Private ruling: Employee share schemes - options - deferred taxing point.
Published: July 2012
Ruling period: Year ending 30 June 2011.
Date scheme commenced: Year ending 30 June 2011.

Ruling: Q1: Should your employee share scheme (ESS) options have been taxed up front? | A1: No. | Q2: Are there provisions in the legislation to provide tax relief for the discount that has been included in your income tax return? | A2: No.

Relevant facts and circumstances: You received the right to acquire shares as part of an ESS. Prior to the options being issued you informed your employer that you wished for the options to be put in the name of your Family Trust which was obliged by the employer. Your employer issued an ESS statement showing that the discount had been calculated at the deferred taxing point. The options were to purchase shares in your employer for $X when the market value of your employers shares reached $X. The five day weighted average price of your employers shares at the date you acquired the right to the options was $X. The terms and conditions of the ESS state that the options will expire on the earlier of: (a) the date being two years from the date of issue of the options; (b) the business day after the expiration of three months, or any longer period which the board may determine, after the option holder ceases to be employed by the company or an associated body corporate of the company, (c) the option holder ceasing to be an employee of the company or an associated body corporate of the company due to fraud or dishonesty, unless earlier exercised.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 83A-25, | Income Tax Assessment Act 1997 Subsection 83A-35(7), | Income Tax Assessment Act 1997 Subsection 83A-105(3) and | Income Tax Assessment Act 1997 Section 83A-310.

Reasons for decision: Detailed Reasoning - Detailed reasoning: Generally, any discount to the market value of ESS rights are taxed upfront on acquisition. That means that the value of the discount must be included in the employee's assessable income for that income year. ESS interests provided under an ESS will be taxed upfront unless the interest was acquired through a scheme that meets the conditions of deferred taxation. If there is a real risk you might forfeit the option you acquired under an ESS you do not include the discount in your assessable income when you acquired it. In situations where there is a real risk that the benefits of options are never realised because the ESS interests may be forfeited, deferral of taxation is considered the appropriate treatment. If an ESS interest is at real risk of forfeiture, taxation will be deferred until the ESS deferred taxing point. Real risk of forfeiture for the right to acquire a share is that there must be a real risk that under the conditions of the scheme the employee will forfeit the right to acquire a share, lose it other than by disposing of it, exercising it or letting it lapse. The 'real risk of forfeiture' test does not require employers to provide schemes in which their ESS benefits are at a significant or substantial risk of being lost. However, 'real' is regarded as something more than a mere possibility. Something is not a real risk if a reasonable person would disregard the risk as highly unlikely to occur or as nothing more than a rare eventuality or possibility. Real risk includes situations in which a share or right is subject to meaningful performance hurdles or the securities will be forfeited if a minimum term of employment is not completed. In your case there is a vesting condition on the options that you have acquired. This vesting condition states that the sale price of the shares of your employer must have increased to $X from the date of issue. As the options will expire within two years from the date of issue there is a two year window for these options to vest. At the date of issue of the right to acquire options the five day weighted average market price of your employer shares was $X. You have argued that there was no real risk of forfeiture and that your options should have been taxed upfront. In your private ruling application you state that share price in the months leading up to the issue of the right to acquire options increased substantially which would reasonably lead to the assumption that the share price would go beyond the vesting point within months of the options being granted. It is more than a mere possibility that the market value of your employer's shares would not reach the vesting point within the two year time frame after the date of issue. Even with the upward trajectory of the share price leading up to the date of issue it was not unlikely that the price would not reach the vesting point given that the five day weighted average market price of your employer was still some distance from reaching the vesting point at the time that you were granted the options. A sharp rise in price was still required for the options to vest and was therefore subject to a meaningful performance hurdle. There is also an employment condition in the options terms that states that the options will expire on the earlier of several events including the business day after the expiration of three months or any longer period which the board may determine after the option holder ceases to be employed by the company or an associated body corporate of the company. Usually cessation of employment would be considered a forfeiture condition. However, there is a period of months after an employee ceases to be employed by your employer to exercise the options with the possibility of more time if the board exercise their discretion to extend the X month period. It could be reasonably argued that this condition in itself does not represent a real risk of forfeiture; however this condition must be considered in conjunction with the vesting condition. If the market value of the shares had not reached the vesting point during the X month period after the cessation of employment or any longer period determined by the board these shares would have been forfeited. As stated above it was more than a mere possibility that the market value of the shares would not reach the vesting point within the two year time frame after the date of issue and your right to the options were subject to a meaningful performance hurdle. Cessation of employment with your employer could only serve to narrow the window in which the vesting condition could be met. On the basis of the vesting condition as well as the employment condition your right to options were at a real risk of forfeiture and meets the conditions of deferred taxation and cannot be taxed upfront. | Detailed Reasoning - Detailed reasoning: Section 83A-310 of the Income Tax Assessment Act 1997 (ITAA 1997) states that division 83A of the ITAA 1997 is taken never to have applied in relation to an ESS interest acquired by an individual under an ESS if: (a) disregarding this section, an amount is included in the individuals assessable income under this division in relation to the interest; and (b) either: a. the individual forfeits the interest; or b. in the case of an ESS interest that it is a beneficial interest in a right - the individual forfeits or loses the interest without having disposed of the interest or exercised the right; and (c) the forfeiture or loss is not the result of: c. a choice made by the individual other than a choice made by that individual to cease particular employment; or d. a condition of the scheme that has the direct effect of protecting (wholly or partly) the individual against a fall in the market value of the interest. As you have exercised your options Section 83A-310 of the ITAA 1997 does not apply to your case and you cannot exclude the discount that you received under the ESS from your income tax return.

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.