Private ruling: Employee share scheme - International - Foreign grant
Date of advice: 22 December 2015
Published: March 2016
Ruling period: 20VV-WW income year | 20WW-XX income year
Date scheme commenced: 1 July 2008

Ruling: Q1: Is the amount to be included in the Applicant's assessable income in relation to the Post July 2009 Stock Awards limited to the increase in their value from the residency date until they vested under subsection 83A-110(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is the amount to be included in the Applicant's assessable income in relation to the Pre July 2009 Stock Awards limited to the increase in their value from the residency date to the date they vested under subsection 83A-5(4) of the Income Tax (Transitional Provisions) Act 1997 (ITTPA)? | 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. The Applicant commenced employment with the company some ten years ago in the foreign country. While living in the foreign country, the Applicant was granted the following ESS interests that later vested after the Applicant had permanently departed the foreign country and commenced living in Australia: • 'On-hire Stock Awards' before 1 July 2009 of which some vested during the 20VV-WW income year ( Pre July 2009 Stock Awards ) • Various other Stock Awards after 30 June 2009 of which some vested during the 20VV-WW and 20WW-XX income years ( Post July 2009 Stock Awards ). The ESS interests were awarded under a number of different schemes. Relevantly, each ESS scheme had the following conditions: • On vesting, the 'Stock Awards' were converted into ordinary shares in the company • The Applicant was not required to pay any consideration when the ESS interests vested • The ESS interests were forfeited if the Applicant's employment was terminated On the residency date, the Applicant ceased being a resident of the foreign country and paid income tax in this country on all the ESS interests based on the market value of the stock awards (which was effectively the value of the underlying shares at the time) when the Applicant left the foreign country. On the residency date, the Applicant became a resident of Australia. During the 20WW-XX income year, the Applicant ceased working for the company and any Stock Awards not vested were forfeited on this date. Certain documents explaining the operation of the employee share schemes are to be read with and form part of the description of the scheme for the purpose of this ruling.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 6, | Income Tax Assessment Act 1997 Division 83A, | Income Tax (Transitional Provisions) Act 1997 Division 83A, | Income Tax Assessment Act 1936 Division 13A of Part III, | International Tax Agreements Act 1953 Section 4 and Foreign Country/Australia Double Tax Agreement Article 11.

Reasons for decision: Summary: The amount to be included in the Applicant's assessable income in relation to the Post July 2009 Stock Awards is not limited to the increase in their value from the residency date until they vested under subsection 83A-110(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The provisions of Australia's domestic tax laws are relevant to this case as are the provisions of the Agreement to avoid double taxation between the Foreign Country and Australia (the Foreign Country Double Tax Agreement). While both sets of provisions technically apply at the same time to a particular situation, it is often easier to apply the provisions in practice if Australia's domestic tax law is considered first. (See paragraph 43 to 45 of Taxation Ruling TR 2001/13.) | Detailed Reasoning - The employee share scheme provisions - general operation: The employee share scheme provisions that apply to the Post July 2009 Stock Awards for the 20VV-WW and 20WW-XX income years are contained in Division 83A of the ITAA 1997. The general operation of the employee share scheme provisions to the Post July 2009 Stock Awards are outlined in a Class Ruling. Specifically, this Class Ruling determines that the Stock Awards are rights to acquire beneficial interests in ordinary shares in the company. | Detailed Reasoning - The employee share scheme provisions - foreign service: The actual liability to tax on employee share scheme discounts is determined by Division 83A of the ITAA 1997 in concert with Division 6 of the ITAA 1997. Both subsections 83A-25(2) and 83A-110(2) of the ITAA 1997 merely define the component of an employee share scheme discount that relates to foreign employment as having a foreign source. As statutory income, the actual amount to be included in assessable income is determined by either subsection 6-10(4) of the ITAA 1997 for Australian residents and subsection 6-10(5) of the ITAA 1997 for foreign residents. Paragraphs 1.347 to 1.357 of the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 confirm this intention and state: 1.347 Consistent with the treatment of most other types of income, whether an amount is included in a taxpayer's assessable income under the new employee share scheme rules will depend on the taxpayer's residency status and the source of the income. 1.348 Under the core rules of the Australian income tax system, an Australian resident taxpayer is subject to income tax on their worldwide income. A foreign resident taxpayer is only subject to Australian income tax on their Australian sourced income. 1.349 Under the existing law, this outcome is achieved by excluding discounts from interests acquired under employee share schemes from tax under the employee share scheme tax rules, to the extent that they relate to foreign service of a taxpayer. 1.350 This mechanism operates in a manner inconsistent with core rules. The new rules use the core rules to achieve the desired outcome. The new rules instead include source rules and rely on the core rules to the exclude foreign sourced income of foreign residents from Australian income tax. That is, the employee share scheme rules attribute a source to discounts received on securities acquired under employee share schemes. 1.351 To the extent that a discount on an ESS interest relates to employment outside Australia, the discount is taken to be from a foreign source. In the case of an ESS interest that is subject to a deferred taxing point, it is the amount included in your assessable income that is attributed a source (that is, both the discount and subsequent gains are attributed with a source). The attribution is done in manner consistent with the rule applying to discounts. [Schedule 1, item 1, subsections 83A-25(2) and 83A-110(2)] 1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development and Cooperation (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005. 1.353 Source is attributed to amounts 'included' in assessable income either upfront or under the deferral method at the ESS deferred taxing point. The inclusion in assessable income is merely notional as all amounts included in assessable income must pass through the core rules before being taken into account in the calculation of taxable income. At this time foreign sourced income of foreign residents will be removed from the calculation of taxable income. 1.354 Whether the discount on the ESS interest acquired under an employee share scheme relates to employment in Australia or outside Australia is a question of fact that needs to be determined on a case-by-case basis. 1.355 Australian resident taxpayers are subject to Australian income tax on all discounts they receive under employee share schemes regardless of whether they received it in relation to employment in Australia or outside Australia. However, this may be affected by Australia's double tax treaties and the temporary residents rules. 1.356 Foreign resident taxpayers are only subject to Australian income tax on discounts they receive under employee share schemes to the extent that the discount relates to the employment in Australia. The core rules are contained in sections 6-5 and 6-10 of the ITAA 1997. 1.357 The outcome effectively mirrors the tax treatment of employment income. It has been necessary to modify the treatment of employee share scheme discounts received in respect of employment outside Australia in order to bring the employee share scheme rules into closer alignment with the ordinary treatment of salary and wage income and to prevent taxpayers avoiding the recent changes to section 23AG of the ITAA 1936 (exemption for foreign employment income). The Applicant was an Australian resident as at both of the deferred taxing points identified for this private ruling for the Post July 2009 Stock Awards. Therefore, the whole of the employee share scheme discounts that relate to these deferred taxing points is to be included in the Applicant's assessable income under Divisions 6 and 83A of the ITAA 1997. | Detailed Reasoning - The Foreign Country Double Tax Agreement - Income from employment: Paragraph 1 of Article 11 of the Foreign Country Double Tax Agreement states: Subject to this Article and to Articles 12, 13 and 14 remuneration or other income derived by an individual who is a resident of one of the Contracting States in respect of personal (including professional) services shall be subject to tax only in that Contracting State unless the services are performed or exercised in the other Contracting State. If the services are so performed or exercised such remuneration or other income as is derived therefrom shall be deemed to have a source in, and may be taxed in, that other Contracting State. Article 17 of the Foreign Country Double Tax Agreement states: Profits, income or gains derived by a resident of one of the Contracting States which, under any one or more of Article 4A, Article 5, Articles 7 to 14 and Article 16A, may be taxed in the other Contracting State shall for the purposes of Article 18 and of the laws of the respective Contracting States relating to tax be deemed to be income from sources in that other State. Paragraph 4.6 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 states: 4.6 The OECD commentary on the articles of the model tax convention is relevant in interpreting Australia's tax treaties. The revised commentary treats the benefit accruing up to the exercise of a right as an employment benefit to which Article 15 (Income from Employment) of the model tax convention applies. The commentary recognises that the facts and circumstances of the particular case will determine the period of employment to which the right relates. The number of days worked in a treaty country during this employment period then determines the extent of that country's source taxing rights. You consider the term 'derived' to be crucial to the interpretation of Article 11 of the Foreign Country Double Tax Agreement; however, this term is not defined in the Double Tax Agreement. Paragraph 4 of Article 2 of the Foreign Country Double Tax Agreement states: Unless the context otherwise requires, any term of this Agreement not otherwise defined shall have, in a Contracting State, the meaning which it has under the laws in that Contracting State from time to time in force relating to the taxes to which this Agreement applies. Taxation Ruling TR 2001/13 provides the following guidance in relation to the interpretation of Double Tax Agreements: | Detailed Reasoning - Overview: characteristics of DTAs that may affect their interpretation: 85. Some of the specific features of DTAs that in practice impact on their interpretation include: • DTAs are written in very much more general terms than domestic law so that there is perhaps more room for courts to give an interpretation based on purpose, the consideration of 'substance over form', etc.; • DTAs use an international tax terminology which may not exist in domestic law (or if it does was usually drawn from treaties so that the international treaty meaning applies; for example, see the consideration of the domestic tax law definition of 'royalties' (which was influenced by treaty meanings) in TR 98/21 on cross border leasing); • there are internationally accepted OECD Commentaries on the meaning of tax treaties which need to be taken account of to fully understand the DTA and its international usages and context where the DTA reflects the OECD Model Commentaries. As noted below, the same can apply for some UN Model materials; • because of the common terms used internationally and the Commentaries, treaties are the subject of a much broader and internationally focused jurisprudence in cases, texts and administrative rulings than domestic tax law, and foreign case law may be particularly relevant; and • tax treaties often have a life of 20 to 30 years and so have to be flexible enough to cope with many changes in domestic law, while remaining true to the negotiated bargain and the agreed balance of obligations and concessions between the two countries. 86. These characteristics necessitate a different conceptual approach to interpretation than is required in construing a statute. In an important article on the interpretation of tax treaties, a group of international DTA experts noted that '[a] point to be made at the outset is that treaty interpretation is a subject in itself and not merely an extension of statutory interpretation, as has sometimes been thought in common law countries where treaties normally take their effect by virtue of a statute.' The authors' approach on this point is in accord with the approach taken by Australian courts in DTA and other treaty cases and represents ATO practice. | Detailed Reasoning - The approach of Australian courts: 87. In Shipping Corporation of India Limited v . Gamlen Chemical Company Australasia , the High Court of Australia considered that, despite the fact that a treaty had been enacted as domestic law, it should be interpreted broadly in a way conducive to producing a uniform international interpretation. The Court said: It has been recognised that a national court, in the interests of uniformity should construe rules formulated by an international convention . . . 'in a normal manner appropriate for the interpretation of an international convention, unconstrained by technical rules of English law, or by English legal precedent, but on broad principles of general acceptation', to repeat the words of Lord Wilberforce in James Buchanan and Co Ltd v. Babco Forwarding and Shipping (UK) Ltd [1978] AC 141, at p. 152. 88. The legislature, when legislating the DTA into domestic law, is therefore taken to expect that it be interpreted in the light of the normal rules for interpreting treaties. As noted above, Brennan CJ in Applicant A recognised the prima facie legislative intention that the text of a treaty transposed into an Act is to be read in accordance with normal treaty interpretation principles. … | Detailed Reasoning - The requirement to interpret treaties 'liberally': 93. Some debate surrounds the requirement just noted that DTAs be interpreted 'liberally'. Some have interpreted this to mean that this requires the terms of DTAs to be read as broadly as possible. The ATO considers, however, that the requirement for a 'liberal' interpretation of a DTA is directed to the rules of construction to be adopted, rather than being directed at the width and ambit of the content of particular DTA provisions. 94. In other words, when the courts speak of DTAs being given a more 'liberal' interpretation than domestic legislation, in the ATO's view they mean that the rules of construction will not be as detailed and rigid as they might be if the courts were to interpret domestic legislation or domestic instruments, and gaps, imprecision and ambiguities should be accepted as sometimes inevitable in such a text, and to some extent accommodated or 'smoothed over' in a way that addresses the context and meets the object and purpose of the DTA. The term 'derived' is defined in subsection 995-1(1) of the ITAA 1997 but only for the purposes of ordinary income where it is used as a timing mechanism. For example, subsection 6-5(2) of the ITAA 1997 states in part: '… your assessable income includes the ordinary income you derived … during the income year' Paragraph 2.2 of the OECD Commentary on Article 15 (about employment) states: 'The condition provided by the Article for taxation by the State of source is that salaries, wages or other similar remuneration be derived from the exercise of employment in that State. This applies regardless of when that income may be paid to, credited to or otherwise definitively acquired by the employee.' It is clear from the manner of the use of the term 'derived' in paragraph 1 of Article 11 of the Foreign Country Double Tax Agreement and from the OECD Commentary mentioned above that it not intended to be used as a timing mechanism. When considered as an element within the whole clause, the term 'derived' in the context that it is used in paragraph 1 of Article 11 of the Foreign Country Double Tax Agreement merely links remuneration to particular services. This then forms the basis of determining whether there is a limitation on the taxing rights of the other Contracting State (not the country of residence). This also provides a basis for enforcing an obligation on the country of residence to allow a credit for tax paid in the other Contracting State on income that has a source within that other Contracting State in accordance with Article 18 of the Foreign Country Double Tax Agreement. Consequently, the ATO is not prevented by the Foreign Country Double Tax Agreement from taxing the whole of the employee share scheme discount as the Applicant is a resident of Australia at our taxing point. | Summary: The amount to be included in the Applicant's assessable income in relation to the Pre July 2009 Stock Awards is not limited to the increase in their value from the residency date to the date they vested under subsection 83A-5(4) of the ITTPA. | Detailed Reasoning - Detailed reasoning: The provisions of Australia's domestic tax laws and the provisions of the Foreign Country Double Tax Agreement interact in the same manner as described above. | Detailed Reasoning - The employee share scheme provisions - general operation: The employee share scheme provisions that apply to the Pre July 2009 Stock Awards for the 20VV-WW income year are contained in Division 83A of the ITAA 1997. Division 83A of the ITTPA provides modifications (transitional provisions) to Division 83A of the ITAA 1997 to ensure that certain outcomes from the former Division 13A of Part III of the Income Tax Assessment Act 1936 continue to apply to the Pre July 2009 Stock Awards as they were granted to the Applicant before 1 July 2009. Under the transitional provisions, the deferred taxing point of the Pre 2009 Stock Awards is based on the 'cessation time' as determined under the former provisions, but may be adjusted if a sale happens within 30 days of the cessation time. Looking at each individual Stock Award, the 'cessation time' is the earliest of: • The time when the Applicant disposed of the Stock Awards(other than by exercising it) • The time when the Applicant's employment with a relevant employer ceased • The later of the time when any selling restrictions end and any forfeiture conditions cease on any share acquired by exercising or converting the Stock Award • If there are no selling restrictions or forfeiture conditions on the share acquired by exercising or converting the Stock Award- when the Stock Award was exercised or converted, and • 10 years from the date of grant of the Stock Award. | Detailed Reasoning - Adjustment for foreign service: Paragraph 83A-5(4)(a) of the ITTPA excludes amounts that relate to employment outside Australia from being included in a taxpayer's assessable income under subsection 83A-110(1) of the ITAA 1997. Paragraph 1.399 of the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 states: 1.399 Consistent with the current law, employees will not pay tax on shares and rights that have been transitioned into the new rules to the extent that the shares or rights relate to the employee's employment outside Australia. [Schedule 1, item 83, paragraph 83A-5(4)(a) of the IT(TP)A 1997] Paragraph 1.352 of the Explanatory Memorandum for the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 states: 1.352 The apportionment between foreign sourced and Australian sourced income is to be done in a manner consistent with Organisation for Economic Development and Cooperation (OECD) practice, as explained in the explanatory memorandum to the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005. Paragraphs 4.1 to 4.7 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 state: 4.1 Schedule 4 to this Bill more closely aligns the taxation of shares or rights acquired under an employee share scheme (employee shares or rights) with international norms developed by the Organisation for Economic Co-operation and Development (OECD). These amendments will be relevant where an individual works in more than one country or changes country of residence. 4.2 These amendments will help prevent double or nil taxation of employee shares or rights and provide greater certainty for individuals. This is achieved primarily by allowing employee shares or rights to benefit from existing mechanisms to prevent double taxation, and clarifying the treatment of individuals with employee shares or rights who subsequently become employed in Australia. Additional rules clarify capital gains tax (CGT) interactions, and make other improvements. 4.3 Unless otherwise indicated, all legislative references are to the Income Tax Assessment Act 1936. | Detailed Reasoning - Context of amendments: 4.4 These amendments are part of the Government's response to the Board of Taxation's report to the Treasurer on international taxation. They will reduce the potential for double or nil taxation of income from employee shares or rights in the international context. Providing a more internationally consistent treatment of employee shares or rights will ensure a fairer and more certain outcome for relevant individuals. It will also assist Australian businesses in attracting skilled workers. 4.5 Employee shares or rights provided at a discount can be seen as a substitute for employment income. The discount may relate to employment over a long period. Hence problems can arise in respect of individuals who acquire such shares or rights and who subsequently change their country of residence, work in more than one country, or work in one country while resident of another. Many of these problems arise as countries tax employee shares or rights in many different ways. To help address these problems, the OECD recently approved revisions to the Commentary to its Model Tax Convention on Income and on Capital clarifying the tax treaty treatment of employee rights. 4.6 The OECD commentary on the articles of the model tax convention is relevant in interpreting Australia's tax treaties. The revised commentary treats the benefit accruing up to the exercise of a right as an employment benefit to which Article 15 (Income from Employment) of the model tax convention applies. The commentary recognises that the facts and circumstances of the particular case will determine the period of employment to which the right relates. The number of days worked in a treaty country during this employment period then determines the extent of that country's source taxing rights. 4.7 These amendments do not seek to incorporate the OECD approach into Australian domestic law. Rather, the amendments align the domestic law more closely with the OECD approach by emphasising the employment income nature of employee shares or rights, clarifying residence and source country taxing arrangements, and improving the interaction of the employee share scheme and CGT provisions. Paragraphs 4.31 to 4.34 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 state: | Detailed Reasoning - Treatment of individuals who become Australian employees (inbound individuals): 4.31 These amendments have the effect that individuals who acquire employee shares or rights while offshore, and then later become Australian employees while still engaged in employment or service that is relevant to the acquisition of the shares or rights, will apply the employee share scheme provisions at the point of becoming an Australian employee [Schedule 4, item 6, subsection 139B(2); item 7, subsection 139B(2A)]. Where an individual acquires an employee share or right in relation to the employment of an associate, the employee share scheme provisions will apply at the time that associate first engages in employment or service in Australia in relation to the acquisition of the share or right. [Schedule 4, item 14, paragraph 139D(1)(c); item 15, subsection 139D(2); item 16, subsection 139D(3)] 4.32 Individuals will need to examine their circumstances and specific employee share plan to determine whether the period after becoming an Australian employee is relevant to the acquisition of the employee share or right The period of employment after becoming an Australian employee will generally not be relevant if no forfeiture conditions remain at the time an individual becomes an Australian employee. If the employee share or right may be forfeited unless the individual undertakes further employment or services at the time employment commences in Australia, a portion of the discount will generally be assessable in Australia. | Detailed Reasoning - Example 4.1: Under the terms of his employee share plan Arnold is required to complete five years of service before obtaining an unforfeitable right to an employee right. Arnold becomes an Australian employee when only four years of service have been completed. One year as an Australian employee will be relevant to the acquisition of Arnold's right. 4.33 For such inbound individuals, they will either be assessed in the year they become a relevant employee for the first time or at a cessation time for qualifying shares or rights where the relevant election is not made (see paragraph 4.35). If assessed in the year of income in which they become an employee in Australia, the discount will still be valued as at acquisition. [Schedule 4, item 7, subsection 139B(2A); item 9, subsection 139CC(2)] 4.34 However, for inbound individuals the portion of the discount that relates to foreign service when a non-resident will not be included in assessable income. This exclusion may also apply in other cases, such as where a taxpayer ceases to be a resident before the end of the relevant period of employment (see paragraph 4.43). [Schedule 4, item 5, subsection 139B(1A)] Paragraphs 4.41 and 4.42 of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 state: 4.41 How, for these provisions, the amount of the otherwise assessable discount will be assigned to the relevant foreign or qualifying service will depend on the facts and circumstances of each case. This is essentially the approach adopted by the OECD in respect of rights, and therefore also of relevance in interpreting the relevant articles of Australia's tax treaties. 4.42 The revised OECD commentary does, however, set out a number of principles that offer guidance as to what outcome the facts and circumstances would typically point to. Those principles suggest that a generally reasonable approach would look at the time worked in the relevant foreign or qualifying service as a proportion of the total period of employment to which the right relates. The standard approach as suggested by these paragraphs of the Explanatory Memorandum for the New International Tax Arrangements (Foreign-owned Branches and Other Measures) Bill 2005 would conclude that the Applicant's service in Australia up until the vesting date was relevant to the earning of the employment income represented by the Pre 2009 Stock Awards. This is because the Applicant was required to continue with the employment past the date that the residency changed or else the Applicant would have forfeited the Pre 2009 Stock Awards. You have submitted that any apportionment should be based on variations to the relevant share price as at the residency date and the taxing point. This is the method that the Tax Authorities in the foreign country in relation to employees leaving the Foreign Country. The Commissioner disagrees. As an employee might change country shortly after ESS interests are granted, your approach would effectively attribute an amount equal to the market value of the shares calculated as at the grant date to the work performed by the Applicant on the grant date with all work performed from that date until the vesting date only being valued positively if the share price increased. Further, you have not provided any evidence to suggest that any variation in the relevant share price reflects the Applicant's effort. The effect of the employee share scheme provisions is to treat ESS discounts as if they were a cash payment made to the employee at the relevant taxing point (grant date or deferred taxing point) with that cash then being used to fund the purchase of the ESS interests for the other purposes of the ITAA 1997 (generally for capital gains purposes) if required. The market value of an ESS interest is used for two purposes only: • to determine whether or not they were granted at a discount to their market value, and • to determine how much (if any) should be included in the employee's assessable income at the taxing point (in other words, the amount of the de facto cash payment made at the taxing point that would be required to purchase the ESS interest at its market value). On the information provided in this case, the Commissioner has concluded that the Applicant partly earned the Pre 2009 Stock Awards as a result of the employment undertaken in Australia and so they partly have an Australian source. The standard approach outlined above is an appropriate method of apportioning the ESS discount over the period that the Applicant earned them. The standard approach effectively treats the ESS discount as being equivalent to a cash bonus that is paid at the taxing point but earned over the vesting period. The bonus is apportioned on a time basis (and therefore equally over the period it is earned). The Commissioner applies the standard approach unless there is definitive evidence to warrant adopting a different approach. You have not provided any evidence that would warrant adopting a differentiated approach. The method submitted by you is not an appropriate method of apportioning the ESS discount over the period that the Applicant earned them.