Private ruling: Emplo yee share schemes
Date of advice: 17 April 2019
Published: June 2019
Ruling period: The year ending 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will the exercise of the vested Options by the Director give rise to an ESS deferred taxing point under subsection 83A-120(7) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: The ESS deferred taxing point will arise at the earliest of the time of the exercise of the vested Options or upon assignment of the Options prior to exercise. | Q2: Where the ESS deferred taxing point arises upon exercise of the Option, can the amount to include in the assessable income of the Director be calculated as being the market value of an ordinary share in the Company at the exercise time less the exercise price paid to exercise each Option? | A2: Yes. | Q3: Where the ESS deferred taxing point arises upon exercise of the Option, will the Commissioner accept, for the purposes of section 83A-110, that the value of an ordinary share in the Company at the exercise time is $Z? | A3: Yes.

Relevant facts and circumstances: 1. The Company is an Australian Resident unlisted public company. 2. The Company has entered into an arrangement involving the grant of options to eligible executives and directors of the Company in accordance with the rules of the Company Option Plan (OP). 3. The OP constitutes an employee share scheme (ESS) within the meaning of subsection 83A-10(2) of the Income Tax Assessment Act 1997 (ITAA 1997). 4. The individual (the Director) is an executive of the Company. 5. The Director is a resident of Australia for tax purposes. 6. The vesting dates and exercise price of the options granted under the OP (the Options) have been determined at the sole discretion of the board of the Company (the Board). 7. On XXXX, Options were issued to the Director for no consideration. 8. Each Option entitles the holder to subscribe for one ordinary share in the Company at the relevant exercise price. 9. None of the Options have been exercised. 10. The Options have an exercise price of $Y and will vest on YYYY. 11. Once the Options vest, there is no risk of loss or forfeiture of the Options (other than by allowing them to lapse). 12. There is a restriction on the disposal of the Options, whether vested or unvested. The Options may not be assigned, transferred, encumbered with a security interest or otherwise disposed of by the Director, unless authorised by the board of the Company (the Board) and only in very limited circumstances. 13. There is no risk of loss or forfeiture of the share acquired as a result of exercising the Option (other than by disposal). 14. Any unexercised Options will lapse and become incapable of being exercised at the earlier of: a. When the Director ceases to be involved in the management of the Company, and b. Three calendar years after the vesting date for the Options. 15. An independent valuation was undertaken which assessed the fair market value of an illiquid minority share in the Company as at ZZZZ as being $Z. 16. There have been no events which materially impact on the valuation of the shares in the Company during the time since the valuation was undertaken until the time the Options are exercised. 17. The Director will exercise their vested Options prior to 30 June 2019. They will not dispose of the shares acquired by exercising their Options within 30 days after exercising the Options. 18. The Director will remain employed until after the exercise of the Options. 19. Immediately after acquiring the Options the Director does not hold a beneficial interest in more than 10% of the shares in the Company, or Options that would allow them to acquire more than 10% of the shares in the Company if exercised, nor on the same basis were they in a position to cast, or control the casting of more than 10% of the maximum number of votes that might be cast at a general meeting of the Company. 20. Subdivision 83A-C of the ITAA 1997 applies to the Options.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 83A | Income Tax Assessment Act 1997 Subdivision 83A-B | Income Tax Assessment Act 1997 Subdivision 83A-C | Income Tax Assessment Act 1997 section 83A-10 | Income Tax Assessment Act 1997 section 83A-15 | Income Tax Assessment Act 1997 section 83A-20 | Income Tax Assessment Act 1997 section 83A-105 | Income Tax Assessment Act 1997 section 83A-110 | Income Tax Assessment Act 1997 section 83A-120 | Income Tax Assessment Regulations 1997 Regulation 83A-315

Reasons for decision: Summary: 21. The ESS deferred taxing point will arise at the earliest of the time of the exercise of the vested Option or upon assignment of the Option prior to exercise. | Detailed Reasoning - Detailed reasoning: 22. Division 83A broadly provides for the taxation of employee share scheme interests acquired at a discount. The discount received on interests acquired under an ESS will generally be included in your assessable income of the income year in which the interests are acquired unless certain conditions are met and there is either a real risk of forfeiture or the interests are acquired under an arrangement where the schemes rules state that the Subdivision applies. Where such conditions are met, your taxing point may be deferred (see Subdivision 83A-C). 23. Section 83A-20 provides that Subdivision 83A-B applies if you acquire an ESS interest under an employee share scheme and at a discount. However, Subdivision 83A-B will not apply and Subdivision 83A-C will apply if subsection 83A-105(1) applies. 24. Subsection 83A-105(1) will only apply to ESS interests which are rights in situations where, pursuant to paragraph 83-105(1)(d), subsection (3) or (6) of section 83A-105 applies. Subsection (6) concerns ESS interests acquired under an arrangement where the schemes rules state that the Subdivision applies and is not applicable here. Thus subsection (3) must be met for subsection 83A-105(1) to apply. 25. Subsection 83A-105(3) relevantly provides that subsection 83A-105 applies to an ESS interest you acquire under an employee share scheme if, when you acquire the interest, there is a real risk that, under the conditions of the scheme, you will forfeit or lose the ESS interest, other than by disposing of it, exercising it, or letting it lapse. 26. Based upon the vesting conditions that apply there is a real risk under the conditions of the scheme that the Director will forfeit or lose the Option/s, other than by disposing of it, exercising it, or letting it lapse. 27. Subsection 83A-110(1) provides that: Your assessable income for the income year in which the *ESS deferred taxing point for the *ESS interest occurs includes the*market value of the interest at the ESS deferred taxing point, reduced by the *cost base of the interest. 28. Subsection 83A-120(2) relevantly provides that the ESS deferred taxing point for rights to acquire shares is the earliest of: a. when there is no real risk that you will forfeit or lose the ESS interest other than by disposing of it, and there are no restrictions on you disposing of the ESS interest (subsection 83A-120(4)), b. when your employment in respect of which you acquired the interest ends (subsection 83A-120(5)), c. the end of the 15 year period starting when you acquired the ESS interest (subsection 83A-120(6)), or d. when you have exercised the right and there is no risk that you will forfeit or lose the resulting beneficial interest in the share (other than by disposing of it) (subsection 83A-120(7)). 29. However, subsection 83A-120(3) provides that if the beneficial interest in the share acquired as a result of exercising a right is disposed of within 30 days after the occurrence of the time worked out under subsection (2), then the ESS deferred taxing point is instead the time you disposed of the beneficial interest in the share. 30. You have provided that the shares acquired as a result of exercising the Options will not be disposed of within 30 days after the occurrence of a time worked out under subsection 83A-120(2). 31. According to the facts provided, the earliest of these times will be the earlier of the following: a. the time the Option is exercised – in such a case, the ESS deferred taxing point will be the time the Option is exercised, pursuant to subsection 83A-120(7), or b. the time when the Board allows the Option to be transferred to another party – in such a case, there is no longer a real risk that the Director will forfeit or lose the ESS interest and there is no restriction on disposal, thus giving rise to an ESS deferred taxing point under subsection 83A-120(4). | Summary: 32. Where the ESS deferred taxing point arises upon exercise of the Option the amount to include in the assessable income of the Director can be calculated as the market value of an ordinary share in the Company at the time of exercise less the exercise price paid to exercise the Option. | Detailed Reasoning - Detailed reasoning: 33. Subsection 83A-110(1) states: Your assessable income for the income year in which the *ESS deferred taxing point for the *ESS interest occurs includes the*market value of the interest at the ESS deferred taxing point, reduced by the *cost base of the interest. 34. Given that the Options were issued for no consideration and no other costs have been incurred by the Directors in relation to the Options, the cost base of the Options is nil, pursuant to section 110-25. 35. Subsection 83A-15 provides that for the purposes of Division 83A whenever the market value of an ESS interest is used, to use instead the amount specified in the Income Tax Assessment Regulations 1997 (ITAR 1997). 36. Regulation 83A-315.01 of the ITAR 1997 relevantly states: (1) For subsection 83A-315 of the Act, the amount, in relation to an unlisted right that must be exercised within 15 years after the date when the beneficial interest in the right was acquired is, at the choice of the individual: (a) the market value of the right; or (b) the amount determined by the application of regulations 83A-315.02 to 83A-315.09. 37. As the Options are unlisted, it is open to the Director to determine the amount under Regulation 83A-315.01. The Director may choose to use paragraph 83A-315.01(b) of the ITAR to determine the amount, which is determined by the application of Regulations 83A-315.02 to 83A-315.09. 38. Regulation 83A-315.02 states: If a right is not quoted on an approved stock exchange on a particular day, the value of the right is the greater of: (a) the market value, on the day, of the share that may be acquired by exercising the right, less the lowest amount that must be paid to exercise the right to acquire the beneficial interest in the share; and (b) subject to regulation 83A-315.03, the value determined in accordance with regulations 83A-315.05 to 83A-315.09. 39. Regulation 83A-315.03 refers to a situation where the amount that must be paid to exercise a right to acquire a beneficial interest in a share is nil or cannot be determined and is, thus, not applicable in these circumstances. 40. Regulations 83A-315.05 to 83A-315.09 prescribe the method of calculating the value, on a particular day, of a right to acquire the beneficial interest in a share, for the purposes of paragraph 83A-315.02(1)(b) of the ITAR. 41. As the value under paragraph 83A-315.02(a) of the ITAR is greater than the value calculated under paragraph 83A-315.02(b), the Director can, at his choice under Regulation 83A-315.02, use the amount calculated under paragraph 83A-315.02(a) as the market value of the Option for the purposes of subsection 83A-110(1) of the ITAA 1997. 42. Thus, where the ESS deferred taxing point arises upon exercise of the Option, the amount to include in the assessable income of the Director can be calculated as the market value of an ordinary share in the Company at the time of exercise less the exercise price paid to exercise the Option. | Detailed Reasoning - Question 3: Where the ESS deferred taxing point arises upon exercise of the Option, the Commissioner accepts, for the purposes of section 83A-110, that the value of an ordinary share in the Company at the time of exercise is $Z.

Reasons for decision: All references are to the Income Tax Assessment Act 1997 unless otherwise stated.