Employee Share Trust: sole activities test

When will a trust satisfy the sole activities test for the purposes of subsection 139C(5) of the Income Tax Assessment Act 1936 (ITAA 1936) and be an 'employee share trust' as defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

A trust will satisfy the sole activities test for the purposes of subsection 139C(5) of the ITAA 1936 and be an 'employee share trust' as defined in subsection 995-1(1) of the ITAA 1997, where the activities of the trustee of the trust are limited to managing an employee share plan (ESP) and the general administration of the trust.

An employer establishes an ESP, which is operated through a trust (the ESP trust).

The employer makes periodic payments to the ESP trust.

The payments are accumulated in the ESP trust's bank account and periodically applied to acquire shares in the employer company, either on market or from new issues.

On acquisition, shares are held by the trustee of the ESP trust for the benefit of participating employees.

After three years, participating employees become absolutely entitled to shares held by the trustee of the ESP trust.

Upon becoming absolutely entitled, participating employees can call on the trustee of the ESP trust to either: • transfer the shares to them; or • sell the shares on their behalf and give them the proceeds net of selling costs.

Any dividends paid in respect of shares held by the trustee, may be distributed to participating employees or accumulated in the ESP trust.

Shares acquired under the ESP may be forfeited.

The default beneficiary of the ESP trust is a nominated charity.

The ESP trust does not engage: • in activities unrelated to obtaining shares and providing those shares to employees; or • in activities which result in employees being provided with additional benefits.

Where, pursuant to subsection 139C(5) of the ITAA 1936, the sole activities of a trustee of a trust are obtaining shares, or rights to acquire shares, and providing those shares or rights to employees of a company or to associates of those employees, the trust will be an 'employee share trust' as defined in subsection 995-1(1) of the ITAA 1997.

Where an ESP is operated through a trust, the activities of the trustee of the trust in obtaining, holding and providing shares or rights will necessarily involve a range of activities that are a function of managing the ESP and administering the trust.

The Commissioner considers that activities that are a necessary function of managing an ESP and administering a trust will satisfy the sole activities test. Such activities include: • 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 trustee, and the retention of those dividends or their distribution to employee beneficiaries of the trust (unless to a default beneficiary - see below); • dealing with shares forfeited under an ESP including the sale of forfeited shares; • the transfer of shares to employee beneficiaries or the transfer to them of the proceeds from the sale of those shares on their behalf, at the time an employee calls on the trustee to either transfer or sell the shares; and • 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.

Activities that the Commissioner considers will not satisfy the sole activities test include: • any activities that are not a necessary function of managing an ESP or administering a trust; and • any activities which result in employees being provided with additional benefits (for example, the provision of a loan to acquire shares).

Thus, as the activities of the ESP trust are limited to managing the ESP and the general administration of the trust, it will satisfy the sole activities test and be an employee share trust. 1