Private ruling: Employee Share Trust
Published: November 2012
Ruling period: Income Tax Year ended 30 June 2012 | Income Tax Year ended 30 June 2013 | Income Tax Year ended 30 June 2014

Ruling: Q1: To the extent that the dividends distributed to the employee constitute franked distributions for the purposes of Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997), will the employee be entitled to tax offsets equal to his/her share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997? | A1: No | Q2: Will the employee's interest in so much of the trust corpus that is comprised by the allocation of shares to the share units by the trustee be taken to be a vested and indefeasible interest in accordance with section 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A2: No

Relevant facts and circumstances: The employer entity intends to implement a long term equity plan for the purpose of providing a long term equity incentive structure to deliver equity based benefits to employees selected by the board of the employer entity.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 160APHD | Income Tax Assessment Act 1936 subparagraph 160APHJ(2)(f) | Income Tax Assessment Act 1936 subsection 160APHJ(4) | Income Tax Assessment Act 1936 section 160APHL | Income Tax Assessment Act 1936 subsection 160APHL(5) | Income Tax Assessment Act 1936 subsection 160APHL(7) | Income Tax Assessment Act 1936 subsection 160APHL(10) | Income Tax Assessment Act 1936 subsection 160APHL(11) | Income Tax Assessment Act 1936 subsection 160APHL(14) | Income Tax Assessment Act 1936 subsection 160APHM(2) | Income Tax Assessment Act 1936 subsection 160APHO(1) | Income Tax Assessment Act 1936 subsection 160APHO(2) | Income Tax Assessment Act 1936 subsection 160APHO(3) | Income Tax Assessment Act 1997 Division 83A | Income Tax Assessment Act 1997 subsection 83A-10(1) | Income Tax Assessment Act 1997 subsection 83A-10(2) | Income Tax Assessment Act 1997 subdivision 207-B | Income Tax Assessment Act 1997 section 207-45 | Income Tax Assessment Act 1997 subsection 207-150(1) | Income Tax Assessment Act 1997 subsection 207-150(3) Explanatory memorandum to the Taxation Laws Amendment Bill (No. 2) 1999 | ATO view documents | Taxation Determination TD 2007/11 | Other references (non ATO view, such as court cases) | Dwight v Commissioner of Taxation (1992) 92 ATC 4192

Reasons for decision: Summary: To the extent that the dividends distributed to the employee constitute franked distributions for the purposes of Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997), will the employee be entitled to tax offsets equal to his/her share of the franking credits on the franked distributions under section 207-45 of the ITAA 1997? No | Detailed Reasoning - Indirect franked distribution: Section 207-45 of the Income Tax Assessment Act (ITAA 1997) sets out the tax implications for an individual in terms of the tax offset associated with an indirect franked distribution: An entity to whom a *franked distribution *flows indirectly in an income year is entitled to a *tax offset for that income year that is equal to its *share of the *franking credit on the distribution, if it is: (a) an individual; or (b) a *corporate tax entity when the distribution flows indirectly to it; or (c) the trustee of a trust that is liable to be assessed on a share of, or all or a part of, the trust's *net income under section 98, 99 or 99A of the Income Tax Assessment Act 1936 for that income year; or (ca) the trustee of an *FHSA trust; or (d) the trustee of a *complying superannuation fund, a *non-complying superannuation fund, a *complying approved deposit fund, a *non-complying approved deposit fund or a *pooled superannuation trust in relation to that income year. Under the trust deed a share unit holder is entitled to receive a distribution equal to the dividend paid to the trust, and any associated franking credits, in respect of each accounting period. As the recipient of the distribution is a unit holder the distribution flows indirectly to the employee. It appears that where a dividend is paid with an associated franking credit, the employee is entitled to a tax offset equal to his/her share of the franking credits on the distribution under section 207-45 of the ITAA 1997. | Detailed Reasoning - 'Qualified' person: However, with this right to be eligible to indirectly receive a franked distribution there are further considerations necessary on whether the entity receiving the distribution is or is 'not a qualified person' as stated in subsection 207-150(1) of the ITAA 1997. The former section 160APHO(1) of the Income Tax Assessment Act 1936 (ITAA 1936) defines a qualified person: A taxpayer who has held shares or an interest in shares on which a dividend has been paid is a qualified person in relation to the dividend if: (a) where neither the taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the primary qualification period in relation to the dividend; or (b) where the taxpayer or an associate of a taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the secondary qualification period in relation to the dividend. The former section 160 APHO(2) ITAA 1936 defines the qualification period: A taxpayer who has held shares or an interest in shares on which a dividend has been paid satisfies this subsection in relation to a qualification period in relation to the shares or interest if, during the period: (a) …… ( b) where the taxpayer held the interest in the shares - the taxpayer held the interest for a continuous period (not counting the day on which the taxpayer acquired the interest or, if the taxpayer has disposed of the interest, the day on which the disposal occurred) of not less than: (i) if the shares are not preference shares - 45 days; or (ii) if the shares are preference shares - 90 days. | Detailed Reasoning - Non-widely held trust: As the employee will be a beneficiary of the trust, former section 160APHL of the ITAA 1936 is the relevant provision to determine his/her interest in the shares held by the trust for the purposes of former Division 1A of the ITAA 1936. Further, given the indicative percentages for the share plan outlined in the employee handbook, it is considered likely that not more than 20 persons will have interests that entitle them to more than 75% of the beneficial interests in the income and capital of the trust. As such, the trust will be considered a 'closely held fixed trust' as that term is defined in former section 160APHD of the ITAA 1936. As the trust will be excluded from the definition of 'widely held trust' in former section 160APHD of the ITAA 1936, it will be treated as an 'other than a widely held trust' scenario for the purposes of former Division 1A of the ITAA 1936. In this context, it should be noted that the term 'widely held trust' is defined in former section 160APHD of the ITAA 1936 as a trust that is neither a 'closely held fixed trust' nor a 'non-fixed trust' (as those terms are themselves defined in former section 160APHD of the ITAA 1936. For the purposes of former section 160APHL of the ITAA 1936, if a trust is not a widely held trust it is treated as 'other than a widely held trust', which will be referred to as a 'non-widely held trust' in this ruling. A beneficiary of a non-widely held trust, as is the case in the employee's situation, must be a "qualified person" by satisfying both the qualification period rule, and the related payments rule. In determining whether the qualification period requirements are satisfied for the prescribed minimum period no account is taken of any days on which the employee has materially diminished risks of loss and opportunities for gain in respect of the shares as stated in former subsection 160APHO(3) ITAA 1936: In calculating the number of days for which the taxpayer continuously held the shares or interest, any days on which the taxpayer has materially diminished risks of loss or opportunities for gain in respect of the shares or interest are to be excluded, but the exclusion of those days is not taken to break the continuity of the period for which the taxpayer held the shares or interest. Under former subsection 160APHM(2) ITAA 1936 a taxpayer has a materially diminished risk in relation to their interest if they have less than 30%, i.e. a delta of less than +0.3, of the risks associated with share ownership, as stated: (2) A taxpayer is taken to have materially diminished risks of loss or opportunities for gain on a particular day in respect of shares held by the taxpayer, or in respect of an interest held by the taxpayer in shares, if the taxpayer's net position on that day in relation to the shares or interest has less than 30% of those risks and opportunities. Net position worked out by reference to deltas (3) A taxpayer's net position is worked out using the financial concept known as delta (see section 160APHJ). For example, an option to sell a share with a delta of minus 0.5 in relation to the share reduces the risks of loss and opportunities for gain by 50%. | Detailed Reasoning - Application of law to the Trust Deed: A position with a positive delta is defined as a long position under former subsection 160 APHJ(4) ITAA 1936. This subsection expressly states an interest in shares is to be treated as a long position with a delta of +1 in relation to itself. In this case, as it is not a widely held trust, the employee's interest in the relevant share is worked out according to the formula in former subsection 160APHL(5) ITAA 1936. The effect of this subsection is to determine through the use of the relevant formula the employee's interest in the relevant share. The interest is worked out from the employee's trust holding, i.e. his/her share of the trust corpus, modified by his/her share of the dividend associated with the holding. When the employee's interest is worked out under former subsection 160APHL(5) ITAA 1936, he/she will have a long position with a delta of +1 in relation to its interest in the shares under former subsection 160APHL(7) ITAA 1936. According to the terms of the trust deed, it is considered that the employee's interest in the shares is a defeasible interest. It is not clear from the trust deed whether the interest will convert to an indefeasible interest within 10 years where the trustee does not cancel share holder units relevant to a specific unit holder. Therefore, the interest is not an employee share scheme security as defined under former subsection 160APHD ITAA 1936. Under former subsection 160APHL(10) ITAA 1936 the employee will have a short position, i.e. a negative delta, equal to his/her long position arising under former subsection 160APHL(7) ITAA 1936 giving an overall delta of zero. Under former subsection 160APHM(2) ITAA 1936 this will constitute a material diminution in the employee's risk of loss or opportunity for gain as the overall delta associated with his/her interest is less than +0.3. However, under former subsection 160APHL(10) ITAA 1936 the employee's interest will also give rise to a corresponding positive delta long position equal to his/her fixed interest in the trust holding. If this gives rise to a positive delta of at least +0.3 the employee would be entitled to claim the franking credits. The former subsection 160APHL(10) ITAA 1936 states: If: (a) the trust is not a family trust within the meaning of Schedule 2F; and (b) the trust is not a trust for the purposes of this Act merely because of the reference to executors and administrators in paragraph (a) of the definition of trustee in subsection 6(1); and (c) the taxpayer's interest in the relevant share or the relevant shares is not an employee share scheme security; the taxpayer has, in addition to any other long and short positions (including the positions that the taxpayer is taken to have under subsection (8)) in relation to the taxpayer's interest in the relevant share or relevant shares, a short position equal to the taxpayer's long position under subsection (7) and a long position equal to so much of the taxpayer's interest in the trust holding as is a fixed interest. Under former subsection 160APHL(11) ITAA 1936 the taxpayer must have a vested and indefeasible interest in the part of the trust corpus comprised of their trust holding in order to have a fixed interest, as stated: For the purposes of subsection (10), the taxpayer's interest in the trust holding is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding. | Detailed Reasoning - A vested interest: A person has a vested right in something if he, she or it has a present right relating to it. A vested interest is one that is bound to take effect in possession at some point in time. It may either be immediate, where it is described as "vested in possession" and refers to a present right of present enjoyment; or it may not, where it is described as "vested in interest" and refers to a present right of future enjoyment ( Dwight v Commissioner of Taxation (1992) 92 ATC 4192). The conjunction of "vested and indefeasible' shows that the right must be absolute. A vested interest is to be contrasted with a contingent interest. The latter may never take effect in possession if the contingency is not met. | Detailed Reasoning - Vested and indefeasible: A vested interest is indefeasible where it is not able to be lost. It is defeasible where it can be brought to an end, and indefeasible where it cannot. It is defeasible, for instance, where it is subject to a condition subsequent. For example, a future occurrence may lead to the divestment of a person's vested entitlement. The circumstances by which this may occur include the happening of an event, or the exercise of a power. Events: A beneficiary's interest in particular assets of the trust will not be vested and indefeasible if: (a) that is the effect of the trust deed; (b) the assets are disposed of by the trustee in the course of administration of the trust prior to the vesting day; (c) the person's status as a beneficiary as at the vesting date is subject to a condition precedent (i.e. a contingency). Exercise of power: Where a beneficiary's vested interest is able to be divested by the exercise of a power by the trustee (or any other person), the interest is defeasible. Under the trust Deed, the share unit holder, in circumstances other than terminated employment, can request cancellation of their share units. The share unit holder has the option upon cancellation to take the in-specie distribution, or a cash payment. However, the employee is limited to two cancellation requests in any 12 month period. However, if their employment is terminated the share unit holders only have the in-specie option if the employer also requests the share units be cancelled. As a result the share unit holder can only receive the in-specie distribution in two circumstances: · their employment is terminated and the employer requests cancellation, or · they make a cancellation request in continuing employment and specify the in-specie option. The trust deed also does not entitle the share unit holders to any rights in respect of the trust fund. Under the trust deed the share unit holders rights in regard to the shares are not clearly defined. The trust deed states the rights to include directing the trustee in terms of voting and to receive dividend income. It also states the share unit holder's entitlements and rights in regards the shares are 'substantially the same rights' as the legal owners of the share would have. How these rights are achieved and what they entail, beyond share voting rights, is not addressed in the trust deed. Conversely, the trust deed prevents a share unit holder from transferring, assigning or dealing with their share units. Also, the trust deed restricts how often a share unit holder can request cancellation (to receive an in specie distribution of the shares to themselves or a cash payment of the market value of the shares) to twice per year. Therefore they do not have the full rights of ownership. However, the trustee is given the power under the trust deed to sell shares. Therefore the trust deed provides for a future contingency at the trustee's discretion which may bring the employee's interest to an end. As a result, the employee has a defeasible interest in the underlying share comprising his/her share of the trust corpus. A non-recourse loan is identified as 'a position' in relation to shares or an interest in shares under former subparagraph 160APHJ(2)(f) ITAA 1936 and therefore has an associated delta. As the position relates to a non-recourse lending to a trust beneficiary in relation to an interest in shares where the lender may not receive the full value of the loan, the delta may be negative, as there is a material diminution of risks of loss or opportunities for gain as described in section 160APHM. The trust deed notes the nature of the non-recourse loan to share unit holders. As a result of the powers given to the trustee under the trust deed, the contingencies provided by the cancellation clauses and the limited recourse elements, the share unit holders may only have a defeasible interest in any particular holding of the shares. Therefore their interest in the trust corpus is defeasible. Therefore on the basis the interest is defeasible, the employee will not have a positive delta in relation to his/her interest as it does not give rise to an additional long position under former subsection 160APHL(10) ITAA 1936. The employee, therefore, would not be a qualified person for the purposes of Division 1A of former Part III A of the ITAA 1936 as the interest in the shares will not be held for the required number of days. As the employee is not a qualified person in relation to the dividend distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 , paragraphs 207-150(1)(a) and (f) and subsection (3) of the ITAA 1997 apply. As the employee is a beneficiary of a trust subsection (3) also applies. Paragraphs 207-150(1)(a) & (f) state as follows: If a *franked distribution *flows indirectly to an entity in an income year in one or more of the following circumstances: (a) the entity is not a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 ; ……… then, for the purposes of this Act: (f) subsection (2), (3) or (4) (as appropriate) applies to the entity in relation to that income year; and (g) the entity is not entitled to a *tax offset under this Subdivision because of the distribution; and (h) if the distribution *flows indirectly through the entity to another entity - subsection 207-35(3) and section 207-45 do not apply to that other entity. History S 207-150(1) amended by No 101 of 2006, s 3 and Sch 2 item 711, by amending the reference to a repealed inoperative provision in para (a), effective 14 September 2006. For application and savings provisions see the CCH Australian Income Tax Legislation archive . Subsection 207-150(3) states in relation to beneficiaries: If the *franked distribution *flows indirectly to the entity as a beneficiary of a trust under subsection 207-50(3), the entity can deduct an amount for that income year that is equal to the lesser of: (a) its share amount in relation to the distribution that is mentioned in that subsection; and (b) its *share of the *franking credit on the distribution. Therefore, as the employee is not a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 he/she is not entitled to the tax offset due to the distribution under paragraph 207-150(1)(g) and he/she would not include the franking credit in his/her taxable income due to the effect of paragraph 207-150(3)(b). The employee will be denied the tax offset otherwise provided under section 207-45 of the ITAA 1997. | Detailed Reasoning - Question 2: Will the employee's interest in so much of the trust corpus that is comprised by the allocation of shares to the share units by the trustee be taken to be a vested and indefeasible interest in accordance with section 160APHL(14) of the Income Tax Assessment Act 1936 (ITAA 1936)? No In circumstances where a beneficiary does not have a vested and indefeasible interest in the corpus of a trust, the Commissioner may, dependant upon the relevant circumstances, exercise the discretion available to him under subsection 160APHL(14) of the ITAA 1936 to treat the interest as being vested and indefeasible. In exercising this discretion, the Commissioner is required to consider a range of factors in determining if an interest, despite the fact that it does not represent a vested and indefeasible interest, ought to be treated as such. Subsection 160APHL(14) of the ITAA 1936 states: 160APHL(14) Commissioner may determine an interest to be vested and indefeasible. If: (a) the taxpayer has an interest in so much of the corpus of the trust as is comprised by the trust holding; and (b) apart from this subsection, the interest would not be a vested or indefeasible interest; and (c) the Commissioner considers that the interest should be treated as being vested and indefeasible, having regard to: (i) the circumstances in which the interest is capable of not vesting or the defeasance can happen; and (ii) the likelihood of the interest not vesting or the defeasance happening; and (iii) the nature of the trust; and (iv) any other matter the Commissioner thinks relevant; the Commissioner may determine that the interest is to be taken to be vested and indefeasible. In the present context, it is considered particularly relevant to focus on the factors provided in subparagraph (c) as regard the trust. | Detailed Reasoning - 160APHL(14)(c)(i): The circumstances in which unit holdings of the trust are capable of not vesting or a defeasance can happen are highlighted through various clauses of the trust deed. | Detailed Reasoning - 160APHL(14)(c)(ii): Whilst it is difficult to estimate, the likelihood of the interest not vesting could be considered to be low to moderate. | Detailed Reasoning - 160APHL(14)(c)(iii): Subparagraph 160APHL(14)(c)(iii) requires the Commissioner to take into account the nature of the trust. In theory, this indicates that a trust exhibiting the nature of a fixed trust would support the Commissioner's decision to exercise his discretion or contributes to his decision to exercise his discretion. In the current case, the trust is a non-widely held trust which does not have the nature of a fixed trust. In this respect, whilst the trust is a unit trust the trustee has various discretions to give it the flexibility when making distributions which are inconsistent with a fixed or vested and indefeasible interest overall. | Detailed Reasoning - 160APHL(14)(c)(iv): Subparagraph 160APHL(14)(c)(iv) requires the Commissioner to consider any other matter he thinks relevant. These are as follows: | Detailed Reasoning - Legislative intent: The Explanatory Memorandum which accompanied the introduction of section 160APHL ITAA 1936 provides the following as an example of when the exercise of the Commissioner's discretion under subsection 160APHL(14) of the ITAA 1936 may be appropriate: 4.82 Even if an interest is not fixed and indefeasible, the Commissioner may, in appropriate circumstances, deem it to be so. For example, it may be appropriate to exercise this discretion, if necessary, in relation to beneficiaries of certain hardship trusts (e.g. trusts established under workers compensation legislation). Using this example as a consideration for the exercise of this discretion, the circumstances in this case are not the type of circumstances envisaged by the introduction of the discretion under subsection 160APHL(14) of the ITAA 1936. Generally speaking, one of the design features of the imputation system is that entities, which are not the true economic owners of a company and therefore not sufficiently subject to the risks of loss and opportunities for gain associated with ownership, are not able to claim a credit for the tax paid by the company. 1 The underlying intention of Division 1A of former Part IIIAA of the ITAA 1936 (according to the Explanatory Memorandum) is to ensure that the benefits of the franking credits on distributions paid on shares are only available to the true economic owners of the shares, that is, those persons who are sufficiently exposed to the risks of loss and opportunities for gain associated with ownership of the shares. It is our view that the employee would not be sufficiently exposed to the risk of loss or gain in respect of his/her shares. This view is supported by the following considerations: · The non-recourse nature of the loan obtained by the employee wholly protects him/her against a fall in the market value of the shares. · The shares referable to the employee's unit holding are not actively traded and therefore do not have an open market value. This indicates that the employee would not have any exposure to fluctuations in the market value of the share. The trust deed also does not allow the employee to deal with the shares as he/she wishes and therefore does not confer the full rights of ownership. As a result, the employee does not have full economic ownership of the shares. The terms of the trust deed leading to the defeasibility of the employee's interest indicate that he/she is not intended to be the effective owner of the shares. That is, there is no real expectation or aim by the employee to obtain the shares upon the occurrence of a cancellation event. | Detailed Reasoning - Division 83A employee share schemes: An employee share scheme (ESS) is defined in subsection 83A-10(2) of the ITAA 1997 to include a scheme under which ESS interests in a company are provided to employees of that company or a subsidiary of that company, in relation to the employees' employment. An ESS interest in a company is defined in subsection 83A-10(1) of the ITAA 1997 as a beneficial interest in a share in the company, or a right to acquire a beneficial interest in a share in the company. Further, employees are ordinarily entitled to a tax offset equal to the amount of the franking credit of the dividend received under the Division 83A ESS arrangements. Whilst the Commissioner accepts that this arrangement does not fall within Division 83A of ITAA 1997, exercising the discretion under subsection 160APHL(14) of the ITAA 1936 would have the effect of treating this arrangement as substantially similar to a Division 83A ESS in respect of the franking credit measures. This would be contrary to the policy of allowing the benefit of the franking credits to the effective owner of, or an interest in, the relevant share. | Detailed Reasoning - Conclusion: Having considered all the factors above, it is considered that defeasance of the interest in the trust is possible by virtue of the trust deed and whilst this may be unlikely, as far as the employee is concerned, the circumstances of this case are not of the type for which the exercise of the discretion under subsection 160APHL(14) of the ITAA 1936 was intended to apply.

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