Private ruling: Employee share schemes
Date of advice: 2 August 2017
Published: November 2017
Ruling period: Income tax year ending 30 June 2017 | Income tax year ending 30 June 2018 | Income tax year ending 30 June 2019 | Income tax year ending 30 June 2020 | Income tax year ending 30 June 2021 | Income tax year ending 30 June 2022
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the irretrievable contributions made by the Company, or any subsidiary member of the Company’s tax consolidated group headed by the Company, to the Trustee to fund the acquisition of the Company shares by the Trust for the purposes of the Company’s employee share plans be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will a capital gain or capital loss that arises for the Trustee of the Trust at the time when a participating employee becomes absolutely entitled to the Company shares (CGT event E5) or when the Trustee disposes of the shares to the employee (CGT event E7) be disregarded under section 130-90 of the ITAA 1997 if the employee acquires the shares for the same or less than the cost base of the shares in the hands of the Trustee? | A2: Yes

Relevant facts and circumstances: Background The Company is an Australian tax resident company. The Company is listed on the Australian Securities Exchange and is the 'head company’ of a 'consolidated group’ for the purposes of Part 3-90 of the ITAA 1997 (tax consolidated group). The Company has wholly-owned subsidiary entities who are employers of the Company’s personnel. Employee share plans Each employee share plan (Plan) broadly operates to provide eligible employees with the opportunity to receive rights for generally nil consideration (Rights). In order to receive shares, the participating employee (Participant) must satisfy the vesting criteria outlined in the relevant plan’s rules (Plan Rules). The Rights are exercised automatically on vesting in some of the plans and in others plans the Company’s board determines whether Rights held will vest or lapse. On exercise of the Rights, the Participant will be entitled to one share in the Company for generally nil consideration. Employee share trust The Trust is an independent legal entity and not a part of the Company’s income tax consolidated group. It was established as a sole purpose trust to administer and maintain the Plans. The Company cannot be a beneficiary of the Trust and cannot receive any income or capital from the Trust. The Trust’s deed (Trust Deed) allows the Trustee to subscribe for, purchase or otherwise acquire shares of the Company for the purposes of administering the Plans and to do things incidental to this activity. The Trust Deed does not allow the Trustee to provide any additional benefits other than those that arise from the Plan Rules. The Trust is funded by contributions from the Company, including the acquisitions of shares in the Company shares at market value either on-market, or by a subscription for new shares. Shares will be held by the Trust on trust for the benefit of the Participants and employees generally until they are allocated or transferred to an employee (on vesting and/or exercise of the Rights). The Trust cannot exercise voting rights in relation to unallocated shares. Contributions to the Trust The Company does not intend to make cash contributions to the Trust prior to the issue of the Rights to the Participants. The Company will make contributions to the Trust when the Rights vest or where it makes commercial sense to do so. For example, it may make cash contributions to the Trust prior to the vesting and/or exercise of the Rights to ensure the Trust has the cash necessary to acquire the Company shares to satisfy the acquisition or subscription of shares related to the Rights.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 130-90

Reasons for decision: Summary: Contributions made by the Company, or any subsidiary member of the Company’s tax consolidated group headed by the Company, to the Trustee to fund the acquisition of the Company shares by the Trust for the purposes of the Plans will not be assessable income of the Trust under section 6-5 nor section 6-10 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Whether the contributions to the Trust constitute assessable income Net income, in relation to a trust, is defined as the total assessable income of the trust estate calculated under the Income Tax Assessment Act 1936 (ITAA 1936) as if the trustee were a taxpayer in respect of that income and were Australian tax resident, less allowable deductions (section 95 of the ITAA 1936). Assessable income, in turn, includes income according to ordinary concepts which is called ordinary income (subsection 6-5(1)). Assessable income also includes some amounts that are not ordinary income (subsection 6-10(1)). Section 10-5 contains a summary list of provisions about assessable income. In this case, none of the provisions listed in section 10-5 are relevant. Accordingly, an irretrievable contribution made by the Company to the Trustee will not be assessable income under section 6-10. It follows that such amounts will only be included in the calculation of the net income of the Trust under section 95 of the ITAA 1936 if they are assessable as income according to ordinary concepts under section 6-5. | Detailed Reasoning - Ordinary income: In Australian law, the classic definition of income according to ordinary concepts was given by Jordan CJ in Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215, he stated: The word “income” is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts. The leading case on ordinary income is Eisner v. Macomber 252 US 189 (1919), which states: The fundamental relation of “capital” to “income” has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. …Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being “derived” that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; …that is income derived from property. Nothing else answers the description. In G.P. International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1, the High Court of Australia held that whether a receipt is income or capital depends on its objective character in the hands of the recipient. Brennan, Dawson, Toohey, Gaudron and McHugh JJ stated (at CLR 138; ATC 4420; ATR 7): To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient’s purpose in engaging in the transaction, venture or business. Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business. In this case, under the Trust Deed: ● the Trustee must hold the Company shares (as well as other proceeds or benefits arising from those shares) on trust for and on behalf of the Participant under the terms of the Trust Deed and the relevant Plan Rules, ● the Company must provide the Trustee any funds required by the Trustee (for the Trustee to purchase, subscribe and participate in issues of the Company shares) under the Trust Deed, ● all funds provided to the Trustee will constitute accretions to the corpus of the Trust and will not be repayable by the Trustee (unless provided by way of loan) and may be paid to the Company as consideration for the subscription for the Company shares under the terms of the Trust Deed, ● the Trustee must apply the funds received for the acquisition or subscription of the Company shares, and ● the Participants are not entitled to receive funds received by the Trust as the funds may only be used for purposes listed in the Trust Deed. These clauses demonstrate that a contribution made by the Company to the Trustee will be used in accordance with the Trust Deed and the Plan Rules and for the sole purpose of administering the Plan. | Detailed Reasoning - Conclusion: Accordingly, the contributions provided to the Trustee, where the funds are used in accordance with the Trust Deed and relevant Plan Rules for the sole purpose of, and under the relevant plan, constitute capital receipts to the Trustee and are not assessable under section 6-5 or 6-10. | Summary: A capital gain or capital loss that arises for the Trustee of the Trust at the time when a participating employee becomes absolutely entitled to the Company shares (CGT event E5) or when the Trustee disposes of the shares to the employees (CGT event E7) will be disregarded under section 130-90 if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee. | Detailed Reasoning - Detailed reasoning: Section 130-90 applies to disregard any capital gain or capital loss made by an employee share trust where certain criteria are met. Subsections 130-90(1) and (2) state: (1) Disregard any capital gain or capital loss made by an employee share trust, or a beneficiary of the trust, to the extent that it results from a CGT event, if: (a) the CGT event is CGT event E5 or E7; and (b) the CGT event happens in relation to a share; and (c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and (d) the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied. (2) Subsection (1A) or (1) does not apply if the beneficiary acquired the beneficial interest in the share for more than its cost base in the hands of the employee share trust at the time the CGT event happens. Accordingly, it is necessary to consider whether the Trust is an 'employee share trust’ as defined in subsection 130-90(1). Whether the Trust is an employee share trust To satisfy the definition of 'employee share trust’, we must establish that the Trust: ● is operating under an employee share scheme, and ● is a trust whose sole activities are: ● obtaining shares or rights in a company (paragraph 130-85(4)(a)), ● ensuring that ESS interests in the company (that are beneficial interest in those shares or rights) are provided under the employee share scheme to employees (or associates of employees) of the company (or its subsidiaries) (paragraph 130-85(4)(b)), and ● other activities that are merely incidental to the above activities (paragraph 130-85(4)(c)). | Detailed Reasoning - Whether the Trust is operating under an employee share scheme: An 'employee share scheme’ is a scheme under which ESS interests in a company are provided to employees, or associates of employees, (including past or prospective employees) of the company (or its subsidiaries) in relation to their employment (subsection 83A-10(2)). An 'ESS interest’ in a company is a beneficial interest in: ● a share in the company, or ● a right to acquire a beneficial interest in a share in the company (subsection 83A-10(1)). In this case, each Right provided to a participating employee under the relevant plan is an ESS interest as it is a right to acquire a beneficial interest in shares in the Company. In addition, a beneficial interest in a share in the Company is also an ESS interest. It follows that each of the Plans is a part of an employee share scheme as it is a scheme under which ESS interests (being the Rights) are provided to employees in relation to their employment. In addition, the Trust was established to acquire, hold and allocate shares in the Company to employees in order to satisfy ESS interests acquired by those employees under the Plans under the Trust Deed (Recital A of the Background to the Trust Deed). Accordingly, subsection 130-90(1) is satisfied. | Detailed Reasoning - Sole activities test: In this case, the Trust satisfies paragraphs 130-85(4)(a) and 130-85(4)(b) because: ● it acquires shares in the Company, and ● it ensures that ESS interests in Company (being the Rights) are provided under an employee share scheme (being each of the Plans). Paragraph 130-85(4)(c) also allows the Trustee to engage in other activities incidental to the above activities. ATO Interpretative Decision ATO ID 2010/108 Income Tax - Employee share trust that acquires shares to satisfy rights provided under an employee share scheme and engages in other incidental activities sets out a number of activities that are considered to be 'merely incidental’ for the purposes of paragraph 130-85(4)(c): ● the opening and operation of a bank account to facilitate the receipt and payment of money, ● the receipt of dividends in respect of shares held by the trust on behalf of an employee and their distribution to the employee, ● the receipt of dividends in respect of unallocated shares and using those dividends to acquire additional shares for the purposes of the employee share scheme, ● dealing with shares forfeited under an employee share scheme including the sale of forfeited shares and using the proceeds of sale for the purposes of the employee share scheme, ● the transfer of shares to employee beneficiaries or the sale of shares on behalf of an employee beneficiary and the transfer to the employee of the net proceeds of the sale of those shares, ● the payment or transfer of trust income and property to the default beneficiary on the winding up of the trust where there are no employee beneficiaries, and ● receiving and immediately distributing shares under a demerger. Activities that the Commissioner considers will not be 'merely incidental’ include: ● any activities that are not a necessary function of managing an employee share scheme or administering a trust, and ● any activities which result in employees being provided with additional benefits (eg the provision of a loan to acquire shares). In this case, the Trustee has power to do all things incidental to the acquisition and allocation of trust assets, shares, rights or privileges as authorised by the Trust Deed. Such activities will fall under paragraph 130-85(4)(c). However, the powers and limitations granted to the Trustee under the Trust Deed do not allow the Trustee to undertake any activity beyond that allowable under subsection 130-85(4). In addition, Company and the Trustee agree that the Trust will be managed and administered in a way that satisfies the definition of 'employee share trust’ for the purposes of section 130-85(4). Accordingly, the Trust is an employee share trust if it is administered in accordance with the Trust Deed and the relevant Plan Rules. Disregarding a capital gain or capital loss under CGT event E5 or CGT event E7 The requirements of subsection 130-90(1) are considered in turn as follows. | Detailed Reasoning - CGT event E5 or CGT event E7 happens in relation to a share: Relevantly, a 'share’ in a company is defined to mean a share in the capital of a company (subsection 995-1(1)). An ordinary share in the Company held by the Trustee, to which a participating employee is entitled on the exercise of a Right, under the relevant Plan, is a share in the capital of the company. Accordingly, paragraphs 130-90(1)(a) and 130-90(1)(b) are satisfied. | Detailed Reasoning - Beneficiary acquires a beneficial interest in the share by exercising a right: Paragraph 130-90(1)(c) is satisfied as the relevant participating employee acquires a beneficial interest in a share in the Company by exercising a Right under the relevant Plan. | Detailed Reasoning - Beneficiary’s beneficial interest in the right is an ESS interest to which Subdivision 83A-B or 83A-C applies: Subdivision 83A-B applies to an ESS interest if it is acquired by a participating employee under an employee share scheme at a discount (subsection 83A-20(1)). As discussed above, each of the Plans is an employee share scheme within the meaning of subsection 83A-10(2) as it is a scheme under which ESS interests in the Company (being the Rights) are provided to employees in relation to their employment. In addition, each Right is acquired by the participating employee for nil consideration – that is, at a discount. Accordingly, Subdivision 83A-B prima facie applies to the Rights provided under each of the Plans, unless the conditions in subsection 83A-105(1) are satisfied in which case Subdivision 83A-C applies. Whether a participating employee is ultimately taxed upfront on some or all of any discount received (under Subdivision 83A-B), or is able to defer the timing of the inclusion of an amount in their assessable income (under Subdivision 83A-C), depends on whether the additional requirements in Subdivision 83A-B or Subdivision 83A-C have been satisfied. In either case, paragraph 130-90(1)(d) is satisfied. | Detailed Reasoning - Beneficial interest in share is not acquired for more than the cost base in hands of the Trust: Notwithstanding the preceding analysis, subsection 130-90(1) will not apply if a beneficiary of the Trust acquires a beneficial interest in a share for more than its cost base in the hands of the Trust at the time the CGT event happens (subsection 130-90(2)). In this case, a participating employee will not pay anything to acquire or exercise the Rights. It follows that the employee cannot have paid more to acquire the shares than the Trustee did at the time of the relevant CGT event and subsection 130-90(2) will not apply. | Detailed Reasoning - Conclusion: Any capital gain or capital loss that arises for the Trustee when CGT event E5 or CGT event E7 happens in relation to the shares held by the Trustee is disregarded under section 130-90.

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