1 Will the irretrievable cash contributions made by Company A to the Trustee to fund the subscription for, or acquisition on-market of, ordinary fully paid shares in Company A (Shares) by the Trust pursuant to the Plan be assessable income of the Trust under section 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
No. Question 2 Will a capital gain or capital loss that arises for the Trustee at the time when capital gains tax (CGT) event E5 happens in relation to Shares held by the Trustee be disregarded under section 130-90 of the ITAA 1997, if the employees acquire the Shares for the same or less than the cost base of the Shares in the hands of the Trustee? Answer Yes.
Background Company A is an Australian registered company listed on the Australian Securities Exchange. Company A is the head company of the Company A tax consolidated group (Company A TCG). The Plan The Plan was approved by the Board and by Company A's shareholders. The Plan allows Company A to issue Performance Rights to eligible employees (Eligible Persons). Performance Rights are conditional entitlements to Sharesand will be acquired at a discount. The Plan is administered by the Board in accordance with the Plan. While the Plan is not restricted to Australian tax-resident employees, the scope of this ruling is limited to the Performance Rights granted under the Plan to Australian tax-resident employees who engage in activities that derive assessable income in Australia. The tax treatment of any contributions made by Company A with respect to non-resident participants, and any associated Australian tax implications for Company A or the Trust, is outside the scope of this ruling. Offer Where the Board invites any Eligible Persons to participate in the Plan at any time at its sole discretion, Company A must issue the Eligible Person with an Invitation.
An Invitation must be in writing and include the total number of Performance Rights being made available, the Issue Price, the Exercise Price, the Vesting Conditions, the Vesting Period, and any Restrictions. The Issue Price (if any) is determined by the Board from time to time and may be nil. An Eligible Person accepts an Invitation by validly signing the application form attached to the Invitation and returning it to Company A, paying to Company A the Issue Price (if any), and signing any other documents required by the Constitution. Performance Rights When vested, each Performance Right entitles the Participant to subscribe for, and be issued with the number of Shares set out in the Invitation in respect of that Performance Right. The Board has discretion to decide that the exercise of a Performance Right will be satisfied by payment in cash to the Participant. However, the Trust will not be involved in the process of satisfying any cash settled Performance Rights as they will be settled outside the Trust directly by Company A.
The Board may at its sole discretion determine the Vesting Conditions which will apply to any Performance Rights granted under the Plan. If and when Vesting Conditions are satisfied to the extent determined by the Board in its sole discretion, the Board must inform the Participant in writing of that determination and inform the Participant of the number of Shares which the Performance Right entitles the Participant to subscribe for. The Shares issued are to be provided to the Participant subject to the Restrictions. Lapse of Performance Rights Performance Rights will lapse on the earliest of: the Board determining that the Performance Rights will not vest a determination of the Board that the Participant has, in the Board's opinion been dismissed or removed from office for a reason which entitles a company in the Group to dismiss the Participant without notice committed any act of fraud, dishonesty or serious misconduct in relation to the affairs of company in the Group done any act which brings the Group into disrepute the date on which the Participant ceases to be employed by any member of the Group (other than due to the occurrence of a Special Circumstance)
the receipt by Company A of a notice from the Participant (after a Special Circumstance has arisen with respect to the Participant) that the Participant has elected to surrender the Performance Right. The Board has absolute discretion to allow any Participant to retain any Performance Rights regardless of the expiry of the Vesting Period or the Vesting Conditions not being fully satisfied. The Trust The Trust was established under the Trust Deed entered into between Company A and the Trustee. Under the Trust Deed, the Trustee obtains and holds Shares for the benefit of Participants in accordance with the Plan and the Trust Deed. The Trustee's activities are limited to the Plan and the Trustee must act in accordance with the Plan. The Trustee has the powers to: enter into and execute contacts and do all acts or things which it deems expedient for the purpose of giving effect to and carrying out the trusts, powers and discretions conferred on the Trustee by the Trust Deed subscribe for, purchase or otherwise acquire and sell, transfer or otherwise dispose of Shares which the Trustee is authorised to on terms and conditions it thinks fit
open bank accounts and retain, on current or deposit account at any bank, any money it considers proper buy, transfer or sell Shares and apply the proceeds of sale in accordance with the Trust Deed receive any money, dividends or distributions in relation to Shares and apply those amounts in accordance with the Trust Deed take and act upon the advice or opinion of any legal practitioner or other professional person do anything the Board reasonably directs or requests the Trustee to do in relation to the Plan as contemplated under the Trust Deed generally do all acts and things the Trustee considers necessary for the administration, maintenance and preservation of the Trust in performance of its obligations under the Trust Deed. The Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of subsection 130-85(4). Nothing in the Trust Deed confers or is intended to confer on Company A or any Group company, any charge, lien or any other proprietary right or proprietary interest in the Shares acquired by the Trustee. Acquisition and transfer of Shares
When the Trustee is to hold Shares on behalf of Participants in accordance with the Plan and/or Offer, the Board must by notice in writing instruct the Trustee to subscribe for, acquire and/or allocate Shares to be held by the Trustee. The Board may also by notice in writing instruct the Trustee to subscribe for or acquire Shares to be held by the Trustee on an unallocated basis on trust for Participants generally. A notice by the Board must do any of the following: offer to the Trustee to have Company A or a member of the Group provide funds for the sole purpose of acquiring Shares request the Trustee to apply some of the capital of the Trust for the purposes of acquiring Shares effect a combination of the above acts. The Trustee may, upon direction by the Board, subscribe for or acquire Shares from time to time in accordance with the notice from the Board. Company A does not, and no Group Company will, have and shall not have any beneficial interest in the Shares. Upon direction from the Board, the Trustee must allocate Shares to the Account established for a Participant, provided any of the following apply:
the Trustee receives sufficient payment from Company A or a member of the Group or having sufficient capital to subscribe for or acquire the relevant Shares the Trustee holds sufficient Shares on an unallocated basis in the Fund any combination of the above. Allocated Shares must be held on the terms of the Trust Deed by the Trustee on behalf of the relevant Participant until the Shares are transferred or disposed of under the Trust Deed, or forfeited by the Participant under the Plan. The Trustee must transfer or dispose of Shares in accordance with the Plan and any Offer. On forfeiture, the Shares will be held by the Trustee on an unallocated basis in the Fund as general Trust property. Unallocated Shares In respect of an unallocated Share, the Trustee may apply any capitals receipts, dividends or other distributions received to purchase further Shares to be held on trust for the purposes of the Trust and pay any reasonable disbursements. The Trustee must hold any bonus Shares issued in respect of an unallocated Share as an unallocated Share within the Fund. Funding
Any funds provided by Company A or a member of the Group to the Trustee for the purpose of purchasing Shares on the terms of the Trust Deed constitute the corpus of the Trust and are irretrievable by Company A or a member of the Group. No loans will be provided by Company A or the Group to the Trust for the period which is the subject of this ruling. Company A will pay to the Trustee, from Company A's own resources, such fees and reimburse such reasonable expenses incurred by the Trustee as Company A and the Trustee agree from time to time. The Trustee is entitled to retain for its own benefit any such fee or reimbursement. The Trustee will not levy any fees or charges for administering the Trust that are payable directly by any Eligible Participant or out of assets of the Trust, other than reasonable disbursements including brokerage and tax levied or incurred in connection with the Trust. Company A incurs costs associated with the services provided by the Trustee, including but not limited to: employee plan record keeping production and dispatch of holding statements to employees
costs incurred in the acquisition of shares on market, such as brokerage costs and the allocation of such shares to Participants initial costs incurred to establish the Trust other trustee expenses such as the annual audit of the financial statements and annual income tax return of the Trust. Rights in respect of allocated Shares A Participant is presently entitled to so much of the Net Income of the Trust for a Year of Income which is attributable to: the Shares held by the Trustee on behalf of the Participant the proceeds of sales arising from any sale of Shares by the Trustee on behalf of the Participant transactions or events related to the Shares or property related to or arising from Shares held by the Trustee on behalf of the Participant. Balance of Net Income The balance of the Net Income of the Trust for a Year of Income to which no Participant is presently entitled may be applied, in whole or in part, to meet any reasonable costs and expenses properly incurred by Company A in relation to the establishment, administration or termination of the Trust. The remaining balance may be accumulated by the Trustee as an Accretion to the Trust.
All legislative references are to provisions of the ITAA 1936 or to provisions of the ITAA 1997, unless otherwise indicated. Question 1 Detailed reasoning The total assessable income of a trust estate is calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1)). The assessable income of a taxpayer includes income under ordinary concepts (section 6-5) or statutory income (section 6-10). Section 10-5 contains a summary list of the provisions for statutory income. None of the provisions listed in section 10-5 are relevant in the present circumstances. Therefore, non-refundable contributions made by Company A to the Trustee for the Trust will not be assessable income under section 6-10. They will only be included in the calculation of the net income of the Trust under section 95 if they are assessable as income according to ordinary concepts under section 6-5. Receipts of a capital nature do not constitute income according to ordinary concepts, whether or not incurred in carrying on a business. In ATO Interpretative Decision ATO ID 2002/965
Income Tax - Trustee not assessable on employer contributions made to it under the employer's employee share scheme , the Commissioner expresses the view that funds provided to the trustee of an employee share scheme (ESS) for the sole purpose of providing shares under an ESS will constitute capital receipts to the trustee, and are not assessable under sections 6-5 or 6-10. An ESS is a scheme under which ESS interests in a company are provided to employees of a company, or their associates, in relation to their employment (subsection 83A-10(2)). An ESS interest is a beneficial interest in a share in a company or a right to acquire a beneficial interest in a share in a company (subsection 83A-10(1)). Under the Plan, each Participant will acquire a Performance Right, with each being a right to acquire a beneficial interest in a Share (that is an ESS interest).
The irretrievable cash contributions made by Company A to the Trustee under the terms of the Plan and the Trust Deed are to be used for the sole purpose of acquiring, holding and transferring Shares for the benefit of Participants. Accordingly, the irretrievable cash contributions constitute capital receipts to the Trustee and will not be assessable income of the Trustee pursuant to sections 6-5 or 6-10. Question 2 Detailed reasoning Pursuant to section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens. CGT event E5 Under subsection 104-75(1), CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee. The time of the event is when a beneficiary becomes absolutely entitled to the asset according to subsection 104-75(2). If CGT event E5 happens, the trustee may make a capital gain or loss if the market value of the asset, at the time of the event, is more than its cost base or less than the asset's reduced cost base respectively (subsection 104-75(3)).
In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies. Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 explains the principles set out in the leading English trust law case of Saunders v Vautier (1841) 49 ER 282 in relation to 'absolutely entitled' as follows: ... if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway.
A Participant will become absolutely entitled to the Performance Rights in accordance with the Plan when those rights have vested and been exercised (if applicable) and the Restrictions in respect of the Shares have ceased or no longer apply. Subject to the Board's discretion to make a cash payment in lieu of allocating Shares and upon the cessation of all the Restrictions, the Participant has the right to request the Trustee to transfer the Shares into their name and deal with the Shares in their own will. At this point, the Participant will become absolutely entitled to the Shares as against the Trustee, and CGT event E5 happens pursuant to subsection 104-75(1). However, any capital gain or loss that a Trustee makes from CGT event E5 is disregarded if section 130-90 applies. Shares held to satisfy the future exercise of rights: subsection 130-90(1) Subsection 130-90(1) applies to disregard any capital gain or loss made by an employee share trust if all of the following apply: the CGT event is CGT event E5 or E7 (paragraph 130-90(1)(a)) the CGT event happens in relation to a share (paragraph 130-90(1)(b))
the beneficiary had acquired a beneficial interest in the share by exercising a right (paragraph 130-90(1)(c)) 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 (paragraph 130-90(1)(d)). Employee share trust In examining whether the requirements of an employee share trust in subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that are relevant. To qualify as an employee share trust, a trustee's activities must be limited to: obtaining shares or rights in a company (paragraph 130-85(4)(a)) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the ESS to employees, or to associates of employees, of the company or a subsidiary of the company (paragraph 130-85(4)(b) other activities that are merely incidental to the activities mentioned in paragraphs 130-85(4)(a) and (b) (paragraph 130-85(c)). The Trust Deed provides:
Without limiting the generality of this clause X, the Company and the Trustee agree that the Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the Tax Act. Paragraph 130-85(4)(a) is satisfied because the purpose of the Trust is to obtain shares in a company, namely Company A, for the benefit of Participants. Paragraph 130-85(4)(b) is satisfied because: the Trust has been established to acquire Shares and to allocate those Shares to Participants to satisfy Performance Rights acquired by Participants under the Plan which subsequently vest and, if applicable, are exercised (with each Performance Right constituting an ESS interest as defined in subsection 83A-10(1)) the Plan is an ESS within the meaning of subsection 83A-10(2) as it is a scheme under which rights to acquire Shares are provided to employees, or associates of employees in relation to the employees' employment.
In respect of paragraph 130-85(4)(c), the phrase 'merely incidental' takes its ordinary meaning, with further guidance drawn from the context and purpose of the legislation in which it appears. 'Merely incidental' is not defined in the legislation and has not been judicially considered in the context of subsection 130-85(4). The Macquarie Dictionary defines 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'. The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13 Income tax: what is an 'employee share trust'? Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental.
In the present case, the objects of the Trust are for the sole purpose of undertaking activities that are in line with the definition of an employee share trust under section 130-85(4), including paragraph 130-85(4)(c) as the other activities undertaken by the Trustee are merely incidental to managing the Plan. Paragraph 130-90(1)(a) CGT event E5 will apply under the terms of the Plan when the Participant becomes absolutely entitled to the Shares as against the Trustee. Therefore, paragraph 130-90(1)(a) will be satisfied. Paragraph 130-90(1)(b) Subsection 995-1(1) defines a share to mean a share in the capital of a company. A Share held by the Trustee and to which a Participant is entitled upon the vesting (or exercise if applicable) of a Performance Right is a share in the capital of a company. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share. Paragraph 130-90(1)(c) Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a Share by being taken to have exercised a Performance Right granted under the Plan once the Performance Right vests in accordance with the Plan and Offer.
Paragraph 130-90(1)(d) Subsection 83A-20(1) is the key condition that an ESS interest must meet for Subdivision 83A-B or 83A-C to apply. Subsection 83A-20(1) states: This Subdivision applies to an ESS interest if you acquire the interest under an employee share scheme at a discount. The Performance Right in the Plan is an 'ESS interest' under paragraph 83A-10(1)(b) because it is a beneficial interest in a right to acquire a share in Company A. Subsection 83A-10(2) defines an ESS as being a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment. The Plan is an ESS within the meaning of subsection 83A-10(2) because it is a scheme under which Performance Rights to acquire beneficial interests in shares in Company A are provided to employees in relation to the employee's employment. Each Performance Right is acquired at a discount. Therefore, Subdivision 83A-B or 83A-C applies to the Performance Rights granted under the Plans. Accordingly, all the conditions in subsection 130-90(1) have been satisfied. Subsection 130-90(2)
Subsection 130-90(1) does not apply if the beneficiary acquired the beneficial interest in the shares for more than its cost base in the hands of the employee share trust at the time the CGT event happens (subsection 130-90(2)). Provided a Participant does not acquire the beneficial interest in the Share for more than its cost base in the hands of the Trust at the time that CGT event E5 happens, subsection 130-90(1) will apply to disregard any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening.