1 Will any capital gain or loss that arises for the Trustee of the Trust, at the time an Employee becomes absolutely entitled to Shares under the Plan under CGT event E5 in section 104-75 of the Income Tax Assessment Act 1997 (ITAA 1997), be disregarded under section 130-90 of the ITAA 1997, if the Employee acquires the Shares for the same or less than the cost base of the Shares in the hands of the Trustee?
Yes
Company A is a public company listed on the Australian Securities Exchange and is the head company of a tax consolidated group (TCG). The Plan was adopted by Company A's Board. To assist with the effectiveness, structure and administration of the Plan, the Trust was established. The Trust is not part of the TCG. Performance Rights Plan The Plan allows Company A to reward their employees for their performance and align their interests with the interests of the Shareholders. The Plan allows Company A to grant Performance rights to Participants. Eligibility and invitation for Performance Rights In accordance with the Plan Rules, the Board, acting in its absolute discretion, may invite Employees to participate in the Plan by applying for Performance Rights. This invitation will be made on such terms and conditions as the Board decides and may include the following: • the number of Performance Rights for which that Employee may apply • the grant date and grant conditions • the performance hurdles and performance periods, and
• the exercise price (if any) applicable to the relevant Employee's Performance Rights. Notwithstanding the discretionary powers of the Board, they are precluded from inviting an Employee to apply for Performance Rights if the aggregate of: • the number of Shares that would be issued or transferred to the Employee on the exercise of those Performance Rights, and • the number of Shares held by the employee, is greater than or equal to five percent of the total number of issued Shares. Application and grant of Performance Rights On receipt of an invitation, an Employee may accept the offer by giving Company A an application by the final acceptance date. By accepting the offer the Employee agrees to be bound by the Plan Rules and the Constitution of Company A. Following receipt of a completed and signed application form, Company A will grant the Employee the relevant number of Performance Rights, subject to the terms and conditions set out in the invitation and the Plan Rules. Lapse of Performance Rights
Performance Rights Lapse where it is not exercised within the applicable Exercise Period, or where it is transferred or purported to have been transferred without the Board's prior written consent. Upon Lapse of a Performance Right under the Plan Rules, the Participant will have no further rights or entitlements in relation to that Performance Right. Exercise of Performance Rights A Performance Right (which has not lapsed under the Plan Rules) becomes a Qualifying Performance Right if: • the performance hurdles set out in the invitation have been met within the Performance Period, or • an Event, being: o a person together with his or her associates acquires more than 50% of the issued Shares in Company A, or o pursuant to applications under section 411 of the Corporations Act , the court orders a meeting to be held in relation to a proposed compromised or arrangement for the purpose of or in connection with reconstruction of the company or its amalgamation with another, or o Company A passes a resolution for voluntary winding up, or o an order is made for the compulsory winding up of Company A, or
• the Performance Rights otherwise become a Qualifying Performance Right under the Plan Rules. Qualifying Performance Rights may be exercised by: • lodging a notice of exercise, and • payment of the applicable exercise price (if any). Following the exercise of Qualifying Performance Rights, Company A must procure the transfer or issue (at its election) of Shares in accordance with the Plan. Shares transferred or issued on the exercise of Qualifying Performance Rights rank equally with all other Shares from the date of allocation. A Participant will be entitled to receive any dividends that have a Record Date for determining entitlements on and from the date of allocation. Restriction on disposal and risk of forfeiture of Shares The Shares may be subject to further restrictions before they can be disposed of by the Participant. The invitation sets out the performance hurdles and Performance Periods that apply. Company A may make such arrangements as it considers necessary to enforce the restriction on disposal of Shares.
A Share issued to a Participant on the exercise of a Performance Rights is issued to the Participant on the terms that it will be forfeited while the Shares are subject to the restriction on disposal upon the Participant: • perpetrating fraud as against Company A or the Company A Group • acting dishonestly to Company A or the Company A Group • committing a breach of the Participant's obligations to Company A or the Company A Group • becoming an employee of, or providing services to, an entity considered to be a competitor of Company A or the Company A Group, or • engaging in any activity considered by the Board to be detrimental to Company A or the Company A Group. Employee Share Trust Company A established the Trust for the purpose of holding shares for the benefit of Participants who are, or will become, the beneficial owners of Shares pursuant to a Company Plan. Operation of the Trust The Trust must be operated in accordance with the Trust Deed and the Plan Rules.
Company A must pay all Trust Expenses; however, the Plan Trustee may pay Trust Expenses from Cash Dividends received in relation to Unallocated Shares and interest earned on funds held in the Trust. Plan Trustee The Trustee has the power to administer, maintain and preserve the Trust in the performance of its obligations under the Trust Deed. These powers including entering into and executing all contracts, deeds and documents and doing all acts or things necessary for the purpose of giving effect to and carrying out the trusts, powers and discretions conferred on the Trustee by the Trust Deed. The Trustee is prevented from charging and is not entitled to receive from the Trust any fees, commission or other renumeration in respect of its office, but Company A may pay to the Trustee, from Company A's own resources, such fees as Company A and the Trustee agree from time to time. No Encumbrance may be granted over any assets of the Trust by any persons, including the Plan Trustee or any company in the Group. The Trust will be managed and administered so that it satisfies the definition of an employee share trust for the purposes of subsection 130-85(4) of the ITAA 1997.
How the Trust works Company A may provide funds to the Trustee to fund the acquisition of Shares for the purposes of a Company Plan. The Trustee must not accept any contribution of money or money's worth from Participants. The Trustee must, if directed by the Board, acquire: • Shares in the ordinary course of trading on the market conducted • Shares, at market value, by way of an off-market transaction, and/or • New Shared issued by Company A, for the purpose of enabling Company A to satisfy its obligations to allocate Shares under the terms of the Plan. Company A must provide the Trustee with any funds required in order to comply with its obligations to acquire Shares for the purpose of the Plan. Unless and until Shares are allocated to a Participant, the Trustee will hold those Shares on trust for benefit of Participants generally from time to time in accordance with the Trust Deed. Until the Shares are allocated, the Trustee may apply any capital receipts, dividends or other distributions received in respect of the Unallocated Share to purchase further Shares to be held on trust for the purposes of the Trust.
On receipt of a direction by the Board to do so, the Trustee must allocate to any Participant nominated by the Board, the number of Plan Shares specified by the Board, on the date specified by the Board. Plan Shares acquired in accordance with the Trust Deed and allocated to a Participant must, subject to the relevant Plan Rules, be held by the Trustee on the terms and conditions of the Trust Deed and on behalf of the relevant Participant, who is the beneficial owner of the Plan Shares. Nothing in the Trust Deed confers, or is intended to confer, on Company A any Encumbrance, proprietary right or proprietary interest in the Shares acquired by the Trustee. A Participant may forfeit any right or interest in their Allocated Plan Shares in accordance with the Plan Rules. Forfeited Shares (or the proceeds of sale of such Forfeited Shares) may be reallocated to other Participants for the benefit of the Plan. The Trustee must not pay the proceeds of sale of any Forfeited Shares or transfer the Forfeited Shares to a company the Company A Group. Dividends
Where the Trustee holds Allocated Plan Shares on a Participants behalf, the Participant is entitled to receive all Cash Dividends paid in respect of their Allocated Plan Shares, and the Trustee must pay those Cash Dividends to the Participant. Rights issues Participants are entitled to Share Rights which accrue to their Allocated Plan Shares held by the Trustee on their behalf. Where the Trustee acquires Shares pursuant to a Share Rights, the Trustee must transfer those Shares to the Participant. Where the Trustee sells the Share Rights, the Trustee must pay to Participant the proceeds of sale. Company A, or any company in the Company A Group, may not acquire any interest in the capital, or be entitled to any income, of the Trust.
All legislative references are to provisions of the ITAA 1997. Question 1 Detailed reasoning Under section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens. CGT Event E5 Under section subdivision 104-75(1), CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee. The time of the event is when a beneficiary becomes absolutely entitled to the asset according to subsection 104-75(2). If CGT event E5 happens, the trustee makes a capital gain or capital loss if the market value of the asset (at the time of the event) is more than its cost base or less than the asset's reduced cost base, respectively (subsection 104-75(3)). However, any capital gain or capital loss the trustee makes is disregarded for employee share trusts (Note in subjection 104-75(4)). Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997
explains the principles set out in the leading English trust law case of Saunders v Vautier (1841) 49 ER 282 in relation to 'absolutely entitled' as follows: ... if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway. In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies.
A Participant will become absolutely entitled to the Rights in accordance with the Plan when those Rights have vested, been exercised (if applicable) and the restrictions in respect of the Shares have ceased or no longer apply. Upon the cessation of all the restrictions, the Participant has the right to request the Trustee to transfer the Shares into their name and deal with the Shares at their own will. At this point, the Participant becomes absolutely entitled to the Shares as against the Trustee, and CGT event E5 happens pursuant to subsection 104-75(1). However, any capital gain or loss that a Trustee makes from CGT event E5 is disregarded if section 130-90 applies. Shares held to satisfy the future exercise of rights: subsection 130-90(1) Subsection 130-90(1) applies to disregard any capital gain or loss made by an employee share trust if all of the following apply: • the CGT event is CGT event E5 or E7 (paragraph 130-90(1)(a)) • the CGT event happens in relation to a share (paragraph 130-90(1)(b)) • the beneficiary had acquired a beneficial interest in the share by exercising a right, and (paragraph 130-90(1)(c))
• the beneficiary's beneficial interest in the right was an ESS interest to which Subdivision 83A-B or 83A-C (about employee share scheme) applied (paragraph 130-90(1)(d)). Employee share trust In examining whether the requirements of an employee share trust in subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that are relevant. To qualify as an employee share trust, a trustee's activities must be limited to: • obtaining shares or rights in a company (paragraph 130-85(4)(a)) • ensuring that ESS interests in the company that are beneficial interest in those shares or rights are provided under the ESS to employees, or to associates or employees, of the company or a subsidiary of the company (paragraph 130-85(4)(b)) • other activities that are merely incidental to the activities mentioned in paragraphs 130-85(4)(a) and (b) (paragraph 130-85(c)). The Trust Deed provides:
Despite any other clause in this deed, the Company and the Plan Trustee agree that the Trust will be managed and administered so that it satisfies the definition of "employee share trust" for the purposes of section 130-85(4) of the Tax Act. Paragraph 130-85(4)(a) is satisfied because the purpose of the Trust is to acquire, hold and transfer shares in a company, namely Company A. Paragraph 130-85(4)(b) is satisfied because: • the Trust has been established to acquire Shares and to allocate those Shares to Participants to satisfy Performance Rights acquired by Participants under the Plan which subsequently vest and, if applicable, exercised (with each Right constituting an ESS interest as defined in subsection 83A-10(1)) • the Plan is an ESS within the meaning of subsection 83A-10(2) as it is a scheme under which rights to acquire Shares are provided to employees, or associates of employees in relation to the employees' employment.
In respect of paragraph 130-85(4)(c), the phrase 'merely incidental' takes its ordinary meaning, with further guidance drawn from the context and purpose of the legislation in which it appears. 'Merely incidental' is not defined in the legislation and has not been judicially considered in the context of subsection 130-85(4). The Macquarie Dictionary defines 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'. The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Tax Determination TD 2019/13 Income tax: what is an 'employee share trust'? Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental.
In the present case, the Trust Deed provides that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of section 130-85(4), including paragraph 130-85(4)(c) as the other activities undertaken by the Trustee are merely incidental to managing the Plan. Paragraph 130-90(1)(a) CGT event E5 will apply under the terms of the Plan when the Participant becomes absolutely entitled to the Shares as against the Trustee. Therefore, paragraph 130-90(1)(a) will be satisfied. Paragraph 130-90(1)(b) Subsection 995-1(1) defines a share to mean a share in the capital of a company. A Share held by the Trustee and to which a Participant is entitled upon the vesting (or exercised if applicable of a Share is a share in the capital of a company. Accordingly, paragraph 130-90(1)(b) is satisfied as CGT event E5 happens in relation to a share. Paragraph 130-90(1)(c) Paragraph 130-90(1)(c) is satisfied as a Participant will have acquired a beneficial interest in a Share by the vesting of a Performance Right granted under the Plan. Paragraph 130-90(1)(d)
Subsection 83A-20(1) is the key condition that an ESS interest must meet for Subdivision 83A-B or 83A-C to apply. Subsection 83A-20(1) states: This Subdivision applies to an ESS interest if you acquire the interest under an employee share scheme at a discount. A Performance Right in the Plan is an 'ESS interest' under paragraph 83A-10(1)(b) as it is a beneficial interest in right to acquire a share in Company A. Subsection 83A-10(2) defines an ESS as being a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employees' employment. The Plan is an ESS within the meaning of subsection 83A-10(2) because it is a scheme under which Performance Rights to acquire beneficial interests in shares in Company A are provided to employees in relation to the employee's employment. Each Performance Right is acquired for no cost. As the Participant acquires the Performance Right for no cost, the ESS interest is acquired by the Participant at a discount. Therefore, Subdivision 83A-B or 83A-C applies to the Performance Rights granted under the Plan.
Accordingly, all the conditions in subsection 130-90(1) have been satisfied. Subsection 130-90(2) Subsection 130-90(1A) and 130-90(1) do not apply if the beneficiary acquired the beneficial interest in the shares for more than its cost base in the hands of the employee share trust at the time the CGT event happens (subsection 130-90(2)). Provided that a Participant does not acquire the beneficial interest in the Share for more than its cost base in the hands of the Trust at the time that CGT event E5 happens, subsection 130-90(1) will apply to disregard any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening.