the Employee holding XX% of the Holding Company's issued capital for an issue price equal to their current market value (as assessed by an expert valuer); and ● An interest-free loan by the Holding Company equal to the issue price. Issuing of shares: ● On issue, the Employee's shares are to be ordinary shares with conditions operating separately to the terms of issue restricting the ability of the Employee to sell the shares (the Vesting Condition). ● The shares will have the same rights as ordinary shares, and hence will attract full voting and dividend rights. The shares will be acquired in the Employee's own name, where under the terms of the loan, YX% of dividends and all of any capital distributions will be applied towards the loan. ● The shares will vest (i.e. the Vesting Condition will be satisfied) according to the Holding Company's annual valuation and/or any liquidity event. ● The shares will be acquired by the Employee for no less than their market value funded by a loan. The Loan: ● Pursuant to the Plan Booklet, the Holding Company will lend the Employee the acquisition price of the shares. ● The Plan loan will be advanced by the Holding Company for the sole purposes of providing funding for the acquisition of the shares offered to the Employee. ● The loan will be interest-free on the basis that the Employee acquires the shares in their own name. ● The plan has no fixed term and is repayable as follows: ● One half of dividends and all of any capital distributions on the Employee's shares, paid in money, will be applied; ● towards the portion of the loan that relates to the vested shares (Vested Plan Loan); ● and when it has been repaid, towards the portion of the loan that relates to the unvested shares (Unvested Plan Loan); ● and when it has been repaid, paid to the Employee. ● From the proceeds of a sale or transfer of shares; and ● By the Employee within X days after the later of cessation of employment or the relevant valuation(s). Treatment of shares: Cessation of employment: ● As specified under the Plan Booklet, on cessation of employment, the Plan restricts the Employee from selling the shares as follows: ● While shares are unvested (i.e. prior to the Vesting Condition having been satisfied) at any time; and ● While shares are vested, before 20XX and within X days after cessation of employment. ● The treatment of shares on cessation of employment can be detailed as follows: ● The Employee's unvested shares will be purchased for discharge of the applicable loan, so the Employee derives no gain and incurs no loss (except for the portion of any prior dividends paid to him); and ● The Employee's vested shares will be purchased, or can be sold, for a sale price equal to the value of the ordinary shares as determined by a valuation of the Holding Company without regard to the Vesting Condition (Plan Value). Treatment of shares: Cessation of Employment - Unvested Shares: ● Pursuant to the Plan Booklet, the unvested shares will be forfeited as follows: ● The shares will be purchased by a nominee of the director(s) of the Holding Company (the Board) (which could be the Holding Company itself) for an amount equal to the loan balance of the Unvested Plan Loan; and ● The transfer of the shares to the Board nominee will be in full and final satisfaction of the loan balance of the Unvested Plan Loan. ● The effect of forfeiture under the Vesting Condition is to deny the Employee any capital gain on the shares, and although a capital loss could be incurred on the shares, the Employee will be protected from effective loss through the limited recourse terms of the loan. Treatment of shares: Cessation of Employment - Vested Shares: ● Pursuant to the Plan Booklet, if cessation of employment occurs and the Board does not procure a purchase of the vested shares within X days after the later of cessation of employment or the relevant valuation; ● the Employee may either; ● repay the loan and retain the shares on the terms of the Shareholders Agreement; ● offer the shares for sale on the terms of the Shareholders Agreement with the sale proceeds applied against the loan and the Employee being paid any surplus or paying any shortfall; or ● require the shares to be purchased by a nominee of the Board for their Plan Value, the sale price being applied against the loan outstanding with any shortfall remaining due and payable by the Employee.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 109B, | Income Tax Assessment Act 1936 Section 109D, | Income Tax Assessment Act 1936 Section 109F, | 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 177EA, | Income Tax Assessment Act 1936 Section 177F, | Income Tax Assessment Act 1936 Former Section 160APHJ, | Income Tax Assessment Act 1997 Section 8-1, | Income Tax Assessment Act 1997 Section 83A-25, | Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 109-10, | Income Tax Assessment Act 1997 Section 110-25, | Income Tax Assessment Act 1997 Section 115-10, | Income Tax Assessment Act 1997 Section 115-15, | Income Tax Assessment Act 1997 Section 115-20, | Income Tax Assessment Act 1997 Section 115-25, | Income Tax Assessment Act 1997 Section 116-30, | Income Tax Assessment Act 1997 Section 207-5, | Income Tax Assessment Act 1997 Section 207-10, | Income Tax Assessment Act 1997 Section 207-15, | Income Tax Assessment Act 1997 Section 207-20, | Income Tax Assessment Act 1997 Section 207-140, | Income Tax Assessment Act 1997 Section 207-145, | Income Tax Assessment Act 1997 Section 207-150, | Income Tax Assessment Act 1997 Section 207-155, | Income Tax Assessment Act 1997 Section 207-157, | Income Tax Assessment Act 1997 Section 207-160, | Income Tax Assessment Act 1997 Section 207-165, | Income Tax Assessment Act 1997 Section 207-170, | Income Tax Assessment Act 1997 Section 245-10, | Income Tax Assessment Act 1997 Section 245-20, | Income Tax Assessment Act 1997 Section 245-35, | Fringe Benefits Tax Assessment Act 1986 Section 14, | Fringe Benefits Tax Assessment Act 1986 Section 16, | Fringe Benefits Tax Assessment Act 1986 Section 18, | Fringe Benefits Tax Assessment Act 1986 Section 19, | Fringe Benefits Tax Assessment Act 1986 Section 40, | Fringe Benefits Tax Assessment Act 1986 Section 43, | Fringe Benefits Tax Assessment Act 1986 Section 67 and | Fringe Benefits Tax Assessment Act 1986 Section 136

Reasons for decision: Detailed Reasoning - Issue 1 Question 1: Will any amount be included in the Employee's assessable income in respect of acquiring shares under the Offer? | Summary: No amount will be included in the Employee's assessable income in respect of acquiring shares under the Offer. | Detailed Reasoning - Detailed reasoning: Section 83A-25 of the Income Tax Assessment Act 1997 (ITAA 1997) states that your assessable income for the income year in which you acquire an employee share scheme interest includes the discount given in relation to the interest. In your situation, the Employee is to be issued shares giving a X% shareholding in the Holding Company for X% of the market value of the Holding Company. This X% stake acquired by the taxpayer relates to shares subject to restrictions that do not otherwise apply to ordinary shares which comprise the remaining Y%. These restrictions, such as the lack of marketability of the shares, would lead to the conclusion that the market value of the shares issued to the Employee is equal to or less than amount the Employee paid for them. Therefore, the shares will not be acquired at a discount and no amount will be included as assessable income under Division 83A of the ITAA 1997. | Detailed Reasoning - Issue 1 Question 2: If unvested shares are purchased from the Employee on ceasing employment in full and final satisfaction of the applicable loan balance and: a. If the value of shares is more than the sale price and the purchase does not take place as a share buy-back, will the Employee make a capital gain? b. If the sale price is less than acquisition price, will the Employee have a capital loss equal to the difference? c. If the value of shares is less than the loan balance: i. Will there be an adjustment to the tax attributes of the Employee pursuant to Division 245 of Part 3-10 of the Income Tax Assessment Act 1997 ? ii. Will there be forgiveness of a debt pursuant to Division 7A of Part III of the Income Tax Assessment Act 1936 ? | Summary: The Employee will not make a capital gain in circumstances where the value of the shares is more than the sale price and the purchase does not take place as a share buy-back. The Employee's reduced cost base will include the first element of their cost base and will therefore be equal to the acquisition price, subject to any future capital expenditure or capital returns in respect of the shares. If the value of the shares is less than the loan balance at the time of the Employee ceasing employment and forfeiting their unvested shares in full and final satisfaction of the loan, there will not be a forgiveness of a debt and the tax attributes of the Employee will not be adjusted. The transfer of the unvested shares in full and final satisfaction of the Unvested Plan Loan will not constitute the forgiveness of a debt and therefore this will not be a forgiveness of a debt pursuant to Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). | Detailed Reasoning - Detailed reasoning: In circumstances where the Employee disposes of their shares on ceasing employment other than by way of a share buy-back, this will result in a change of legal and beneficial ownership and a disposal of a CGT asset, where CGT event A1 will happen under section 104-10 of the ITAA 1997. The Employee will make a capital gain if the capital proceeds from the disposal are more than the cost base of the shares. The cost base of the shares will include the money paid in respect of acquiring them as the first element. This will equal the amount borrowed from the Holding Company in respect of the original issue of the shares. This is assuming that there are no additional items of the second to fifth element of the cost base that are incurred in the future to increase the cost base and that there are in future no returns of capital resulting in CGT event G1, reducing the cost base of the shares. The capital proceeds from this CGT event will be the total of the amount the Employee receives or is entitled to receive in respect of the event happening. The CGT rules apply to the Employee as if the Employee had an entitlement to receive money if it has been applied for their benefit (including by discharging all or part of a debt owed). The capital proceeds will therefore equal the amount of the loan that will be extinguished as consideration for their transfer of the shares. However, if the Employee and the entity that acquires the shares from the Employee did not deal with each other at arm's length in connection with the disposal, the capital proceeds from the CGT event are replaced with the market value of the shares at the time of the event. In determining whether parties deal at arm's length, any connection between them and any other relevant circumstances may be considered. The Commissioner considers that parties are dealing with each other at arm's length in relation to a transaction if the independent minds and will of the parties are applied to the transaction and their dealing is a matter of real bargaining. In the present case, the shares will be sold in accordance with the terms as set out in the Plan. This is a commercial arrangement between parties in which the Employee will receive certain benefits in exchange for their services as an employee to the Employer, including benefits from share ownership, subject to certain restrictions and conditions. One of these restrictions is the ability to enjoy the benefits of the capital growth of the Holding Company until shares vest. The Employee is also protected from a capital loss if the shares fall in value. In either case, the Employee will have lost the right to enjoy half of any dividends and all of any capital distributions while the Employee's loan from the Holding Company remains outstanding. The Plan creates rights and obligations for both parties and the agreement is one that has been reached as a result of real bargaining. This can be likened to the case of Granby Pty Ltd v FCT in which the purchaser of a certain asset agreed to pay an amount as stipulated as the residual value in a prior lease arrangement. Even though this may have deviated from the market value of the asset at the time, the parties were nevertheless found to have acted at arm's length in respect of the transaction. The capital proceeds in respect of the disposal of unvested shares will therefore not be substituted with their market value. The proceeds will equal the outstanding loan balance which will be equal to or lesser than the amount of the original loan (i.e. the first element of the cost base) and the Employee will therefore not make a capital gain. Under subsection 104-10(4) of the ITAA 1997, the Employee makes a capital loss from CGT if the capital proceeds from the disposal are less than the asset's reduced cost base. The Employee's reduced cost base will include the first element of the Employee's cost base and will therefore be equal to the acquisition price, subject to any future capital expenditure or capital returns in respect of the shares. As above, the capital proceeds will be equal to the balance of the loan that is discharged in consideration for the transfer of shares. The reduced cost base will exceed the capital proceeds by the difference between the acquisition price and the sale price and the Employee will have a capital loss equal to the difference under section 100-45 of the ITAA 1997. This capital loss will represent the dividends that are applied against the Employee's loan being the amounts forgone and lost in respect of acquiring the shares. (a) (i) An adjustment to the tax attributes of the Employee will occur if the Employee has a net forgiven amount of a debt as a result of transferring their unvested shares in full and final satisfaction of the prevailing Unvested Plan Loan balance. This will happen if the full and final satisfaction of the loan constitutes the forgiveness of a commercial debt. Under paragraph 245-10(b) of the ITAA 1997, the Unvested Plan Loan is a commercial debt to which Subdivisions 245-C to 245-G apply. In circumstances where an amount of interest was payable by the Employee in respect of the debt, the whole or part of the interest could have been deducted by the Employee as it would have been incurred in gaining or producing assessable income from dividends paid by the Holding Company out of its profits. Under paragraph 245-35(a) of the ITAA 1997, a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full. In the present circumstances, the Employee will satisfy a condition of a pre-existing arrangement upon a transfer of an unvested share in full and final satisfaction of the prevailing balance of the Unvested Plan Loan. The fulfilment of the debtor's obligation in this manner will not constitute a release or waiver of the debt by the Holding Company. Furthermore, the debtor's obligation in the circumstances in which unvested shares are forfeited will be comprised of the obligation to give property (i.e. the unvested shares) to a nominee of the Board. If the Employee satisfies this obligation, then this will constitute a repayment of the debt in full. Therefore, if the value of the shares is less than the loan balance at the time of the Employee ceasing employment and forfeiting their unvested shares in full and final satisfaction of the loan, there will not be a forgiveness of a debt and the tax attributes of the Employee will not be adjusted. (c) (ii) Under subsection 109F(3), a debt will be forgiven for the purposes of Division 7A of Part III of the ITAA 1936, if and when the amount would be forgiven under section 245-35 of the ITAA 1997. As explained above, the transfer of the unvested shares in full and final satisfaction of the Unvested Plan Loan will not constitute the forgiveness of a debt under section 245-35 of the ITAA 1997 and therefore this will not be a forgiveness of a debt pursuant to Division 7A of Part III of the ITAA 1936. | Detailed Reasoning - Issue 1 Question 3: If vested shares are purchased by the Holding Company from the Employee on ceasing employment in partial satisfaction of the applicable loan balance and: a. If the value of shares is more than the sale price and the purchase does not take place as a share buy-back, will the Employee make a capital gain? b. If the sale price is less than acquisition price, will the Employee have a capital loss equal to the difference? c. If the value of shares is less than the loan balance: i. Will there be an adjustment to the tax attributes of the Employee pursuant to Division 245 of Part 3-10 of the Income Tax Assessment Act 1997 ? ii. Will there be forgiveness of a debt pursuant to Division 7A of Part III of the Income Tax Assessment Act 1936 ? | Summary: The Employee will not make a capital gain if the capital proceeds are less than the cost of acquiring the vested shares. The Employee will make a capital loss equal to the difference from the sale of vested shares if the shares are merely sold in accordance with the terms set out in the Plan An adjustment to the tax attributes of the Employee will not occur if the Employee is still obligated to repay the Holding Company the balance of the loan in full. There will be no forgiveness of a debt as a result of the Holding Company purchasing the shares in partial satisfaction of the debt | Detailed Reasoning - Detailed reasoning: As above, the Employee will not make a capital gain if the capital proceeds are less than the cost of acquiring the vested shares. This will be the case if the market value substitution rule in subsection 116-30(2) of the ITAA 1997 does not apply. Relevantly, in the case of vested shares, the Board will have the right to nominate a purchaser of the vested shares for the prevailing Plan Value within X days of the cessation of employment. If the Board fails to exercise this right, the Employee may choose to forfeit the vested shares in partial satisfaction of the Vested Plan Loan. As above, the Employee and the Holding Company are dealing with each other at arm's length in entering into the agreement under the Plan. Whether or not the capital proceeds from the Employee disposing of the vested shares are replaced with their market value will depend upon a consideration of the dealing between the relevant parties at the time when the Employee ceases employment. If the shares are merely sold in accordance with the terms set out in the Plan, the capital proceeds will not be replaced with the shares' market value (as in the case of unvested shares under 2(a) above). As above, the Employee will make a capital loss equal to the difference from the sale of vested shares, if the shares are merely sold in accordance with the terms set out in the Plan (as in the case of unvested shares under 2(b) above), subject to any other relevant circumstances at that the time of the sale. (a) (i) As above, an adjustment to the tax attributes of the Employee will occur if the Employee has a net forgiven amount of a debt as a result of transferring their vested shares in partial satisfaction of the prevailing Vested Plan Loan balance. This will happen if the partial satisfaction of the loan constitutes the forgiveness of a commercial debt. The Vested Plan Loan will be a commercial debt and will be forgiven if the Employee's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full. Under section 245-20 of the ITAA 1997, Division 245 applies to part of a debt in the same way as it applies to a whole debt. In the situation where the value of the shares is less than the loan balance and the Board exercise its rights to repurchase the shares for their current value, which will be applied in part repayment of the debt the Employee owes to it, the Employee will be obligated to repay the remainder of the debt within X days. If the Board fails to exercise the right to buy the shares back for less than the amount of the debt owed to it, the Employee may forfeit the shares for their Plan Value and would still be obligated to repay the Holding Company the balance of the loan in full. A repayment of the debt in full will not constitute the forgiveness of a debt and therefore no adjustment will occur under Division 245 of the ITAA 1997. (c) (ii) As above, there will be no forgiveness of a debt as a result of the Holding Company purchasing the shares in partial satisfaction of the debt and subsection 109F(1) of the ITAA 1936, will not apply. | Detailed Reasoning - Issue 1 Question 4: If vested shares are sold by the Employee more than 12 months after acquisition, will any capital gain be a discount capital gain for the purposes of Division 115 of Part 3-1 of the Income Tax Assessment Act 1997 ? | Summary: If a sale of vested share occurs at least 12 months after the Employee acquired the shares then the Employee will be able to treat any capital gain on the disposal as a discount capital gain. | Detailed Reasoning - Detailed reasoning: For the capital gain of an individual to be a discount capital gain, it must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain after 21 September 1999 and at least 12 months before the CGT event. Under Item 2 of section 109-10 of the ITAA 1997, the Employee acquires the issued shares at the time they enter into the contract constituted by the Plan. Under paragraph 104-10(3)(a) CGT event A1 happens at the time the contract for the disposal of the vested shares are entered into. In order for the gain to be a discount capital gain, the contract under which the disposal occurs must be a contract entered into at least 12 months after acquisition and not the contract entered into under the Plan at the time of acquisition. As per ATO ID 2004/668, this will depend upon whether the terms and conditions in the Plan are conditions precedent to the formation of an agreement or conditions precedent to the performance of an agreement. The Employee will be able to dispose of their vested shares in various ways under the terms of the Plan. These include the following: ● Sale after 20XX in accordance with the rules in the Holding Company's Constitution and Shareholders Agreement; ● An Initial Public Offering or Trade Sale; ● Sale following cessation of employment; ● Pursuant to an offer for sale to other shareholders in accordance with the terms of the Shareholders Agreement. ● Pursuant to the Board exercising its right to procure a purchase of the shares within 60 days of the later of cessation of employment or the relevant valuation; or ● Pursuant to the Board procuring a purchase within 5 years after cessation of employment following a decision of the Employee to repay the loan and retain the shares. Each of these scenarios will involve a new agreement being entered into for their disposal rather than a mere fulfilment of the original contract. In Elmslie and Ors v FCT at 4976, Wilcox J interpreted the words “under a contract” in the predecessor to paragraph 104-10(3)(a): “It seems to me that, for the legislation to work satisfactorily, it is necessary for the courts to confine the words ``under a contract'', in s. 160U(3), to the contract that directly effected the acquisition. It is necessary to disregard any earlier contract obliging one or both parties to the acquisition to enter into the immediately operative contract.” As per section 1-3 of the ITAA 1997, there is no relevant difference in meaning between the phrases “contract for the disposal” and “disposed of under a contract”. Furthermore, the concepts relating to determining when a contract for acquisition was entered into also apply to a contract for disposal. Any sale of vested shares, even though contemplated by the Plan, will be effected by a contract entered into at a later time. If this occurs at least 12 months after the Employee acquired the shares then the Employee will be able to treat any capital gain on the disposal as a discount capital gain. | Detailed Reasoning - Issue 1 Question 5: Will the Commissioner seek to make a determination that Part IVA of the Income Tax Assessment Act 1936 applies to deny a tax benefit to the Employee as a result of participating in the Plan under the Offer? | Summary: The Commissioner will not seek to apply Part IVA of the ITAA 1936 to the specific arrangement as described in this ruling. | Detailed Reasoning - Detailed reasoning: Part IVA of ITAA 1936 applies to a scheme, entered into or carried out by a person for the dominant purpose and with the effect of enabling a taxpayer to obtain a tax benefit in connection with the scheme. The Commissioner then can make a determination under section 177F to cancel the tax benefit obtained under the scheme. | Detailed Reasoning - The scheme: The definition of scheme in subsection 177A(1) is broad and can cover all aspects of the agreement entered into between the Employee and the Holding Company. | Detailed Reasoning - Tax benefit: The obtaining of a tax benefit in connection with a scheme is defined by subsection 177C(1) includes the non-inclusion of an amount of assessable income of the taxpayer and a capital loss being incurred by a taxpayer during a year of income where that result would have otherwise not occurred or might reasonably be expected not to have occurred if the scheme had not been entered into or carried out. In the present case, a potential tax benefit is created by the Employee not having a discount included in assessable income as a result of acquiring the shares and the Employee incurring a capital loss as a result of the forfeiture of shares. To determine whether a tax benefit has been derived by the Employee “in connection with” the scheme, it is necessary to examine alternative hypotheses or counterfactuals, called a 'postulate'. For example, if an amount is not included as assessable under the Plan but would be under the relevant postulate, then the scheme produces a tax benefit. Part IVA poses two postulates: 1. what would have occurred if the scheme had not been entered into or carried out, and 2. what might reasonably be expected to have occurred if the scheme had not been entered into or carried out. The first limb requires assuming that the transaction or conduct in question would have occurred but without the steps that comprise the scheme, i.e. by annihilating the steps that comprise the scheme. The second limb requires considering a reasonable alternative, i.e. what is reasonably likely to have happened instead in the absence of the scheme? The choice of a 'reasonable alternative' must be based on the substance and effect of the scheme and not on the tax consequences of the scheme or the postulate. In relation to the first limb, explanatory material to the relevant legislation introducing it indicated that it might generally apply where the particular scheme has no other commercial or economic consequences other than tax. This is not applicable in the present case as the scheme is entered into for a clear commercial purpose to reward an executive for their performance in growing the underlying business. Alternatively, the second limb could refer to a postulate that the Employer has an incentive scheme for the Employee but not this particular scheme. The most common alternative to a loan plan would be an option plan whereby the Holding Company issues an employee options to acquire ordinary shares upon meeting certain conditions. The value of these options would be included in the employee's assessable income upon their acquisition, whether or not they are ultimately exercised. The loan plan may therefore be said to give rise to a tax benefit. However, the option plan may not be a reasonable alternative as it is a fundamentally different commercial outcome which does not achieve the same objectives as the loan plan such as allowing the Employee an immediate right to enjoy the benefits of dividends, capital distributions and voting rights, and giving the Employee a X% stake which has strategic value in allowing them to veto a decision requiring a Special Majority of more than Y%. For similar reasons, simply paying the Employee a bonus commensurate with the growth in the company would not be a reasonable alternative to the loan plan. | Detailed Reasoning - Dominant Purpose: The Employer and the Employee are not undertaking the scheme for the dominant purpose of obtaining a tax benefit. The Plan clearly has a commercial basis unrelated to the non-inclusion of assessable income in respect of the share acquisition or a capital loss being generated in respect of certain share forfeitures, being the motivation and reward of employees. The purpose in structuring the Plan as involving an immediate share acquisition with a loan, rather than a delayed share acquisition, was to immediately provide the Employee with most of the rights of a shareholder (rights to dividends, capital distributions and voting rights) but not all of the rights of a shareholder (no right to enjoy the benefits of the capital growth until the shares have been held for a sufficient period of time and certain benchmarks having been achieved). The scheme aligns the Employee's interests with the Employer's in the immediate short-term whilst keeping some rewards contingent on success. The structure of the Plan matches this commercial purpose and was not undertaken for the dominant purpose of obtaining a tax benefit. | Detailed Reasoning - Section 177EA: Section 177EA of the ITAA 1936 allows the Commissioner to make a determination that no imputation benefit is to arise in respect of a distribution or a part of a distribution made to a relevant taxpayer where it would be concluded that a party to a scheme entered into or carried it out for a non-incidental purpose of enabling the relevant taxpayer to obtain the imputation benefit. Relevantly, the Employee may receive an imputation benefit as a result of being entitled to a tax offset under Subdivision 207-A of the ITAA 1997 in respect of franked dividends paid by the Holding Company. Subdivision 207-A is subject to Subdivision 207-F of the ITAA 1997 which cancels the effect of the tax offset in certain circumstances including where the entity receiving the franked distribution is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. It is necessary to have regard to these rules despite their repeal. The Employee may be a qualified person by holding the shares for a continuous period (excluding the day on which the shares were acquired or disposed of) of 45 days during the primary qualification period, beginning on the day after the Employee acquires the shares and ending on the 45th day after the day on which the shares become ex dividend . In calculating the number of days the shares were continuously held, any days on which the taxpayer has materially diminished risks of loss or opportunities for gain in respect of the shares are excluded. The Employee will be taken to have such a materially diminished risk of loss or opportunity for gain on a particular day if their net position on that day in relation to the shares has less than 30% of those risks and opportunities or a delta of less than 0.3. The Employee's net position is ascertained by adding together the deltas of the Employee's long positions and short positions in the shares. Each unvested share held by the Employee will have a long position in relation to itself with a delta of +1 as per former subsection 160APHJ(4) of the ITAA 1936. The Employee will also have rights under the Plan that have negative deltas and therefore are short positions in relation to the unvested shares. The present circumstances include a complex vesting mechanism based on annual valuations of the Holding Company as well as certain liquidity events. These result in there being some probability of vesting at certain future points in time and therefore the sum of the deltas of the short positions will be something between -1 and 0. Whether the sum of the deltas of the short positions is more or less than -0.7 will ultimately determine whether the Employee is a qualified person in respect of any franked dividends paid on unvested shares and whether he will receive imputation benefits. If the Employee is a qualified person, then section 177EA of the ITAA 1936 may have potential application. In considering whether the conclusion under paragraph 177EA(3)(e) of the ITAA 1936 as to whether or not the scheme was carried out with a non-incidental purpose of enabling the Employee to obtain an imputation benefit can be reached, the Commissioner must have regard to the relevant circumstances as per subsection 177EA(17). The most relevant circumstance on these facts is found in paragraph 177EA(17)(a) of the ITAA 1936. The mechanism that governs the Employee's ability to share in the opportunities for profit or gain and the extent and duration of the risks of loss from holding unvested shares will ultimately determine whether he is able to obtain a tax offset from receiving franked dividends on these shares. If the Employee's ultimate exposure to the potential for gains and losses from holding these membership interests is small then the Commissioner is more likely to make the conclusion under paragraph 177EA(3)(e). However, if such exposure to potential gains and losses is small, then it is unlikely that the Employee would be qualified person in the first instance and therefore not receive an imputation benefit. Additionally, the other relevant circumstances found in subsection 177EA(17) of the ITAA 1936 do not lead to the conclusion that the scheme was carried out for the purpose of obtaining an imputation benefit. Further, for reasons similar to those discussed in relation to the application of section 177D, the purposes of the parties to the scheme were not to obtain a tax benefit but rather to align the interests of the parties in a commercial way to incentivise the Employee to grow the value of the Holding Company but to deny him the benefits of capital growth if certain benchmarks are not met. | Detailed Reasoning - Issue 2 Question 1: Will the Employee acquiring shares under the Plan result in the Employer being subject to fringe benefits tax? | Summary: The Employee acquiring shares under the Plan will not result in the Employer being subject to fringe benefits tax. | Detailed Reasoning - Detailed reasoning: A fringe benefit will arise if the benefit is provided to an employee by the employer in respect of the employee's employment (subsection 136(1) Fringe Benefits Tax Assessment Act 1986 (FBTAA)). A property fringe benefit arises under section 40 of the FBTAA in circumstances: Where, at a particular time, a person (in this section referred to as the provider) provides property to another person (in this section referred to as the recipient), the provision of that property shall be taken to constitute a benefit provided by the provider to the recipient at that time. Further, section 43 of the FBTAA relates to determining the taxable value of external property fringe benefits, defined as a property fringe benefit in relation to the employer other than an in-house property fringe benefit (subsection 136(1) FBTAA). Paragraph 43(c) of the FBTAA provides that the taxable value of an external property fringe benefit in relation to an employer in relation to a year of tax is: ….. the notional value of the recipients property at the provision time; reduced by the amount of the recipients contribution. The “recipients contribution” is defined under subsection 136(1) of the FBTAA as: ……Any consideration paid to the provider or the employer by the recipient or by the employee in respect of the provision of the recipients….property…… reduced by the amount of any reimbursement paid to the recipient in respect of that consideration. The acquisition of shares by the Employee will be a property fringe benefit under section 40 of the FBTAA 1986 as the provision of the shares will be considered to constitute a benefit provided by the Employer (provider) to the Employee (recipient). The taxable value will be reduced to zero pursuant to section 43 of the FBTAA because the recipient's contribution will be equal to the value of the shares. | Detailed Reasoning - Issue 2 Question 2: Will the holding of a loan under the Plan result in the Employer being subject to fringe benefits tax? | Summary: The holding of a loan under the Plan will not result in the Employer being subject to fringe benefits tax. | Detailed Reasoning - Detailed reasoning: A fringe benefit will arise if the benefit is provided to an employee in respect of the employee's employment by the employer (subsection 136(1) of the FBTAA). A loan fringe benefit will arise under section 16 of the FBTAA in circumstances: Where a person (in this subsection referred to as the provider) makes a loan to another person (in this subsection referred to as the recipient), the making of the loan shall be taken to constitute a benefit provided by the provider to the recipient and that benefit shall be taken to be provided in respect of each year of tax during the whole or a part of which the recipient is under an obligation to repay the whole or any part of the loan. In determining the taxable value of loan fringe benefits, section 18 of the FBTAA provides that the taxable value, in relation to a year of tax, of a loan fringe benefit provided in respect of the year of tax is the amount (if any) by which the notional amount of interest in relation to the loan in respect of the year of tax exceeds the amount of interest that has accrued on the loan in respect of the year of tax. The otherwise deductible rule in section 19 of the FBTAA provides that the taxable value of a benefit may be reduced in the event that the employee would have been entitled to claim an income tax deduction if the employer has not paid for the expense. An employee can claim a deduction under section 8-1 of the ITAA 1997 for the expense that is a loss of outgoing to the extent that it is incurred in gaining or producing assessable income. However, a deduction cannot be made for an expense that is of a capital, private or domestic nature, or relates to the earning of exempt income. The holding of a loan will involve an associate of the Employer, being the Holding Company, providing a loan fringe benefit, with a taxable value equal (broadly) to the amount of notional interest each FBT year at the FBT benchmark rate. However, the otherwise deductible rule will reduce the taxable value to zero because: ● The recipient of the loan fringe benefit is an employee of the Employer; ● If the recipient had incurred interest in the relevant FBT year at the FBT benchmark rate, the recipient would have been able to claim all such interest as a deduction on the basis that the Employee will acquire and continue to hold the shares for the purpose of producing assessable income - that is, there is a reasonable expectation or likelihood that the shares will generate dividends; and ● As the fringe benefit is an 'employee share loan benefit' as defined under subsection 136(1) of the FBTAA, the recipient is not required to give the employer a declaration confirming use of the loan as required under subsection 19(1) of the FBTAA. | Detailed Reasoning - Issue 2 Question 3: Will the sale of shares under the Plan result in the Employer being subject to fringe benefits tax? | Summary: The sale of shares under the Plan will not result in the Employer being subject to fringe benefits tax. | Detailed Reasoning - Detailed reasoning: A fringe benefit is defined under subsection 136(1) of the FBTAA to include: A benefit provided to the employee or to an associate of the employee… by… the employer … in respect of the employment of the employee… Therefore, in order for a benefit to be a fringe benefit it must be provided “in respect of” the employment of the employee. ATO Interpretive Decision ATO ID 2003/316 considers the issue of whether a fringe benefit defined under subsection 136(1) of the FBTAA will arise upon the discharge of a limited recourse loan provided to an employee. The ATO ID considers the test established in J and G Knowles and Associates Pty Ltd v Federal Commissioner of Taxation (2000) 96 FCR 402; 2000 ATC 4151; (2000) 44 ATR 22 to determine whether a benefit is provided “in respect of employment”. The test requires for there to be a sufficient or material, rather than a causal connection or relationship to employment. Further, the ATO ID refers to the case of Federal Commissioner of Taxation v McArdle (1988) 19 ATR 1901. It was considered in this case, that where an employee enters into a loan agreement, they obtain the right to transfer the shares to the lender. In establishing whether a fringe benefit would arise, the case considered the following: If these rights are subsequently exercised and the shares surrendered, any benefit would be in respect of the exercise of these rights, and not in respect of employment. At the time the shares are surrendered, the rights given up are considered to have a value equal to the loan balance. Thus, the benefit that arises to the employee upon the surrender of the shares, does not give rise to a fringe benefit as no benefit has been provided to the employee “in respect of” the employment relationship. A sale of shares by the Employee under the Plan will not involve the provision of a fringe benefit because it will occur by exercise of the Employee's rights in respect of the shares rather than in respect of employment. As such, any gain or benefit from the sale will not satisfy the definition of 'fringe benefit'. The discharge of pre-existing rights does not constitute a benefit as at the time the shares are surrendered, it is considered the rights given up have a value equal to the loan balance as well as no benefit being provided “in respect of” the employment relationship. In particular, where the Employee discharges the loan through the transfer of shares and the shares have a lesser value than the loan balance, the test in Abbott v Philbin [1961] AC 352 provides that the original right, rather than the advantage on enforcement of the right, must be valued. In considering the above, there is no amount written off the loan and hence this will not constitute a debt waiver fringe benefit pursuant to Section 14 of the FBTAA. In relation to the anti-avoidance provision for fringe benefits tax, there is no reasonable basis for saying that fringe benefits tax would be payable if not for the Plan or the Offer. Further, section 67 of the FBTAA requires a sole or dominant purpose test to be satisfied. For the reasons stated in Issue 1 Question 5, the Commissioner does not consider the sole or dominant purpose test to apply. Therefore, section 67 of the FBTAA will not apply as a result of participating in the Plan under the Offer. | Detailed Reasoning - Issue 3 Question 1: Will any amount be included in the Employee's assessable income, as a dividend or otherwise, in respect of the loan under the Offer (whether in the year of income during which the shares are acquired or any other year of income during which the loan is outstanding)? | Summary: No amount will be included in the Employee's assessable income as a dividend or otherwise in respect of the loan under the Offer. | Detailed Reasoning - Detailed reasoning: Under subsection 109D(1) of the ITAA 1936 an amount lent by a private company to a current or former shareholder, or an associate of such a shareholder, during the current year is taken to be a dividend for the purposes of Division 7A if the loan is not fully repaid before the private company's lodgment day for that income year, and Subdivision D of Division 7A of Part III of the ITAA 1936 does not otherwise prevent the private company from being taken to have paid a dividend because of the loan. The loan is made to the Employee in order to acquire the shares and is therefore made at a time when the Employee is neither a shareholder nor an associate of a shareholder as the Employee is not yet registered or entitled to be registered as a member of the issuing company at that time. | Detailed Reasoning - Issue 4 Question 1: If unvested shares are purchased by the Shareholder from the Employee on ceasing employment in full and final satisfaction of the applicable loan balance, will the Shareholder have a cost base equal to the loan balance? | Summary: The Shareholder will have a cost base equal to the loan balance if unvested shares are purchased by the Shareholder on cessation of employment in full and final satisfaction of the applicable loan balance. | Detailed Reasoning - Detailed reasoning: The Plan Booklet sets out the treatment of the unvested shares in the event the Employee's employment ceases at a time when he holds unvested shares. Under the Plan Booklet, the shares will be forfeited as follows: ● A nominee of the Board purchases the shares (which could be the Holding Company itself) for an amount equal to the loan balance of the Unvested Plan Loan; and ● By transferring the shares to the Board Nominee in full and final satisfaction of the loan balance of the Unvested Plan Loan. The effect of forfeiture under the Vesting Condition is to deny the Employee any capital gain on the shares, and although a capital loss could be incurred on the shares, the Employee will be protected from effective loss through the limited recourse terms of the loan. Division 110 of the ITAA 1997 covers the general rules about cost base with section 110-25 covering the five elements of the cost base. Relevantly, under subsection 110-25(2) of the ITAA 1997, the first element is the total of: (a) the money you paid, or are required to pay, in respect of *acquiring it; and (b) the *market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition). Under the Vesting Condition (which is part of the terms of the Plan), unvested shares are transferred to a Board nominee for an amount equal to the loan balance referable to the unvested shares. The Shareholder will owe the Employee an amount equal to the loan balance, but the Shareholder's obligation to pay the Employee may be set off against the Employee's obligation to pay the loan to the Holding Company, resulting in a payment or debt owing of an amount equal to the loan balance by the Shareholder to the Holding Company. The Shareholder will have a requirement to pay an amount of money to the Holding Company in respect of acquiring the shares. Therefore, it follows that this results in the Shareholder having a cost base for the shares equal to the loan balance referable to the unvested shares. | Detailed Reasoning - Issue 4 Question 2: If the Shareholder sells the shares acquired from the Employee more than 12 months after acquisition, will any capital gain be a discount capital gain for the purposes of Division 115 of Part 3-1 of the Income Tax Assessment Act 1997 ? | Summary: Any capital gain made by the Shareholder will be a discount capital gain in circumstances where the Shareholder sells the shares acquired from the Employee more than 12 months after acquisition. | Detailed Reasoning - Detailed reasoning: Section 115-5 of the ITAA 1997 provides that in order for a capital gain to be a discount capital gain, the requirements of sections 115-10, 115-15, 115-20 and 115-25 must be satisfied. Section 115-10 of the ITAA 1997 provides that the capital gain must be made by: (a) an individual; or (b) a complying superannuation entity; or (c) a trust; or (d) a life insurance company in relation to a discount capital gain from a CGT event in respect of a CGT asset that is a complying superannuation asset. Section 115-15 of the ITAA 1997 provides that the capital gain must be made after 21 September 1999. Further, section 115-20 of the ITAA 1997 provides that the capital gain must not have an indexed cost base. Moreover, section 115-25 requires that the capital gain must result from a CGT event happening to a CGT asset acquired at least 12 months before the CGT event. In considering the above, provided the shareholder had acquired the shares for at least 12 months before sale, the capital gain will be a discount capital gain due to the fact that: ● It is made by a trust (since the Shareholder acts in its capacity as a trustee); ● The shares were acquired after 21 September 1999; ● The cost base of the shares do not include indexation;

Issues for the Employee and the Holding Company | Issues for the Shareholder