Issue
Did the transfer of an amount from the option premium reserve of a company to its share capital account "taint" the share capital account under section 160ARDM of the Income Tax Assessment Act 1936 (ITAA 1936)?
Decision
Yes, the transfer tainted the company's share capital account under section 160ARDM of the ITAA 1936.
Facts
The company issued options to all its shareholders at an issue price of x per option (the option premium). The options were exercisable several years later at y per option.
The total amount of option premiums received was credited to the company's option premium reserve.
Subsequently, all the options were exercised by the exercise date. At this time the total of the exercise amounts received, plus the above option premium total, were credited to the company's share capital account.
Reasons for Decision
Tainted share capital is defined in subsection 160ARDM(1) of the ITAA 1936. Under this provision a company's share capital account is "tainted " if the company transfers an amount to its share capital account from any of its other accounts. Certain exceptions to this definition are contained in subsection 160ARDM(2) of the ITAA 1936, including an amount that can be identified in the books of the company as an amount of share capital at all times before it was credited share capital account.
Unless the option premium reserve can be characterised as a "share capital account", or the option premium amount credited can be characterised as share capital at all times before it was credited to the share capital account, the share capital account has been tainted by the above transfer.
The characterisation of the option premium account must be done both before and after the exercise of the options. The nature of the amount must be determined as a matter of law, and not be based on the accounting treatment, as this is at best only a help in characterising the legal situation.
The fact that all the options were exercised is essentially irrelevant to the characterisation process as it only goes to the post exercise position. Prior to the exercise of the option, it is legally impossible to determine how many, if any, of the options will actually be exercised, as this is at the discretion of the holders of the options.
Therefore, prior to the exercise of the option, the option premium does not represent share capital to the company. It is only the exercise of the option that may result in the premium being subsequently treated as share capital.
It is concluded that the transfer by the company of the option premium reserve to its share capital account did taint the latter. This is based on the view that the option premiums are not share capital at all times before the transfer took place.