Issue
Is any of the discount on the exercise of share rights acquired under an employee share scheme included in the assessable income of the taxpayer, where the taxpayer is a resident of the United States of America (US) at the cessation time but was an Australian resident working in and out of Australia during the vesting period for the rights?
Decision
Yes. The portion of the discount that is attributable to employment exercised in Australia may be taxed in Australia under Article 15 of the Convention between Australia and the US (US Convention) contained in Schedule 2 to the International Tax Agreements Act 1953 (Agreements Act) and is included in the taxpayer's income under paragraph 6-10(5)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) in the year of income in which the cessation time occurs.
Facts
The taxpayer, a company executive, acquired rights to shares in their Australian resident employer under an employee share scheme, before 26 June 2005, while they were an Australian resident.
The rights were acquired under an employee share scheme for the purposes of Division 13A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936). They are qualifying rights within the meaning of section 139CD of the ITAA 1936 and are not covered by an election made under section 139E of the ITAA 1936.
Division 13A of Part III of the ITAA 1936 is not a provision that includes amounts in the assessable income of a foreign resident on a basis other than having an Australian source for the purposes of paragraph 6-10(5)(b) of the ITAA 1997.
The rights vest and become exercisable if a performance condition is met. The performance of the company is measured over a three year performance period which starts one month before the rights were acquired by the taxpayer. The performance of the company is measured against the performance of other comparable companies over the same period. Rights are only granted to persons who were employed with the company from the start of the performance period.
The rights lapse if the employee ceases employment before the rights vest. However, in some circumstances, the employer may allow the rights of a ceased employee to vest subject to the satisfaction of the performance condition.
During the performance period, the taxpayer worked 220 days each year (for a total of 660 days). The taxpayer was required to engage in employment activities in the US and other countries during the performance period. The taxpayer worked in Australia 500 days and worked in the US and in other countries 160 days.
After the rights had vested, the taxpayer moved to the US and became a foreign resident for Australian tax purposes and a resident of the US for the purposes of the US Convention. The taxpayer continued to work for the company in the US.
The taxpayer exercised the rights after moving to the US. The cessation time for the rights occurred when the rights were exercised under section 139CB of the ITAA 1936.
Reasons for Decision
Subsection 6-10(5) of the ITAA 1997 provides that a foreign resident taxpayer's assessable income includes statutory income from all Australian sources and other statutory income included by a provision on some basis other than having an Australian source.
Section 10-5 of the ITAA 1997 lists those provisions about assessable income.
Included in this list are sections 139 to 139GH (contained in Division 13A of Part III) of the ITAA 1936 which provides for the taxation of shares and rights acquired under employee share schemes.
Pursuant to subsection 139B(1) of the ITAA 1936, the discount given in relation to a share or right acquired under an employee share scheme is included in the taxpayer's assessable income. If the share or right is a qualifying share or right and is not covered by an election made under section 139E of the ITAA 1936, the discount is included in the year of income in which the cessation time occurs under subsection 139B(3) of the ITAA 1936.
The discount is statutory income to be included in the taxpayer's assessable income as determined under Division 13A of Part III of the ITAA 1936.
At the cessation time, the taxpayer is a foreign resident. Therefore, the taxpayer's assessable income includes the discount on the rights, if it has an Australian source (see paragraph 6-10(5)(a) of the ITAA 1997).
In determining liability to tax in Australia, it is necessary to consider any applicable tax treaty contained in the Agreements Act. Section 4 of the Agreements Act incorporates the ITAA 1936 and the ITAA 1997 into the Agreements Act so that all those Acts are read as one. The Agreements Act effectively prevails over the ITAA 1936 and the ITAA 1997 where there are inconsistent provisions (except for limited situations not relevant for present purposes).
Article 15(1) of the US Convention provides that salaries, wages and other similar remuneration derived by an individual who is a resident of the US in respect of an employment or in respect of services performed as a director of a company shall be taxable only in the US unless the employment is exercised or the services performed in Australia. If the employment is exercised or the services performed in Australia, such remuneration as is derived from that exercise or performance may also be taxed in Australia.
The Commissioner's view expressed at paragraph 104 of Taxation Ruling TR 2001/13 is that the OECD Model Tax Convention and the associated commentaries (the OECD Commentary) may be considered in interpreting tax treaties.
Paragraph 2.1 of the OECD Commentary on Article 15 states that member countries have generally understood the term "salaries, wages and other similar remuneration" to include benefits in kind (e.g. stock-options) received in respect of an employment. Paragraph 2.2 goes on to explain that the condition provided by the Article for taxation by the State of source is that the salaries, wages or other similar remuneration be derived from the exercise of employment in that State . This applies regardless of when that income may be paid to, credited to or otherwise definitively acquired by the employee. (emphasis added)
The treatment of employee stock options is discussed in detail in paragraph 12 of the OECD Commentary, and introduces the topic by commenting that different country rules for taxing employee stock-options create particular problems, which is largely due to the fact that stock-options are often taxed at a time that is different from the time when the employment services that are remunerated through these options are rendered.
The OECD Commentary provides that Article 15 will be interpreted to allow the State of source to tax the benefits accruing up to the time the option is exercised, sold or otherwise alienated, but it is left to the Contracting State to decide how to tax such benefits (paragraph 12.4). Further, it states at paragraph 12.6: The determination of whether and to what extent an employee stock-option is derived from employment exercised in a particular State must be done in each case on the basis of all the relevant facts and circumstances, including the contractual conditions associated with that option ...
The OECD Commentary notes two general principles for the purposes of making such a determination: • an option should not be considered to relate to any services rendered after the period of employment that is required as a condition for the employee to acquire the right to exercise the option (see paragraph 12.7). • options should only be considered to relate to services rendered before the time when it is granted to the extent that such grant is intended to reward the provision of services for a specific period (see paragraph 12.11).
Where a period of employment is generally required to obtain the right to exercise the option but such requirement is not applied in certain circumstances, such as retirement, redundancy etc, the benefit of the stock option should only relate to the period of service actually performed (see paragraph 12.12).
Having regard to the terms and conditions associated with the taxpayer's rights in this case, the benefit should be considered to relate to the employment exercised during the performance period that gives rise to the vesting of the rights (except in cases where a taxpayer has ceased employment prior to the end of the performance period and has retained the rights, in which case the relevant period would end when the taxpayer ceased employment).
The OECD Commentary provides that where the benefit of an option is derived from employment rendered in more than one State the employment benefit attributable to the stock option should be considered to be derived from a particular country in proportion of the number of days during which the employment has been exercised in that country to the total number of days during which the employment services from which the stock option is derived have been exercised (see paragraph 12.14).
The OECD Commentary, specifically related to employee stock options was inserted in the OECD Model Commentary in 2005 after a review by the OECD Committee on Fiscal Affairs produced several documents (see 'Other References' below for details) which are considered relevant to an analysis of the Commentary. These documents provide further background and detail to the OECD Commentary and the examples illustrate that the OECD consider the benefit derived from employment is calculated based on working days.
While not binding, the OECD Model and Commentaries create a general or 'quasi-political', rather than 'legal', expectation that OECD Members will basically comply (see Taxation Ruling TR 2001/13, at paragraph 101). Accordingly, the Commissioner sees no reason to depart from the method put forward by the OECD.
Therefore, for the purposes of calculating the amount that Australia can include in the taxpayer's assessable income, the discount that is determined under either subsection 139CC(3) or subsection 139CC(4) of the ITAA 1936 needs to be apportioned for the period that is attributable to the employment exercised in Australia. The apportionment is calculated by the number of days that the taxpayer worked in Australia for their employer during the performance period, to the total number of days worked for their employer during the performance period.
In this case, the relevant portion of the discount that is attributable to employment exercised in Australia is determined by multiplying the discount by 500/660.
Article 15(2) of the US Convention provides that, notwithstanding the provisions of Article 15(1), remuneration derived by an individual who is resident of the US in respect of an employment exercised in Australia or in respect of services performed in Australia as a director of a company shall be taxable only in the US if: (a) the recipient is present in Australia for a period or periods not exceeding in the aggregate 183 days in the taxable year or year of income of Australia; (b) the remuneration is paid by, or on behalf of, an employer or company who is not a resident of Australia; and (c) the remuneration is not deductible in determining taxable profits of a permanent establishment, a fixed base or a trade or business which the employer or company has in Australia.
The remuneration was paid to the taxpayer by an Australian resident company, therefore, Article 15(2)(b) is not satisfied. Accordingly, Article 15(2) of the US Convention does not prevent Australia from taxing a portion of the benefit from the rights.
Where the US Convention gives Australia the right to tax an amount derived by a resident of the US, Article 27(1)(a) will deem the amount to have an Australian source for the purposes of the ITAA 1936 and ITAA 1997.
Accordingly, the portion of the discount that is attributable to employment exercised in Australia may be taxed in Australia and is included in the taxpayer's assessable income under paragraph 6-10(5)(a) of the ITAA 1997. Note: For rights acquired on or after 26 June 2005 the amendments made by the New International Tax Arrangements (Foreign-Owned Branches and Other Measures) Act 2005 (No 64 of 2005) will need to be considered.