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Will the accounting entries used by employer Company XYZ (XYZ), for the provision of shares in their Employee Share Scheme (ESS), result in the application of the share capital tainting provisions in Division 197 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. There is no transfer into the share capital account as required for the application of subsection 197-5(1) of the ITAA 1997. Therefore, there is no share capital tainting.

XYZ are required to account for shares granted under an ESS by virtue of Accounting Standard AASB 2 Share-based payment (AASB2). Once the shares are granted to the employees the following amounts are accrued over the vesting period: Share based expense component DR Share based expense (P&L) $100 CR Equity based payment reserve $100

Share based expense component

DR | Share based expense (P&L) | $100

CR | Equity based payment reserve | $100

Once the shares have vested in the employee the company makes the following accounting entries: Vesting Date - Reduction in reserve DR Equity based payment reserve $100 CR Share based expense (P&L) $100 Vesting Date - Recognition of vested shares DR Share based expense (P&L) $100 CR Paid up capital $100

Vesting Date - Reduction in reserve

DR | Equity based payment reserve | $100

CR | Share based expense (P&L) | $100

Vesting Date - Recognition of vested shares

DR | Share based expense (P&L) | $100

CR | Paid up capital | $100

There are two parts to the accounting entries for the ESS. These are: • The company accounts for the potential impact of the share based payments prior to the shares vesting in the employees. • The company accounts for the actual impact of the share based payments when the shares are vested in the employees.

These two parts will be considered separately.

Prior to vesting date

XYZ accounts for the accrual of the share based expense in respect of the ESS in accordance with AASB2. The accounts are adjusted at various times, prior to the vesting of shares to an employee, to reflect the estimation of the share based expense that will be incurred. This is accomplished by: • Debit 'Share based expense' • Credit 'Equity based payment reserve'.

The 'Equity based payment reserve' account is not a share capital account. A share capital account is defined in section 975-300 of the ITAA 1997 as 'an account that the company keeps of its share capital' and the first amount credited to the account was an amount of share capital. Share capital is not defined in the ITAA 1997. However, the Explanatory Memorandum (EM) accompanying Taxation Laws Amendment (2006 Measures No. 3) Bill 2006 provides that 'share capital includes amounts received by a company in consideration for the issue of shares.'

The 'Equity based payment reserve' account does not meet the criteria of a share capital account because: • It is not an account which is used to keep account of the company's share capital. • The first amount credited to the account was not share capital. The first amount credited to the account was an amount which recognised the potential value of the shares provided to the employees and was not an amount received for the consideration of an issue of shares.

Since the 'Equity based payment reserve' account is not a share capital account, subsection 197-5(1) of the ITAA 1997 does not apply to transfers into the account.

Upon vesting of the shares in the employees, the accounting entries that recognised the actual share expense accrued at the vesting date are reversed and new entries record the actual issue of shares by increasing the 'Share based expense' account and increasing the 'Share capital' account.

The accounting transactions which occur on the actual issue of shares to XYZ's employees are not a transfer for the purposes of subsection 197-5(1) of the ITAA 1997. This is because, as stated in the EM: 4.12 An amount is transferred from one account to another where that amount is moved from one account to another. This, in turn, requires the balance of the first account to be reduced, while the balance of the second account is increased by the same amount.

Since the entries are not a transfer, subsection 197-5(1) of the ITAA 1997 does not apply. Therefore there is no share capital tainting.