Private ruling: Employee share scheme - Deferred taxing point - Termination of foreign employment
Date of advice: 24 July 2015
Published: July 2015
Ruling period: 2013-14 income year | 2014-15 income year
Date scheme commenced: 1 July 200X

Ruling: Q1: Did the deferred taxing point in relation to the unvested rights that were acquired prior to you becoming an Australian resident occur when you completed your ongoing employee activities? | A1: No. | Q2: Did the deferred taxing point in relation to the unvested rights that were acquired prior to you becoming an Australian resident occur on the Termination Date specified in the Settlement Agreement? | A2: Yes. | Q3: Should the discount included in your assessable income be apportioned based on the number of days, between the grant and the deferred taxing point where you were a non-resident? | A3: No, the entire discount will be assessable. | Q4: Will you be entitled to a foreign income tax offset for any income tax paid in the foreign country in respect to the rights that have been taxed in Australia? | A4: Yes. | Q5: Will the cost base of the stock already vested prior to becoming an Australian resident be the market value on the day you became an Australian resident? | A5: Yes. | Q6: Will the cost base of rights that vest after you became an Australian resident be the market value as at the deferred taxing point? | A6: Yes. | Q7: Will there be any tax consequences of the rights converting into common stock, where this occurs after you became an Australian resident? | A7: 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 arrangement that is subject of the private ruling is described below. This description is based on certain documents that form part of, and are to be read with this description. You commenced employment with company A about a dozen years ago. You were not an Australian tax resident at any time between this date and the time you were notified of your pending redundancy. You became an Australian tax resident shortly after receiving this notification when you re-entered Australia with the intent to reside here permanently. You did not qualify as a temporary resident of Australia on that date. You were granted parcels of restricted share units (the rights) between your commencement date and the final grant date under Company A's employee incentive plans. You did not pay any money for the rights. Pursuant to the plan rules, the rights represented an entitlement to one share of common stock in Company A. A right would automatically convert to one share of common stock in Company A upon vesting. The rights were typically granted on or within a particular few days of each year and generally vested proportionately over a four year period. For example an rights granted in 2009 would have been fully vested by 2013. Vesting of the rights was not subject to any performance hurdles or targets. Forfeiture of the rights could only occur under specified conditions such as engaging in conduct materially adverse to Company A. The rights are non-transferable pursuant to the terms of the plan rules. At the time you became an Australian tax resident some of the rights had not yet vested. These 'unvested rights' represented various proportions of the rights granted in 2010, 2011, 2012 and 2013. At the time of granting these rights you were a foreign resident. You were granted a new tranche of rights (the final grant) one week after you became an Australian resident. As part of the negotiations for finalising your employment with Company A, you entered into a Settlement Agreement which modified the terms of vesting in relation to the awards. In particular: • so long as you did not breach your Settlement Agreement with Company A, any unvested awards would not be forfeited (to the extent that they had been granted but remained unvested following the cessation of your employment with Company A); and • your awards would continue to vest despite no longer being employed by Company A on the basis that you satisfied the 'good leaver' provision. The Settlement Agreement states that the termination of your employment with the Company will occur some three months after it was signed which is defined as the 'Termination Date' for the purposes of the Agreement. You completed your ongoing employee activities for Company A at about the date the Settlement Agreement was signed. For the next three months, you were on 'Garden Leave' under the terms of your Settlement Agreement, similar to a restrictive covenant. Under this Settlement Agreement, you were not permitted to perform work for any other employer during the Garden Leave period, but were permitted to apply to prospective employers. You were paid your salary and all other benefits in the usual way, less income tax and related payroll deductions. During the Garden Leave period, you did not perform any services for Company A and in fact spent the first part of this period on leave. The rights are subject to income tax in the country where you performed the services for company A when they vest.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5, | Income Tax Assessment Act 1997 Division 83A, | Income Tax Assessment Act 1997 Part 3-1, | Income Tax Assessment Act 1997 Part 3-3, | Income Tax Assessment Act 1997 Division 770 and | Income Tax Assessment Act 1997 Section 855-45.

Reasons for decision: Detailed Reasoning - Employee Share Schemes (ESS): All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise noted. Division 83A applies to shares, rights and stapled securities acquired under an employee share scheme on or after 1 July 2009. An employee share scheme is defined in subsection 83A-10(2) as a scheme under which ESS interests in a company are provided to employees, or associates of employees, of the company, or a subsidiary of the company, in relation to the employee's employment. An ESS interest in a company is defined in subsection 83A-10(1) as a beneficial interest in: a) a share in the company; or b) a right to acquire a beneficial interest in a share in the company. The rights issued under the plan entitle the holder of the right to be allocated one fully paid ordinary share on vesting. Accordingly the rights give an ownership interest in a share which is clearly a beneficial interest, therefore Division 83A will apply. | Detailed Reasoning - Subdivision 83A-C: Subdivision 83A-C allows for the deferral of tax on the amount assessable in respect of an ESS interest if certain conditions are satisfied. Subdivision 83A-C will apply to the rights if the following conditions in section 83A-105 are satisfied: a) Subdivision 83A-B would, apart from section 83A-105, apply to the rights b) subsections 83A-35(3), (4), (5) and (9) apply to the rights, and c) there is a real risk that you will forfeit or lose the interest (other than by disposing of it, exercising the right or letting it lapse) pursuant to subsection 83A-105(3). ATO ID 2010/61 provides the Commissioner's view on what constitutes a real risk of forfeiture in relation to minimum terms of employment and good leaver provisions. It provides that a condition imposing a minimum employment period of 12 months is considered to give rise to a more than a 'mere' or 'rare' possibility of forfeiture and to be a condition genuinely directed to retaining employees and aligning their interests with the interests of the company. In your circumstance all the above requirements are met as: • at the time of receiving the rights you were employed by Company A. • the rights grant an interest in an ordinary share • you will not hold a beneficial interest in more than five percent of the total securities of Company A • the rights were under a real risk of forfeiture due to the requirement of a minimum term of employment of at least 12 months. Consequently deferred taxation will apply and the value of the employee share scheme will need to be included in your taxable income at the deferred taxing point calculated under section 83A-120. | Detailed Reasoning - ESS deferred taxing point: Section 83A-120 provides the rules for determining when the ESS deferred taxing point occurs where you are the holder of beneficial interest in a right. This will be the earliest of the following times: • when the employment in respect of which you acquired the rights ends as per subsection 83A-120(5) • seven years after acquiring the rights as per subsection 83A-120(6) • when the right has not been exercised, there is no real risk of forfeiting the right, and the scheme no longer genuinely restricts disposal of the right as per subsection 83A-120(4) • when there is no real risk of forfeiting the right or underlying share, and the scheme no longer genuinely restricts exercise of the right or disposal of the resulting share as per subsection 83A-120(7). In the circumstances of your case, the first of these to occur was the termination of your employment. This private ruling considers when that termination actually occurred. The term 'employment' is not directly defined for the purposes of Division 83A and so as a starting point it takes its ordinary meaning. However, the relevant legislation modifies its effect in a number of ways. First, section 83A-330 provides that for the purpose of Division 83A you will only be treated as ceasing employment when you are no longer employed by any of the following: a) your employer in that employment; b) a holding company of your employer c) a subsidiary of your employer d) a subsidiary of a holding company of your employer. Second, section 83A-325 expands the application of Division 83A to the following relationships that are similar to employment: 1. an individual who receives, or is entitled to receive 'work and income support withholding payments' (otherwise than as an employee) 2. an individual who is engaged in service in a foreign country as the holder of an office 3. an individual who provides services to an entity (other than services covered by a previous item in this table and service provided as an employee) The term 'gardening leave' covers a multitude of situations where an employee is away from their normal workplace and therefore does not by itself provide a basis for reaching a conclusion about when your employment ended. Generally, a situational analysis is required before reaching any conclusion about when employment is terminated. This conclusion then informs about the nature of the gardening leave payments. Relevant factors considered when reaching a conclusion about when employment ends includes: • the cause of the issue that led to the situation • the intentions of the parties • the obligations placed on the parties under the settlement agreement • other relevant factors (for example, legal requirements) The following case law decisions have been analysed for the purpose of determining which tests to apply when reaching this conclusion: • Tullett Prebon (Australia) Pty Ltd v. Purcell [ 2008] NSWSC 852 • Bearingpoint Australia Pty Ltd v. Hillard [2008] VSC 115 • Delaney v. Staples [1992] 1 All ER 944 • Metcash Limited & Anor v. Joao Louis Jardim (aka Louis Jardin) & Anor (No 3) [2010] NSWSC 1096 • Seven Network (Operations) Limited & Ors v. James Warburton (No2) [2011] NSWSC 386 • AGA Assistance Australia Pty Ltd v. Carole Tokody [2012] QSC 176 These cases, in general, acknowledge that there is a distinction between the time when the employment ends and when the employment contract ends. A restraint of trade clause beyond termination of employment would be ineffective if both the employment and the employment contract ended at the same time. However, it must be noted that each case mentioned above represents a situation where the parties have disagreed about aspects of the termination of employment and where other consequences flow from or may be determined from the employment termination date. The case Delaney v Staples suggests the following as the principle categories that exist where an employer acts to terminate the employment of an employee (with an eye to the characterisation of payments that might be made shortly thereafter): (1) An employer gives proper notice of termination to his employee, tells the employee that he need not work until the termination date and gives him the wages attributable to the notice period in a lump sum. In this case (commonly call 'garden leave') there is no breach of contract by the employer. The employment continues until the expiry of the notice: the lump sum payment is simply advance payment of wages. (2) The contract of employment provides expressly that the employment may be terminated either by notice or, on payment of a sum in lieu of notice, summarily. In such a case if the employer summarily dismisses the employee he is not in breach of contract provided that he makes the payment in lieu. But the payment in lieu is not a payment of wages in the ordinary sense since it is not a payment for work to be done under the contract of employment. (3) At the end of the employment, the employer and the employee agree that the employment is to terminate forthwith on payment of a sum in lieu of notice, Again, the employer is not in breach of contract by dismissing summarily and the payment in lieu is not strictly wages since it is not remuneration for work done during the continuance of the employment. (4) Without the agreement of the employee, the employer summarily dismisses the employee and tenders payment in lieu of proper notice. This is by far the most common type of payment in lieu and the present case falls into this category. The employer is in breach of contract by dismissing the employee without proper notice. However, the summary dismissal is effective to put an end to the employment relationship, whether or not it unilaterally discharges the contract of employment. Since the employment relationship has ended no further services are to be rendered by the employee under the contract. It follows that the payment in lieu is not a payment of wages in the ordinary sense since it is not a payment for work done under the contract of employment. In your case, your position has been made redundant. The normal notice period for an employee on your pay grade is three calendar months. A 'garden leave' option was available to company A under the Terms and Conditions of Employment. Prior to the termination of employment taking effect, you have negotiated a Settlement Agreement with your employer. The terms of that Agreement state that your employment would end on the specified Termination Date. You have not provided any evidence or documentation that would suggest that either you or the company has acted in a manner that would call the terms of the Settlement Agreement into question. You have not provided any evidence to suggest that either party entered into the Settlement Agreement under duress. There is also no evidence to suggest that either you or your employer has taken action to terminate your employment otherwise than in accordance with the Settlement Agreement (be that when you completed your ongoing employee activities, or any other date). In fact, the Settlement Agreement is at pains to state that you would continue as an employee until the Termination Date with the obligations that exist for you as a continuing employee (other than attendance). In conclusion, the Settlement Agreement states that your employment with company A ended on the Termination Date. There is no reason to conclude that your employment was terminated other than in accordance with the Settlement Agreement and it is noted that you would not have been entitled to receive the final grant of rights if your employment had ended when you completed your ongoing employee activities (which was before they were actually granted). Further, the payments that you received during the period that you were on gardening leave could constitute 'work and income support withholding payments' as they would have been salary under the Settlement Agreement. If so, you would still be considered to be in employment for employee share scheme purposes even if you had ceased to be an employee at common law. Consequently the deferred taxing point for any rights that were still to vest as at the date your employment ended will be the Termination Date being the first of the dates mentioned in section 83A-120. Note: the final grant occurred after you became an Australian resident. | Detailed Reasoning - Foreign source and the amount of assessable discount: The former ESS rules covered in Division 13A of Part III of the Income Tax Assessment Act 1936 contained a mechanism by where the discount received in relation ESS interests was excluded to the extent that it related to foreign employment. Division 83A of the Income Tax (Transitional Provisions) Act 1997 continues this in relation to grants before 1 July 2009. However the new rules in Division 83A contain no such legislative mechanism, instead subsections 83A-25(2) and 83A-110(2) deem any ESS interest that relates to foreign employment to be foreign source income. Whether the discount is included in your assessable income then depends on the rules in section 6-5. This is confirmed to be the intent of parliament in paragraph 348 to 350 of the Explanatory Memorandum (EM) to the Tax Laws Amendment (2009 Budget Measures No.2) Bill 2009 which provides : 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. Under the existing law, this outcome is achieved by excluding discounts from interests acquired under the employee share schemes from tax under the employee share scheme tax rules, to the extent that they relate to foreign service of a taxpayer. 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 the discounts received on securities acquired under employee share schemes. Australia has entered into the Convention between the Government of Australia and the Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and on Capital Gains [2003] ATS 22 (UK double tax agreement) with the government of the United Kingdom. Note 10 provide that income or gains derived by employees in relation to share option schemes shall be treated as other similar remuneration for the purpose of Article 14 which relates to employment income. The effect of article 14 and 22 of the (UK double tax agreement) is that neither the United Kingdom nor Australia has an exclusive right to tax the income. The agreement represents that both the country of residence and the country of source both have the right to tax the income, but the resident country will provide relief from double taxation through a credit against tax paid in the source country. The effect of Subdivision 83A-C is that all your unvested rights will be treated as derived and received at the deferred taxing point. Based on the facts provided, we consider the entire amount of assessable discount to be attributable to your foreign employment and consequently foreign source income under subsection 83A-110(2). As per subsection 6-5(2), at the deferred taxing point you were an Australian resident, so you will need to include the entire discount received in relation to the unvested rights in your assessable income. | Detailed Reasoning - Foreign income tax offset: To provide relief from double taxation, you are entitled to an Australian foreign income tax offset in relation to the income tax you paid in the foreign country under section 770-10. To be entitled to a foreign income tax offset: • the foreign tax must be foreign 'income tax' • you must have actually paid, or be deemed to have paid, the foreign income tax, and • the income on which you paid foreign income tax must be included in your assessable income in Australia. The offset is available in the income year in which the income (on which the foreign income tax has been paid) forms part of your assessable income in Australia. To count towards a tax offset, foreign income tax must be imposed under a law other than an Australian law and be: • a tax on income • a tax on profits or gains, whether of an income or capital nature, or • any other tax that is subject to an agreement covered by the Agreements Act. Taxation Ruling IT 2507 Income tax: foreign tax credit system - foreign taxes eligible for credit against Australian income tax states that a taxpayer will be entitled to a credit against Australian tax payable on foreign income for any of the foreign taxes listed in the ruling. The taxes listed for the foreign country are the: • Income tax (including surtax) • Corporation tax • Capital gains tax In your case, as the rights vest you will be charged income tax in the foreign country and are entitled to a foreign income tax offset based on the amount you paid. As the rights continue to vest in the future you will be able to amend your income tax return to receive a credit for the tax paid in the foreign country. | Detailed Reasoning - CGT consequences: In accordance with section 855-45, the stock that had vested prior to you becoming an Australian resident ceased being ESS interests and became CGT assets for income tax purposes. Therefore, the cost base of those shares will be their market value of the stock on the day you became an Australian resident. As per section 83A-125 the cost base of the rights that had not yet vested when you became an Australian resident will be the market value of those rights at the deferred taxing point. CGT event C2 happens when restricted stock units you own are exercised, however, any capital gain or capital loss you make at that time is disregarded. The cost base and reduced cost base of the resulting shares will include the cost base or reduced cost base of the restricted stock units plus any amount paid to exercise them.