Private ruling: ESS – deferred taxing point – vesting date
Date of advice: 6 February 2019
Published: May 2019
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2013

Ruling: Q1: Did the deferred taxing point for the non-qualified stock options happen when they vested? | A1: Yes. | Q2: Does the Commissioner have the discretion to change the deferred taxing point so that the non-qualified stock options are assessable when they are exercised? | A2: 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. You are an Australian resident working for an Australian subsidiary of a listed company that is a resident of Country A. You were granted non-qualified stock options as part of your remuneration package. (The term ‘non-qualified’ refers to the Country A tax treatment for employees who are subject to tax in Country A.) You were granted non-qualified stock options at a specified exercise price (which was the market value of the shares at that time. These non-qualified stock options were subject to vesting conditions and you would forfeit them if you left your employment before they vested for any reason other than long-service separation, disability, death or in connection with a change in control (each of these terms is defined in the Grant Notice). The vesting schedule for the non-qualified stock options was: ● One-third were to vest on the first anniversary of the Grant Date ● One-third were to vest on the second anniversary of the Grant Date, and ● The final one-third were to vest on the third anniversary of the Grant Date Your non-qualified stock options also vest if your employment ends by reason of long-service separation, disability, death or in connection with a change in control. The non-qualified stock options expire on the tenth anniversary of the Grant Date (or various earlier periods after the termination of your employment depending on the reason for the termination). A short extension might be available if the expiry date occurred during a blackout period. All of your vested and unvested non-qualified stock options would expire immediately if your employment was terminated for cause. The non-qualified stock options provide you with the right to acquire ordinary shares in the holding company by paying the exercise price. Your employer has advised you that your non-qualified stock options were granted under an employee share scheme that met the conditions to be treated as a tax-deferred scheme. Your employer has provided you with an employee share scheme statement for the year ended 30 June 2017 advising that the deferred taxing point had occurred for some of your non-qualified stock options at their vesting date. These were granted to you between 1 July 2009 and 30 June 2015. Your employer has provided you with an employee share scheme statement for the year ended 30 June 2018 advising that the deferred taxing point had occurred for some of your non-qualified stock options at their vesting date. These were granted to you between 1 July 2009 and 30 June 2015. You did not exercise any of the vested non-qualified stock options during the year ended 30 June 2017 and the year ended 30 June 2018.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 83A | Income Tax Assessment Act 1997 Section 83A-120

Reasons for decision: Summary: The deferred taxing point for the non-qualified stock options happened when they vested. | Detailed Reasoning - Detailed reasoning: The employee share scheme provisions are contained in Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997). In short, the employee share scheme provisions recognise the dual nature of grants of shares and rights to acquire shares (defined as ESS interests) as both remuneration and investments. To this end, the employee share scheme provisions provide a mechanism for recognising an appropriate value for remuneration purposes and an adjustment to the purchase price for investment purposes to reflect the amount treated as remuneration. The employee share scheme provisions achieve this outcome by: ● Determining when a taxpayer needs to include any discount received in relation to a share or right to acquire the share in their assessable income ● Calculating the amount of this discount using the market value of the share or right to acquire the share at this date ignoring any selling restrictions or forfeiture conditions, and ● Using this date and the market value of the share or right as the acquisition date and amount paid for it for all other income tax purposes. The grants of non-qualified stock options meet the deferral conditions. Therefore, they are assessable to you at their ‘deferred taxing point’. What is the deferred taxing point for the non-qualified stock options The deferred taxing point for ESS interests that are rights to acquire shares is defined by subsection 83A-120(2) of the ITAA 1997 to be the earliest of the times mentioned in subsections 83A-120(4) to 83A-120(7). Subsections 83A-120(4) to 83A-120(7) of the ITAA 1997 identify four potential deferred taxing points related to: ● The removal of selling restrictions on the rights – you cannot sell the non-qualified stock options ● The ending of your employment – you are a continuing employee with your employer ● The maximum deferral period (seven or 15 years starting when you acquired the non-qualified stock options) – neither period has ended, and ● Exercising the right and being able to sell the resulting shares The third and fourth potential deferred taxing points were amended as from 1 July 2015. The amendment only applies to rights to acquire shares that you acquired on or after 1 July 2015. Your non-qualified stock options were granted on 3 March 2014 and 2 March 2015 and so their deferred taxing point is determined using the former legislation. (For example, the maximum deferral period is seven years under the former legislation.) The former subsection 83A-120(7) of the ITAA 1997 stated that the fourth possible taxing point is the earliest time when: (a) there is no real risk that, under the conditions of the scheme, you will forfeit or lose the * ESS interest (other than by disposing of it, exercising the right or letting the right lapse); and (b) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately exercising the right - the scheme no longer so restricts you; and (c) there is no real risk that, under the conditions of the scheme, if you exercise the right, you will forfeit or lose the beneficial interest in the * share (other than by disposing of it); and (d) if, at the time you acquired the ESS interest, the scheme genuinely restricted you immediately disposing of the beneficial interest in the share if you exercised the right - the scheme no longer so restricts you. In your case, the non-qualified stock options were at a real risk of forfeiture until they vested, as you would have lost them if you resigned from your employment. Considering each of these conditions from the vesting date of the non-qualified stock options: ● While it is still theoretically possible for you to lose the non-qualified stock options after they have vested, this is an unlikely outcome. Also, it is not a loss if you exercise them. Therefore, it is not considered that they are still at a real risk of forfeiture once they vest. ● You are allowed to exercise the non-qualified stock options from the vesting date. You could not exercise them before they vested. ● There were no forfeiture conditions on any shares you would acquire by exercising the non-qualified stock options. ● There were no selling conditions on any shares you would acquire by exercising the non-qualified stock options. Each of the conditions mentioned in former subsection 83A-120(7) of the ITAA 1997 is satisfied as from the vesting date of the non-qualified stock options and this was the first of the four potential deferred taxing points to happen. Therefore, this is deferred taxing point for the non-qualified stock options and the point in time when the value of your employee share scheme discount is calculated. In this regard, the employee share scheme statement provided to you undertaken by your employer is correct. Your concerns The Commissioner notes your concerns that the value of the non-qualified stock options is being included in your assessable income before you have exercised them. You cannot sell the non-qualified stock options and have not yet acquired shares that you can actually sell to convert into cash to pay the income tax. You do not acknowledge that the non-qualified stock options have any value until they are exercised, in part, due to the size of their exercise price. You also indicate that there remains a possibility that you will forfeit or lose the non-qualified stock options. You are not protected from a fall in the share price and therefore the value in exercising the non-qualified stock options. The Commissioner’s response The application of the employee share scheme provisions is not based on your ability to convert the non-qualified stock options into cash. Rather, they are based on the fact that you have received the non-qualified stock options as remuneration. Your non-qualified stock options are only considered to be remuneration because they were granted to you at a discount to their market value. It is this discount that is assessable under the employee share scheme provisions as remuneration. The non-qualified stock options are valuable assets as they provide you with the right (but not the obligation) to buy ‘holding company’ shares at an exercise price that doesn’t vary. You can finance the exercise price at a time of your choosing to take advantage of any increase in the share price and you can walk away from the deal if the share price goes down. The default outcome under the employee share scheme provisions is that grants should be taxable upfront (that is, on acquisition). Deferral is only available if a number of conditions are satisfied. There are other potential deferred taxing points that are not linked to the non-qualified stock options vesting or you actually exercising them – the maximum deferral period of seven years and the ending of your employment. If you were to forfeit the non-qualified stock options through no fault of your own, then the claw-back provision would apply (if the conditions were satisfied) and you could amend your assessment to remove the amount declared in relation to the non-qualified stock options lost. There is no time limit for an amendment for this reason. You will still be entitled to a capital loss if you lose the non-qualified stock options but are not entitled to remove the employee share scheme discount, as this is assessable income. The employee share scheme provisions treat you as if you had received salary or wages at the deferred taxing point (with no tax withheld) and then used those funds to buy the non-qualified stock options for their market value on the same day. Effectively, all of this puts you are in the same position as any investor who owns volatile assets. Their value can go up allowing you to sell for a capital gain, or go down meaning any sale would crystallise a capital loss. Note: this ruling only considers the employee share scheme provisions as they apply to grants between 1 July 2009 and 30 June 2015. The employee share scheme provisions operate in a number of different ways before and after this period. | Summary: The Commissioner does not have any discretion under the law to change the deferred taxing point so that the non-qualified stock options are assessable when they are exercised. | Detailed Reasoning - Detailed reasoning: The employee share scheme provisions contain specific rules about how income tax applies to grants of your non-qualified stock options. These include the concession of deferring your liability to tax to the deferred taxing point. The other component of the employee share scheme system is the reporting obligation placed on employers. They are required to analyse the attributes of their employee share scheme and determine when your non-qualified stock options are assessable and how much discount you receive. They then report their conclusion to you and to the Commissioner. As an element within this, section 83A-120 of the ITAA 1997 provides the complete statement on how to determine the deferred taxing point for rights to acquire shares. It would not be consistent with this reporting strategy if the conclusions reached by employers were open to being changed by the exercise of a power held by the Commissioner such as a Commissioner’s discretion. Section 83A-120 of the ITAA 1997 does not contain a Commissioner’s discretion or any other authority to alter the deferred taxing point. Further there are no other relevant provisions that would allow the Commissioner to change the deferred taxing point. The Commissioner is required to apply the law as it has been written.