Employee share options: assessability of an unrealised gain by an Australian resident taxpayer from share options granted to the taxpayer when they were working in the UK

Is an unrealised gain accrued from share options granted under an employee share scheme assessable to the taxpayer under subsection 6-10(4) of the Income Tax Assessment Act 1997 (ITAA 1997), where the options were granted to the taxpayer when they were a resident of the United Kingdom (UK)?

Yes. A resident taxpayer's assessable income includes an unrealised gain accrued on share options granted under an employee share scheme under subsection 6-10(4) of the ITAA 1997 where the options were granted to the taxpayer when they were a resident of the UK.

While the taxpayer was a resident of the UK, the taxpayer was granted employee share options in a foreign company subject to certain conditions. The taxpayer satisfied these conditions while working in the UK.

These options were granted as a reward for service which was carried out entirely in the UK.

The taxpayer subsequently relocated to Australia and became an Australian resident.

The taxpayer has not exercised the options.

Through the share options, the taxpayer held an interest in a foreign investment fund (FIF) under subsection 483(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

The options appreciated in value while the taxpayer was an Australian resident and none of the FIF exemptions in Part XI of the ITAA 1936 applied.

Subsection 6-10(4) of the ITAA 1997 provides that the assessable income of an Australian resident includes statutory income from all sources, whether in or out of Australia.

Subsection 6-15(2) of the ITAA 1997 provides that an amount is not assessable if it is exempt income. Foreign employment income may be exempt under section 23AG of the ITAA 1936 where the income constitutes foreign earnings. The unrealised gain from the options is capital in nature and therefore does not constitute 'foreign earnings' within the meaning of subsection 23AG(7) of the ITAA 1936. (see FC of T v. McArdle 89 ATC 4051; (1988) 19 ATR 1901).

Subsection 6-10(2) of the ITAA 1997 provides that statutory income are amounts that are not ordinary income, but are included in the taxpayer's assessable income by provisions about assessable income.

Section 10-5 of the ITAA 1997 lists those provisions about assessable income which are statutory income. Included in this list are sections 139 to 139GH (Division 13A) of the ITAA 1936 dealing with employee share acquisition schemes and section 529 of the ITAA 1936 dealing with FIF income accrued to a taxpayer.

The employee share acquisition scheme provisions include certain discounts given on a share or right in assessable income. In this case, the discount is not included in assessable income under Division 13A of the ITAA 1936 as the taxpayer was a non-resident for the entire period of foreign service for which discount was given (subsection 139B(1A) of the ITAA 1936).

As the taxpayer held an interest in the FIF and none of the FIF exemptions apply, FIF income that accrued during the time the taxpayer was an Australian resident is assessable income (sections 485 and 529 of the ITAA 1936).

In determining liability to Australian tax, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953 (Agreements Act). Schedule 1 to the Agreements Act contains the tax treaty between Australia and the UK (UK Convention) and the UK Notes.

Article 14 of the UK Convention provides that salaries, wages and other similar remuneration derived by a resident of one of the Contracting States in respect of employment exercised in the other State may be taxed in that other State.

The employee share options are 'other similar remuneration' for the purposes of Article 14 of the UK Convention under 8(a) of the UK Notes.

It is accepted that the employment that gives rise to the gain on the employee share option is entirely carried out in the UK and, accordingly, the UK has source taxing rights under Article 14.

However, the Article does not prevent the country of residence of the taxpayer from also taxing the gain. That much is clear from the words of the Article which prima facie , only permits the country of residence of the taxpayer to tax the remuneration, unless the employment is exercised in the other country, in which case the remuneration may be taxed by that other country.

The words 'may be taxed' in this context do not mean that the other country is the only one entitled to tax that income. Under international tax law principles, the residence country (in this case Australia) may also continue to tax such remuneration (see paragraph 23 of Taxation Ruling TR 2001/13). However, double tax is avoided by the residence country providing appropriate relief.

Accordingly, there is nothing in Article 14 or any other part of the UK Convention that prevents Australia from taxing the gain accrued on the options granted under the employee share scheme in accordance with its normal domestic tax law provisions.

Consequently, the FIF income accrued on the employee share options while the taxpayer is an Australian resident is taken into account in calculating the taxpayer's assessable income.